No heroes as dust settles on Reddit revolution

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If you’re thinking of buying GameStop Corp. shares to help those plucky Redditors in their battle against Wall Street, please don’t.

The folks you think are the heroes in this saga nearly certainly aren’t.

Now that the frenzy has abruptly ended – with huge declines Tuesday in the share prices of Redditors’ favourite stocks such as GameStop (down 60 per cent), AMC Entertainment Holdings Inc. (41.2 per cent) and BlackBerry Ltd. (21.1 per cent) – it is clear the whole flare-up never lived up to its original billing. As for the price of silver, which hit an eight-year high on Monday, it fell 7 per cent. Instead of being an epic showdown of the People versus the Man, it now seems more like the usual Wall Street wrestling match in which rival groups of money-hungry traders scramble to make a buck by promoting their own versions of the truth.

In the case of the folks that congregate on Reddit’s WallStreetBets forum, this promotion has reached epic proportions. The pseudonymous posters have a simple message they keep repeating – that small investors are rising up against the fat cats of the investment industry. They are doing so by engineering a “short squeeze” on the hedge funds that are betting against the likes of GameStop, a fading bricks-and-mortar retailer.

The rhetoric around this manoeuvre can hit extreme levels. So can the self-righteousness. “We have to FIGHT for this to work out, it’s a [expletive] blood bath,” stocktipsinstockings wrote in a post on Tuesday as GameStop shares plummeted. “You’ve now seen how the game is played, how it’s rigged, how it’s contorted and drawn out and galvanized to benefit the other side of the trade desk.”

Really? It’s not entirely clear how small investors are being abused after a decade in which anyone who invested in a humdrum S&P 500 index fund tripled their money.

Even odder is the Redditors’ choice of targets. Whatever hedge funds’ sins may be, these investing vehicles did not cause the financial crisis in 2008, as many Redditors suggest.

Hedge funds were not the folks who peddled wonky mortgages or built towering piles of debt that collapsed when the housing market turned sour. That was the handiwork of mortgage originators and banks.

Hedge funds’ only real sin in recent years has been charging big fees for mediocre performance. But those fees are paid by well-heeled clients who voluntarily sign up for the deal, not by the public at large.

None of this matters to Redditors. They keep complaining that many hedge funds engage in short-selling – that is, betting on stocks to go down. Redditors denounce this practice, supposedly because it profits from pain. They try to depict short-sellers as a league of blood-sucking villains.

All of this amounts to an epidemic of silliness. Short-sellers may not be the nicest people, but they fill a valuable role. They are the skeptics who challenge Wall Street’s happy fables, the cynics who question companies’ upbeat reports. They do this to make money, yes, but their digging often exposes serious wrongdoing.

In the past year alone, short-sellers have helped spotlight accounting scandals at Luckin Coffee Inc., a previously high-flying Chinese coffee chain, and at Wirecard AG, a payments processor that was once considered a star of the German stock market.

Going further back, Canadian investors may recall Sino-Forest Corp., a Toronto-listed company that was revealed to be a fraud after a blistering report in 2011 by short-seller Carson Block of Muddy Waters Research.

In all these cases, short-sellers exposed bad behaviour that was eluding auditors and regulators. If you are really on the side of Main Street versus Wall Street, as Redditors like to claim, it is difficult to see why you would want to punish short-sellers for casting a glaring light on corporate malfeasance.

One possibility is that the Reddit crew is more than just a bunch of bored guys in their basement trading their stimulus cheques and fighting for public good. Mr. Block, the short-seller who exposed Sino-Forest and later ignited the ire of the Reddit crowd with his bearish take on GameStop, is among many people who are questioning whether some hedge funds may have co-ordinated efforts with Reddit members to drive GameStop share prices higher and squeeze rival funds.

“What constitutes co-ordination? Did they cross the line? That could be interesting,” Mr. Block told Bloomberg TV.

Whoever the driving minds behind the Reddit frenzy may be, it is clear they don’t mind hurting small investors.

Their chosen short-squeeze strategy consists of buying options and shares to drive up the share price of their target company. This buying binge puts pressure on short-sellers and option-makers, who have to scramble to buy shares before the price rises even higher.

The upshot of all this is that the target company’s shares soar above their true value. At some point, though, the buying binge ends. At that point, the share price collapses and the people left holding the shares suffer severe losses. This appears to be what happened on Tuesday.

Who are the suffering shareholders? A significant number are likely to be naive investors lured into the game by the Redditors’ fiery rhetoric and extravagant stories. They won’t likely wind up thinking of the Redditors as heroes. Neither should you.

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