GameStop saga shows ‘democratisation of finance’ has limits

Tempers rose after online stock trading platforms temporarily blocked retail investors from buying shares in GameStop, the American video game retailer which is at the centre of a brewing debate around inequalities in the finance world. 

Robinhood, Webull Financials, Interactive Brokers and a few others drew sharp criticism from the public and politicians after they said on Thursday that investors can only sell GameStop, Blackberry and a few other volatile stocks but cannot buy them. 

On Twitter, the decision was widely seen as a way to help established Wall Street firms that were bleeding money after betting against GameStop. 

US lawmakers have called for a hearing to investigate the entire saga with Alexandria Ocasio-Cortez, a Democrat senator renowned for her progressive views, saying the restriction imposed by the brokers was “unacceptable”. 

In recent weeks, GameStop stock shot through the roof rising more than 600 percent between January 12 and 26. 

The unprecedented rally has little to do with a change in the fortunes of the Delaware-based retailer, which has been haemorrhaging money as video games sales via its brick-and-mortar stores have plummeted. 

Instead, the rush to buy its shares followed calls on a Reddit forum, r/WallStreetBets, that it was a way to push back against deep-pocketed funds who were shorting “an underdog company”.

By encouraging enough people to buy the stock, they have created an artificial rally, entrapping short-sellers in their own game. 

Short-sellers borrow shares from brokers and then immediately sell them in the hope that by the date it’s time to return the shares, the price would have dropped. 

They return the shares and pocket the difference as profit. 

But if the price of the share starts to go up the short sellers have to buy the shares to cover their positions. That’s exactly what’s happened with GameStop. 

As the traders on Reddit shared the stories of how easily they had converted a few thousand dollars into millions within days, it encouraged other retail investors to join the party. 

This is where the Robinhood app comes in. With a mission to “democratize finance” it allows users to trade in shares free of cost by opening up an account with only $1. 

Robinhood, which has more than 13 million users, recorded the highest number of downloads of its app in a single day on January 27. 

Robinhood along with other online brokers also lend money to investors to make the trades - known in industry parlance as margin trades. With no economic fundamentals justifying GameStop’s rise, there’s a risk that investors will lose money and won’t be able to return the money they have borrowed to buy the stock.

The brokers now want investors to put aside more cash beforehand as equity if they want to trade in GameStop shares. 

Besides the brokerage firms, the clearing agents, which are responsible for processing the securities’ transactions at the backend, have also become cautious about GameStop and other volatile stocks. 

There is a fear that if short sellers fail to cover their positions it could lead to a cascade of failures in the market.  

Hedge funds that were betting against GameStop have already incurred huge losses. One such fund, Melvin Capital, has reportedly received a $2.75 billion bailout to remain afloat.  

But lawmakers are not happy with how things have turned out. 

“We’re done letting hedge fund billionaires treat the stock market like their personal playground, then taking their ball home as soon as they lose,” said congressman Ro Khanna in a statement. 

“While retail trading in some cases, like on Robinhood, blocked the purchasing of GameStop, hedge funds were still allowed to trade the stock.”