What's happening with GameStop and the stock market?

For the last couple of weeks, GameStop—a struggling brick-and-mortar video game retailer—has been at the center of one of the financial world's biggest news stories. Activity by social media investors pushed GameStop's shares to major heights, forcing Wall Street hedge funds to pay up huge sums of money.

The price of the video game company's shares have been extremely volatile alongside shares of AMC Theatres, Blackberry and Nokia after WallStreetBets—a Reddit group— encouraged individuals to buy stock in these companies, resulting in stock prices skyrocketing. The social media rally is unprecedented in the financial world. 

FIU News caught up with Flavio Carrillo, director of FIU's Capital Markets Lab, to discuss what is going on with GameStop and the wider trend that is affecting the stock market.

Can you explain what has been happening with GameStop stock recently?

The story of what happened is not complicated at all. It starts with understanding the phrase, ‘shorting.’

You can ‘short’ a position in the stock market, which means selling something that you do not own. But then you must ‘close’ that position also, which means buying that same position back at a later time.

And so when hedge funds and institutions are thinking of shorting a position, they figure out, ‘Hey, here is a business that doesn’t make a lot of sense. We can make money if we short-sell its stock. The selling of shares should cause the price to go down. And then we could buy back the stock pretty much pennies on the dollar.’

Hedge funds were doing this to GameStop. And so these gamers and people on social media said, ‘Hey, we’re going to revolt. We’re going to start buying this stock.’ And so when GameStop stock started to rise, all of these short-sellers had no choice but to buy at higher prices. It is called a short squeeze.

When the short-sellers were forced to buy the stock at higher prices, it exacerbated the situation because then the stock price rose even more. At that point, the market frenzy hit its zenith.

Why do you say there is no economic viability behind this trend?

GameStop operates in an industry that many consider to be in decline. They are in the brick-and-mortar video games industry, and that is slowly going away, similar to what happened to Blockbuster video not too long ago.

You have many gamers who may have an emotional attachment to the company, but that doesn’t change the fact that the firm itself is losing money. The company may likely be forced to cease operations in the near future.

Are hedge funds really buying back GameStop shares at huge losses to close their positions?

They do not really have a choice. Since they borrowed the shares that they sold, they are forced to buy them back. They have probably lost billions in the process.

Is there a way for GameStop to receive the money flowing into its stock?

Not unless they were making more shares available to the public. These are transactions that happen in the secondary market. A company gets equity capital when it goes public, either through an initial public offering or a subsequent public offering. These are transactions happening in the secondary market between buyers and sellers.

Does it affect those closely associated with the firm? Sure it does. You have officers and other insiders that own stock trading at low values, and all of a sudden this happens and many of them experienced a windfall. But for the company itself, it does not change the fact that the business is not doing well. The added publicity, however, may give it a temporary boost, sort of like bucking the trend.

Does the United States have a historical precedent for something like this?

Yes, similar hype-fueled buying frenzies have happened before. In the late 90s, early 2000s, during the dot-com era, many early staged firms in the tech industry had ridiculous valuations. You had many people throwing money at anything that was technology-related regardless of economic viability. Companies had valuations that significantly exceeded their potential, and so the expectations of ‘investors’ were unrealistic.

I think that what is unique about the GameStop event is the role that social media played. A bunch of gamers and sympathizers banded together and decided to fight the hedge funds, reminiscent of the story of David and Goliath. I do not think this would have been possible without social media.

What do you think is the reasoning behind Robinhood temporarily not allowing people to buy GameStop?

There may be several factors affecting their decision. Given the extreme volatility of the stock, the firm may have worried that they may not have had the necessary funds to settle the trades with the clearinghouse. If the stocks were purchased on margin, given the extreme swings and the quick pace, many investors may not meet margin calls. 

Another factor may be that they didn’t want to be associated with the publicity that was being generated since such episodes rarely end well. This was a buying frenzy that had nothing to do with investing and the firm markets itself as a portal for investors. Investors could potentially argue that Robinhood did not do enough to stop the speculative buying resulting in lawsuits.  

Finally, the transactions and those firms associated with the case may be investigated by regulators such as the SEC. And you are now seeing both Democrats and Republicans calling for a probe on the matter.  

What long-term effects do you see coming out of these events?

I think the harm here may be greater than the benefit. Yes, you may see more people opening investment accounts, but many may be doing so for the wrong reasons. Speculating is not the same as investing.

If you are buying a stock, it should be done because you believe in the long-term economic prospects of the company and think that it operates in a sustainable industry. Any time you are purchasing stock because of hearsay, or you are not grounded on economic reasoning, you are not investing but rather, speculating.

That worries me because speculating in the market can wreck an individual’s finances and negatively impact the market and the economy. Publishing stories of ‘investors’ that struck it rich with GameStop stock can actually hurt novice investors who may feel that they were left out and wish to participate.