By now, the markets have passed the point of no return. Reddit users and investment apps have disrupted the reign of short selling hedge funds. While in the short-term, this has meant that the a few arrogant and irresponsible financial firms have gotten their comeuppance, the long-term implications are still unknown. At a minimum, the impenetrable fog of war that accompanies high-end trading has been demystified. Now, through social media, YouTube tutorials, and Wikipedia, suddenly anyone can be an expert in derivatives, interest rates, and the push and pull of bull and bear markets. The deference to experts that defined the 2008 crash—that only those responsible for the calamity had the technical knowledge to fix it—has vanished.
All this is good, but it does not deal with high finance trading’s fundamental conceit. In Capital, Marx famously noted that “Capital is dead labor, which, vampire-like, lives on by sucking living labor and lives the more, the more labor it sucks.” The metaphor of capitalists as vampires is a powerful one. It conjures up the parasitic nature of profit-seekers. However, short selling hedge funds are more than mere parasites. They are essentially economic death cults. With sadistic glee, they drive companies into bankruptcy with a form of complicated rent-seeking. For years, their ability to create their own markets and then destroy them was unchallenged. Now, a decentralized network of small retail investors on r/wallstreetbets—led by the user DeepFuckingValue—pushed back. Still, a pushback is not the same as a transformed relationship. The inherently destructive nature of short selling will not go away without fundamental shifts in America’s financial regulatory system.
For those unaware, a short is when investors “borrow” stocks from brokers, then sell those “borrowed” stocks on the market. Because the stocks are “borrowed,” investors must eventually repurchase the stocks and return them to the brokers. Since the investors do not own the “borrowed” stocks, the initial selling of them presents no risk. The risk is only involved when the investors must repurchase them to return to the brokers. In a short market, investors make a profit by inverting the usual Wall Street credo of “buying low and selling high.” Instead, they sell high, then buy back low, and the difference between those two numbers is their margin of profit. Meanwhile, brokers are happy to “borrow” out their stock because they can charge interest and transaction fees on their “borrowed” stocks.
Major financial firms will only short stocks that appear to be depreciating. However, and highly problematic for companies, short markets can turn appearance into reality regardless of a company’s fundamentals. Economic demand is as much a psychological phenomenon as it is a metabolic one. If enough people believe a commodity is valuable, it becomes so in the market regardless of its actual utility. The inverse is just as true; if enough people believe that a commodity is worthless, it will lose value even if it contains meaningful utility.
During the Great Depression, short sellers were blamed for contributing to the Wall Street crash of 1929. In the aftermath, short sellers were regulated, including banning the practice during a downward market. However, by the mid-2000s, these regulations were rolled back or interpreted by the Security and Exchange Commission so that they were rendered effectively meaningless. Since that time, short sellers have taken full advantage of pregnable companies. By constantly shorting stocks, sellers not only respond to market signals but create them. When the market is flooded with shorted stocks, those stocks’ prices go down because everyone is trying to sell. Even if investors rally to push back on the shorts, major financial firms can double down. This has been devastating for traditional brick-and-mortar stores. The declining value of their stock limits their access to credit. No one wants to lend to a company that appears to be falling apart. In due course, the constant shorting leads to a self-fulfilling prophecy. Major financial firms short the stocks of struggling companies; the shorting reduces the value of those stocks; the poorly valued stocks make it difficult for the companies to access credit; eventually, companies whose stock is constantly shorted end up going bankrupt. The situation is utterly ruinous for companies—especially the workers who are laid off in the process—but can create significant windfalls for hedge funds.
Shorting extracts capital from companies rather than investing it. It does not lead to the creation of any new goods or services but simply takes advantage of changes in the market. For this reason, economists have referred to contemporary modern hedge funds as “rent seekers,” who, like the landed aristocracy of feudal Europe, played no role in the actual production of goods and services but extracted wealth based on their noble title alone. Undoubtedly, Marx leaned into this metaphor when describing capital’s vampiric qualities. According to Marx, with capitalism’s development, the new bloodsuckers were not another generation of the landed aristocracy, but the bourgeoisie. Profit-seekers had overthrown the rent-seekers, and unlike the languorous nobility, they threw the global economy into a brave new world of rapacious production. Through opening new markets, producing new goods and services, the bourgeoisie could suck value from the working-class without returning to a time of stifling economic development.
Problematically, the age of rent-seeking appears to have come back with a vengeance. Modern financial firms not only produce nearly nothing for the economy, but actively destroy it. Europe’s medieval aristocracy may have resisted change and innovation, but even they had an incentive to see their fiefdoms prosper. Parasitic rent-seekers damage their host, but they still want them to be healthy to continue their extraction. In contrast, short sellers have every incentive to see their host die as quickly as possible. In all its perversity, contemporary capitalism has created an entire economic sector whose profitability is dependent on cannibalizing the American economy. There are no Schumpeterian musings on the “creative destruction” of new markets or romanticism that a “rising tide lifts all boats” for the hedge funds. Instead, there is nothing but the harsh reality of dog-eat-dog competition; it is Mad Max but with MBAs. Hedge funds bet on companies failing, then in a relentless pursuit to make sure the bet pays, do everything possible to rig the market to make it so.
What has made the r/wallstreetbets phenomenon so remarkable is that, for a brief moment, it appeared that their standard rigging failed. As usual, GameStop was shorted, but anyone who investigated the company’s fundamentals knew that the situation was not nearly as dire as the hedge funds were making it look. Investors rallied to GameStop’s defense, and the short sellers attempted to bury them in the market. Normally, it would end there, but this time the rally was not only fought off but surpassed everyone’s expectations. The stock shot to the stratosphere. To be clear, the small retail traders alone did not upturn the order on the short sellers. Most modern day investing occurs through advanced algorithms shepherded by institutional investors. Investors’ computer programs most likely recognized the GameStop buying trend, then compounded it by jumping on the bandwagon. What the retail traders hanging out on r/wallstreetbets did was reach a critical mass to force investors’ algorithms to take note. Once they did, it was all over for the short sellers. The tables completely turned. Instead of the brick-and-mortar store being forced into an early bankruptcy, huge hedge funds like Melvin Capital were forced to the brink of insolvency. They had to beg for an emergency bailout from even larger financial fish in the sea and desperately pleaded with regulators to protect them from the nefarious market manipulations of small retail investors.
The irony was richer than Jeff Bezo’s fortune. For years, financial firms had been doing all they could to weaken the Security and Exchange Commission. Their practice of piling on a downward trending stock to profit from bankruptcies—which for decades was illegal because it contributed to the Great Depression—was dismissed as part of the market’s natural whims. Now that technology had given everyday people access to trading, allowing millions of small retail investors to act with the might of a single firm, the hedge funds were running scared. Robinhood, the investment app largely responsible for the whole situation, naturally came to their defense.
Robinhood’s slogan to “democratize finance” was always a marketing gimmick. The company could offer free trading services because it makes its money selling user data to financial firms. With millions of new data points from small retail investors, Robinhood promised the big players that their information would lead to the creation of even more sophisticated algorithms. When it realized its creation would put its business model at risk by potentially bankrupting hedge funds, Robin Hood shutdown the buying of stocks from GameStop and restricted the buying of stocks from other brick-and-mortar stores. Users could sell their shares, helping to decrease those stocks’ value, but they could not buy them. The Security and Exchange Commission has rules against such blatant market manipulations. But again, according to the Gospel of Wall Street, those rules are not supposed to apply to institutional investors. Since Robinhood was protecting those institutions, it is highly unlikely that they will be criminally prosecuted.
Robinhood of course, denies such willful manipulations. It claims that it was only and always looking out for the best interest of its traders. The claims are absurd. The entire app was designed using Silicon Valley’s playbook on “engagement.” Like with modern social media, Robinhood’s app intentionally has game-like qualities to entice inexperienced investors to make risky trades. More so than any other retail trade app, Robinhood’s users tended to trade in the riskiest products and at the fastest pace. Plus, the risk is not only a matter of tricking retail investors into gambling away their life savings while playing Robinhood’s version of Candy Crush. In December of 2020, Robinhood paid a $65 million settlement with the Security and Exchange Commission for misleading users. For years, the company had taken payments from high-speed traders for the right to execute users’ trades. These high-speed traders are from institutional investors. Naturally, they would use the trades from small retail investors to strengthen their own position in the market, often to the detriment of Robinhood’s users. Unsurprisingly, the Security and Exchange Commission’s investigation found that people who traded with Robinhood were far worse off than compared to their rivals.
By restricting its users’ trades, Robinhood blew up its business model; its CEO does not seem to care. It saved its major clients and its connections to financial firms, specifically Citadel. In all likelihood, with increasing competition and a flood of civil lawsuits coming, Robinhood will leave the investor app market and pursue other business. Yes, their brand was hurt and will probably pay out several settlements, but there is no reason for them to come back stronger with a new gimmick. The tables were turned on the rigging, but that does not mean that the rigging has gone away.
Because the rigging has not gone away, the question on everyone’s mind is how will the major financial firms adapt to a financial ecosystem where small retail investors can exercise some degree of power? There is little doubt that everyone involved in the short markets is now skittish, but a hedge fund’s strategic retreat does not necessarily mean the working-class gains. While many small retail investors managed to get rich by squeezing the GameStop short, those that got into the market late will likely suffer heavy losses. Additionally, it is unknown how many institutional investors supported the rally. In the end, the wealth transfer might be more lateral than downward. Nevertheless, the r/wallstreetbets phenomenon has pulled the curtain on finance’s most parasitic and vile sector. In that regard, it has exposed America’s financial oligarchs for what they are: a malignant conspiracy of rent-seekers who derive profits from forcing others to suffer.