This is where we are in the story of GameStop. At least one hedge fund was committed to delivering shares of this company at a few bucks per share, but now the shares are many times higher and becoming something close to unobtanium. The result is the hedge fund, Melvin Capital, has been wiped out. They had to liquidate all of their other holdings to cover their short position. Even with help from other hedge funds, they will file for bankruptcy next week.
By itself, this is an amusing story, but hardly big news. But, no one really knows if this is an isolated situation. The insiders were targeting a number of companies, hoping to jawbone down their share prices while they aggressively shorted those stocks. It is not unrealistic to think there are dozens of hedge funds out there working this grift, so this could be the tip of a much larger iceberg. The movie chain AMC Entertainment is seeing its stock follow GameStop for the same reasons.
Now, this may not sound very interesting, but even in today’s world of magical finance, math still matters. If you have to raise cash to cover your bad bet on a naked short sell, it means selling something to raise the cash. Hedge funds tend not to sell their furniture or expensive sports cars, so they sell their good holdings. Usually, they sell their best holdings, as they are the most liquid. If enough hedge funds are forced to liquidate their good holdings, those holdings will decline in price.
This is the great fear in these situations. No one knows how much exposure there is to this bad trade. That is why the general market will decline, as the robots that do almost all of the trading move into the safest of safe harbors. This, in turn, can result in selling of otherwise solid assets, simply because no one wants to be holding an asset in decline, especially in a declining market. Given the ridiculously inflated share values, this short squeeze could signal a very big correction.
It could also be a big nothing or it could mean the government comes in and makes everything right with bailouts or new rules to prevent further erosion. That really is the story here with GameStop. This revolt of small retail investors against this hedge fund is about the larger issue. The marketplace has been perverted by insiders with special access to both market makers and market regulators. The financial markets are no longer tethered to economic reality. It is just a giant bust out.
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you should go check out that subreddit.
