The recent GameStop story coming out of the U.S. pushed arcane financial dealings into a prominence they rarely enjoy. The public was introduced to weird concepts such as “short selling and short squeezes” and, for a while, they are likely to be part of many Zoom conversations. Not least because, whatever these strange things are, to many they appear to have delivered a rare victory to the little guys who cunningly used apps to hoist the captains of finance–who often refer to themselves as the Masters of the Universe–on their own petard.
Many commentators tell this story with relish. The envied, and seemingly, untouchable (and sometimes hated) rich and powerful have been bested. One big guy, the hedge fund Melvin Capital Management Fund LP, is said to have lost $3-billion. Pete Evans, from the CBC, reported that, in the aggregate, hedge funds may be down as much as $5-billion as a result of the GameStop caper. And some little guys are said to have made out like bandits! The David and Goliath story is invoked, again and again. Who does not love this kind of story?
Of course, the big guys are hitting back. Wall Street pundits are eager to give interviews, saying it will all end badly for the upstarts. That is how they see those investors whom they have derisively labelled as “dumb money” investors. And they are not just talking. The rich and powerful are using their clout to shut down the entities that the upstarts had used. As if to demonstrate their fecklessness, these most notorious of denouncers of government regulation are calling on regulators to step in and quash the unregulated upstarts. Given the obvious sympathy the public is evincing for the little guys, U.S. politicians have been forced into action. Both the Senate and the House of Representatives have set up committees of inquiry to determine whether the retaliating hedge funds are overstepping their bounds by trying to crush their small-time rivals. At the same time, not being all that opposed to the big guys, regulators are asking whether there is a need to bring the little players down a peg or two.
Little Guys vs Big Guys: Who Is Winning?
Alexandria Ocasio-Cortez and Rashida Tlaib want to know why retail investors, those little guys, should not be allowed to do what hedge funds, the big guys, do all the time. As credentialled progressives, they are outraged by the big guys’ fight-back. Some go further, characterizing the fight between hedge funds and retail investors as evidence of the never-ending class war, the parties in struggle as class antagonists. Congressman Jamal Bowman writes:
Capitalism has no problem when the working class plays. But has an issue when the working class starts winning.
I want to make two things clear. First, the struggle generated by the GameStop saga is about how share market trading is to be conducted, not about whether it should be allowed to exist. The little and big guys are not at war but are disputing who, as between them, should get the spoils from a war fought on others. The second point, then, is that the daily operations of share markets is one of the ways in which capitalists wage war against the working class. I begin with a question.
Why Do We Have Share Markets?
To fund corporations. That is the conventional answer. A capitalist political economy entrusts the creation of general welfare to private competing individuals who, selfishly pursuing their own interests, will yield wealth for all. In contemporary capitalism, corporations have become the ‘individuals’ best situated to discharge this task. A corporation might be formed by one or more owners of wealth who fund the incorporated firm themselves. This does not require a share market. The corporations in which we are interested are those that ask unconnected people with disposable capital to invest some of it in them. The holding out to the would-be investors is that they will make a profit on their investment.
Such corporations get themselves put on a register where potential investors can glean information to guide them as to whether they want to take a risk. The deal is that when investors agree to contribute capital to the corporation, a transfer of ownership takes place. The money contributed becomes the property of the corporation. In return, the investors get a certificate that documents their contribution and gives them the right to a share of any profits that reflect the proportion their contributions bear to the total capital invested in the corporation. The certificate detailing the entitlement to a particular share is, unsurprisingly, known as a share certificate. And the market in which such share certificates are bought is the share market.
Once the corporation has sufficient capital, it is ready to do what it is designed to do: trade and produce goods and services, that is, corporations are ready to privately accumulate socially produced wealth and, incidentally, to generate overall wealth. If this goal is facilitated by share markets, then, for capitalist purposes, the existence of share markets is fully justified.
How Share Market Players are Enticed to Play
But why would red-blooded owners of disposable wealth hand over their money to another person, a corporation, to do with it as it pleases? After all, they cannot be sure that there will be profits to share. They have to be given incentives. These turn out to be very generous.
In addition to having a right to share in profits, shareholders have a right to vote. They can influence who gets appointed to the board of directors that will set out corporate policies for executives to implement. They also have a right to vote on a set of decisions by a corporation that will change the fundamental nature of the corporation. Further, although corporations, not being humans, are potentially immortal, they do sometimes go out of business. After they have paid their debts, there may be some property left over. This will then be distributed to shareholders according to their holdings. An even more important inducement is the fact that shareholders are seen legally as totally distinct from the corporations in which they invest. Just as gamblers who bet on a horse are not responsible for the way in which the owner treats the horse or the trainer prepares it or the jockey rides it, shareholders are not responsible for the way the corporation treats its property or the way its directors and executives set policies or have them implemented.
Shareholders have been given real powers over the corporation. Their only risk is that they might lose the money they invested initially. Shareholders have considerable powers and seriously limited risk.
But that is not all. Shareholders are also allowed to sell their shares. The share certificate being assigned represents a right to dividends and voting rights. Its sale does not affect the amount of capital a corporation has. The legal relationship between a corporation and its shareholders is impersonal. The nexus is a monetary one. Similarly, shareholders are all distinct from each other, and their relationships, in corporate law terms, are also impersonal.
The Casino Aspects–the Tail Wagging the Dog
In a much-noted article in the conservative Harvard Business Review Justin Fox and Jay Lorsch asked themselves the question: “What good are shareholders?” Their answer: little to none. They found that, while corporations do get some funding by issuing shares to investors, most of the capital corporations gather for productive activities comes from retained earnings and borrowing (especially when interest rates are low). In addition, in recent years, there has been an increase in the number of corporations who buy-back their own shares. This means that they spend corporate capital not to invest in productive activities but to ‘clear up the books’ (as their accountants claim) and, not incidentally increase the value of shares held by major shareholders and executives. Fox and Lorsch conclude that, once dividends and buy-backs are factored in, there is a net transfer of wealth from corporations to shareholders, rather than the other way round. Shareholders’ contributions mean little when it comes to productive activities.
These findings are supported by respected researchers such as Marjorie Kelly & William Greider and Doug Henwood.(1) Their verdict: of the trillions of dollars flowing through share markets, only around 1% of the capital goes into the activities that justify the existence of corporations and, therefore, share markets.
Business pages, news bulletins on radio, television, brokers’ blogs, etc., continuously report the prices of shares at any one moment. What they are reporting on, so breathlessly, are the outcomes of bets the gamblers, known as shareholders, are making. Why? Are these shareholders, unlike the bettors at the race track, doing something valuable?
This does not mean that these vast flows of circulating monies do not serve any capitalist purpose at all. The share markets work for new start-ups. Moreover, the gigantic flows of money do serve capitalism–as a system, rather than corporations directly. They do so by providing liquidity, enabling the rationalizing of production by mergers and acquisitions.(2) It is a sort of grease. But, in the end, the facilitation of raising capital for corporations via share markets serves its stated purpose in a minority of circumstances only. The actual operations of share markets (which are supposedly intended to serve corporations as the producers of real wealth) have turned–as is the norm in capitalism–everything on its head.
From the shareholders’ point of view, the corporation is the platform for them to do what they want to do: make money by selling and buying certificates. From where they sit and act, the corporation is the substratum for their pursuit of wealth. They have little interest in whether a corporation actually does provide goods and services efficiently, or what goods and services it produces or how it goes about doing so. Here, the fact is that the shareholders have limited liability and legal immunity, so they do not have to care how the corporation behaves. Inasmuch as they exercise influence over the corporation, it is much more likely to be used to fatten dividends and to have executives deliver on shareholder value than it is on good social behaviour. Anti-social corporate behaviour is the norm, not the exception. Cheerleaders for corporate capitalism do not want to remember that there was much opposition to the idea of granting limited liability to shareholders, it being seen as a “Rogues Charter” by the Law Times in 1824, a sure-fire recipe for anti-social behaviour. Forgotten, maybe, but still true.
It now should be clear why a struggle between one set of shareholders, the little guys, and another, the big guys, about how the share markets should operate is not a prologue to radical change. However it turns out, the result will be a further embedding of a scheme in which investors will be encouraged to satisfy their greed without contributing anything much of value to society.
The Rules of the Casino and the Opportunities They Offer
Notionally, the price of shares is set by the value that investors place on the corporation, on its potential return of profits. If gambler A believes a share’s current value at $10 is the best that can be hoped-for, A will be happy to sell it to B for $14 if B believes that the current value is way below the potential price of the share. One of them will be right. What one wins, the other will lose. In the aggregate, it is a sum-zero game.(3) Of course, the aggregate is made up of millions of actors engaged in millions of transactions. Some will do better than others. They may be luckier in their guesses than others. After all, everyone is betting on the future and good fortune will play a part. So, also, will cleverness and the capacity to do deep research. Much effort is put into painting a picture of financial wizards who take the luck out of betting on the markets. They do not like to be seen as gamblers. So, they adorn styles of investing with monickers tailored to give the impression that they are scientific formulae: ‘value investing’, ‘random walk’, ‘efficient market hypothesis’, ‘contrarians’, and the like. In the end, because it is a guessing game, no one method proves better than any other.
Still, it is useful to have the belief out there that not only do share markets provide a social benefit by providing the capital essential to generating welfare but that they also reward cleverness, research and merit, not just luck. Of course, there are occasional reminders that this is to be doubted. One study shows that, in the U.S., the investments of members of the House of Representatives beat the market by 12 per cent over a number of years.(4) Legislators might either have much more dumb luck than most people or just have much more aptitude for picking the right stocks than do other punters. Of course, these kinds of results also might be a tip-off that not all is as it should be.
It is important, therefore, to reassure the gamblers that they will be placing their bets on a level playing field. They are told that that they will be engaged in a well-administered activity that serves the public weal, in which no one is to have information that could affect the prices of shares that is not equally available to all members of the gamblers’ universe. If some people are privy to such information because of their position in, or relation to, a corporation, they will be forbidden from buying or selling shares. It is a serious criminal offence–that of insider trading–to violate this principle.
These kinds of rules are necessitated because the logic of capitalism, which promotes taking advantage of anything or anyone as profit-seekers pursue their own interest, is likely to distort any system trying to create a level playing field. One well-documented instance illustrates this inherent problem. Large traders, having a great advantage in technological capacities, are able to find out, nanoseconds before slower traders can act, that someone wants to buy a particular stock. Taking a quick position in the market enables the swifter traders to reap a profit at the expense of the slower traders, all too often workers’ pension funds that will now have to pay more for the stock. Distortions and sharp practices are the norm.(5)
This was understood by the very first regulatory body that had to deal with the problems spawned when the rise of corporations involved the sale and purchase of stocks. In 1696, the English Board of Trade wrote that it would lead “ignorant men, drawn in by the reputation, falsely raised and artfully spread, concerning the thriving of the stock” to suffer financial abuse. Nothing has changed.
Pro-share market policy-makers go to great lengths to deflect these fears. We have myriads of elaborate rules regulating the share markets, dedicated to reassuring the public that this kind of gambling is secured against abuses. The existence of this sophisticated regulatory scheme signifies to the regulatees that if they stay within the bounds of those protective rules, they are free to follow their animal instinct. They are free to chase whatever benefits they can get, even if it is at the expense of others. It turns out that, as a consequence, these clever and greedy people have been left with numerous ways to inflict legalized harms. The following illustration, taken from a study by Iman Anabtawi and Lynn Stout,(6) makes the point.
Gaming the System – Examples
A number of hedge funds held shares in an insurance firm named MONY. The same hedge funds had lent money to a conglomerate called AXA. The IOU’s issued by AXA would increase in value if AXA succeeded in buying MONY, a bid AXA had made. MONY’s management team thought it would be deleterious to it and to its shareholders to accept the bid. The hedge funds successfully used their shareholding voting rights in MONY to defeat MONY’s management and make MONY accept AXA’s bid. It did decrease the value of the hedge funds’ shares in MONY but not as much as it increased the value of the debts owed to them by AXA. Whether this was good for either MONY or AXA or any of their shareholders or those who depended on them, such as their workers, did not bother the hedge funds’ strategists the least little bit. Whether or not it would lead to increased wealth for society did not trouble their minds in any way.
This kind of economically unproductive game playing is what ‘earns’ analysts, accountants, lawyers, brokers and all such intermediaries the big bucks. They are paid to look for, and then to legitimate and promote, these kinds of opportunities. Welfare for all be damned: gaming the game is the norm. Here is another commonly exploited bit of ingenious trickery, pertinent to the GameStop story.
A hedge fund holds shares in a corporation. It sees an opportunity to make some cash by ‘shorting’ its stock. What this means is that it will borrow some shares in the same corporation held by another investor. It will have to replace the shares. It then immediately sells the shares at whatever the current price is. The hedge fund now has an interest in seeing the price of the shares go down. If they do, the borrowed shares can be replaced with shares worth less than the hedge fund had obtained for them after they had borrowed them. A nice profit will be booked; no physical effort required. As part of the scheme, the hedge fund and its allies (brokers, analysts) have an incentive to talk down the potential of the ‘shorted’ corporation by demeaning its managers or throwing doubt on its accounts. At the same time, the hedge fund can also use the votes attached to its original shares to push the board and the executives to take actions that will drive the price of the shares down. Loyalty be damned. The relations are money relations, impersonal relations. This is such a common practice that it has a name: Empty voting, empty because the hedge fund has averted the risk of the share price going down by its shorting of the stock.
The share markets regularly undermine the economic goal of a firm’s incorporation, namely, to create material wealth for itself and all others. The separation between share market practices and what is often called, the ‘real economy’, could not be plainer. This is the context for the GameStop saga.
GameStop–Little and Big: They are all Anti-Social Gamblers
Hedge funds had shorted GameStop shares. That is, they held shares in GameStop, borrowed some more, sold those, and now were waiting (passively or otherwise) for a collapse of GameStop shares. All perfectly legal, unless their ‘otherwise tactics crossed some line or other’. There was initial success as the share price had been around $25 in 2017 and, after a year of shorting, shares had fallen to $4.75. By the last quarter of 2020, GameStop had lost 63 per cent of its value.
This was not surprising. Its business was running about 5000 retail stores selling video games. The business model was no longer as attractive as it once might have been. The hedge funds had taken a calculated risk and had seemingly triumphed. That risk, of course, had been the possibility that GameStop’s shares might increase in value. Suddenly, unexpectedly, this happened. The irrationality of share markets sailed into plain view.
Many people see, indeed are taught to see, playing the share market as a quick and respectable way to get rich. But it is costly–and supposedly requires ‘smarts’. Some two to three million less well-heeled people had found a cheap way to participate by joining a Reddit supplied thread, r/WallStreetBets. There, using ribald language and enjoying trash-talking, they, as proper Wall Street elites do, communicated their views about share markets. They noted that GameStop stock had been shorted by hedge funds. This provided an opportunity to make some money and to have fun. Many of them bought GameStop shares. This drove up their value, which, in turn, alarmed the hedge funds with skin in the game. They might have to return the stock they had borrowed at a much higher price than they had realized when selling it after borrowing it. A short squeeze had been engineered. This forced them into buying shares in GameStop before they became too pricey and this, in turn, drove the value of those shares up some more. The value of the shares, calculated as a capitalized amount, had turned GameStop, a faltering enterprise in the actual world, into a $22-billion firm, a mini-giant.
The Share Market at Work: Fake Economic News
The social media gamblers’ purchases of the stock had made them, on paper, tidy sums of money. When it all began, a GameStop share had been valued at $21 on 6 January and, at the end of January, it was worth $325. As noted, one major hedge fund operator, Melvin, lost 53 per cent of its value and had to reach out to comrades for a bail-out. It got a cash infusion of around $3-billion from Steve Cohen’s Point72Asset Management and Ken Griffin’s Citadel. It must have helped Melvin that its founder and manager, one Gabriel Plotkin, had worked at Citadel. Capitalists have links and connections; the markets have visible operators even while they supposedly operate as if guided by invisible hands.
The popularity of the story is easy to understand. Ordinary folk, folks without connections, not belonging to the inner circles, had drawn blood from large insiders. They had done so by the very same technique and with the same malice with which hedge funds act every day. The high and mighty, like Queen Victoria, were not amused.
What upset the elites so much is that to succeed, these small investors had to act cohesively. Only if enough of them bought the same stock and if enough of them refused to sell it as soon as a profit could be made would their scheme work. And it did. The dominant class always fears unregulated collective power. Working class history is a testament to this. Indeed, one of the tactics deployed here by the elites is to argue that these WallStreetBets people had not acted like decent capitalists because they had combined to distort the markets. They had engaged in unfair, perhaps illegal, manipulation. This, of course, dovetails with the successful development of the judicial doctrine of conspiracy used successfully by employers for nearly 100 years to beat down workers’ strike actions. Undoubtedly, there are some proper Wall Streeters who think the regulators who have been called into action might support the claim that unacceptable manipulation took place. After all, the overseer of these regulatory bodies will be the new Secretary of the Treasury, Janet Yellen, who, before she was appointed by President Joe Biden, had ‘earned’ close to $900,000 for giving eight talks sponsored by Citadel, one of Melvin Capital’s rescuers.
This fear of cohesion, of collectivity, manifested itself in the language of the hedge fund managers and their intellectual and political gatekeepers. While the mainstream press liked the David and Goliath story, the elites drew analogies between WallStreetBets followers and the barbarians at the gate of the Capitol. On the very day the hedge fund losses were made public, an on-line platform called Discord, banned WallStreetBets members from its servers, citing their homophobia, racism, and use of hate speech (likely their dissing of Wall Street). Collectivism, other than that of capitals aggregated in a single corporation, is unwelcome.
The Wall Street magnates identified the problem. New, cheap technologies had made it easier for upstarts to organize. They were able to use an on-line broker that charged no fees to process their transactions. As is the norm in capitalism, it was the exact opposite of what it claimed to be. Its name, Robinhood (the best-known equivalent in Canada is Wealthsimple) suggests that just like Uber and Airbnb, Robinhood, is the antithesis of a capitalist firm, a business that encourages neighbours to come together in a self-help scheme. Indeed, one of its slogans is that it sets out “to democratize finance for all.” Like the rapacious Uber and Airbnb, Robinhood is far from benevolent.
The data it collects on those who use its platform is for sale. More importantly, when it receives an order to buy or sell, it must, like any broker, execute it. Ordinary brokers have a legal duty to get the best deal possible for the clients who give them orders to buy or sell. But, as Robinhood does not make its money from these users, it owes more fealty to those who do pay it. Those are large firms to which it routes the orders. These firms pay Robinhood for putting this business their way. Robinhood puts aside some money in a clearinghouse to pay the firm that fulfills the orders, just in case its users cannot complete the transaction, a real possibility if the stock prices are volatile. This unusual system in which the broker does not charge its users but collects fees from the firms to which it sends orders, is called ‘Payment for Order Flow’. It creates a potential conflict between brokers like Robinhood and its users as the brokers are focussed on satisfying their paymasters with whom they have a symbiotic relationship. (Oh, by the way, Citadel, one of Melvin Capital’s rescuers and former employer of Gabriel Plotkin, is one of Robinhood’s favoured order fulfillers.) The scheme, whose design is attributed to Bernie Madoff, is so problematic that it has been outlawed in the UK and Australia.
Knowing that Robinhood’s reserves in the clearinghouse had to be under pressure and that it wanted to continue to do business with the order-filling firms, hedge funds pushed Robinhood to act. Robinhood suddenly put a stop on any further buying of GameStop shares (as well as on a few other stocks, such as ACM, Explorer who, subject to similar shenanigans, had seen their stock rise three-fold). They could only sell them. This put pressure on the holders of these shares and the share price of GameStop has dropped alarmingly. Those left holding the shares may well be lucky if they finish up in the black. Those who did sell, that is, got out of the ‘collective’, may have done very well. Angry users of Robinhood wrote nasty reviews which Google, now flaunting its new status as a censor, removed from the site. Others have brought a civil action against Robinhood for manipulation.
It is a saddening, tawdry tale of a dispute over the spoils of a betting game that does little, if anything, to contribute to the well-being of society. It is a tale that reveals what is hiding under some of the rocks on which finance capitalism rests.
From GameStop to Financial Capital: Some lessons
1. Share markets are just glorified betting shops. Whatever it is they do, it is not the function that they claim to fulfill, namely, providing capital for productive activities.
2. Shareholders have limited financial risks and legal immunity for corporate failures and wrongdoing. This is a major reason why publicly traded corporations engage in so much scandalous, often illegal, behaviour.
3. The buying and selling of shares does not affect the amount of capital available to corporations. This should give some pause to advocates of divestment as a means to influence corporate behaviour. Divesting means selling. As long as there are willing purchasers, the divestment strategies’ impacts may be much less effective than might be expected.
4. The buying and selling of shares has created a world of very highly paid professional services’ renderers. The intermediaries make up a large segment of the new class of extremely wealthy people, exacerbating inequality. As they are parasitic on a parasitic undertaking, social injustice is deepened and legitimated by share market trading.
5. Share market trading, as has been understood since 1696, invites sneakiness and cheating (often resulting in what is called the creation of financial products). It contributes mightily to a corroded culture. Thus, WallStreetBets users might be seen as victims of a debased value system.
Harry Glasbeek is a Professor Emeritus and Senior Scholar, Osgoode Hall Law School, York University. His latest books are Class Privilege: How law shelters shareholders and coddles capitalism (2017) and the follow-up, Capitalism: a crime story (2018) both published by Between the Lines, Toronto.
Endnotes
- Marjorie Kelly, The Divine Right of Capital: Dethroning the Corporate Aristocracy, foreword by William Greider, San Francisco: Berrett-Koehler, 2003; Doug Henwood, Wall Street, London: Verso, 1997.
- Leo Panitch and Sam Gindin, The Making of Global Capitalism: The Political Economy of American Empire, London: Verso, 2012.
- Lynn Stout, “Are Stock Markets Really Costly Casinos? Disagreement, Market Failure, and Securities Regulation,” Virginia Law Review, 81, 1995, 611.
- Alan Ziobrowski, Ping Chen, James Boyd and Brigitte Ziobrowski, “Abnormal Returns from the Common Stock Investments of the U.S. Senate,” Journal of Financial and Quantitative Analysis, 39, 2004.
- On front-running, see Michael Lewis, Flash Boys: A Wall Street Revolt, New York: W.W. Norton & Co., 2014. There are reports that not only little guys got the best of Melvin Capital and others. There are claims that, gleaning data from Robinhood, BlackRock, J.P. Morgan and Goldman Sacks bought up GameStop shares, making handsome book profits. If this turns out to be true, it makes the David and Goliath, let alone class war, stories even less believable.
- Iman Anabtwai and Lynn Stout, “Fiduciary Duties for Activists Shareholders,” Stanford Law Review, 60. 2008, 1255; T.C Hu and Bernard Black, ”Empty Voting and Hidden(Morphable) Ownership: Taxonomy, Implications, and Reforms,” Business Law, 61, 2006, 1011.