One of the most amusing bits of the 2008 financial crisis, for me anyway, was seeing the US$1-billion-plus that British billionaire Joe Lewis had sunk into Bear Stearns, some of it just hours before the Wall Street firm collapsed, vaporize in seconds. Rich guys who live as tax exiles in the Bahamas generally do not garner our sympathy.
I had the same reaction this week, when an army of amateur traders derided – or celebrated – as “basement dwellers” or “trolls” drove the shares of GameStop Corp. into the exosphere, shredding the massive short positions of the Wall Street funds that were betting the shares of the struggling U.S. video-game retailer would collapse.
The hedge funds exposed to GameStop lost billions, effectively triggering a massive transfer of wealth from undeserving billionaires and millionaires to taco-stuffed kids armed with the Robinhood mobile-trading app and accounts on Reddit message boards. Justice, revenge, retribution! What’s not to like?
Here’s what one Redditor said: “We have a once in a lifetime opportunity to punish the sort of people who caused so much pain and stress a decade ago … Your ilk were rewarded and bailed out for terrible and illegal financial decisions that negatively changed the lives of millions.”
Never mind that the hedgies and their private equity fund brethren had little to do with the 2008 financial meltdown – it was a lovely narrative, but also entirely fanciful. The losers in this romantic little romp were not the Wall Street biggies; the losers were the investors, notably the pension funds, that backed them. Since most of us have pensions, that would be you and me.
The other losers, eventually, will be the Robinhood-Reddit mob itself. At some point, the equity of GameStop, AMC Entertainment Holdings Inc. , Bed Bath & Beyond Inc. and other heavily shorted stocks will stop defying gravity (their latest target is Top Glove Corp., the Malaysian rubber-glove maker). The young traders stand to lose everything, and the hedgies may have the last laugh.
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Hedge fund and private equity bosses would have you think they are red-blooded capitalists who embrace risk and suck up the losses as much as they celebrate the wins. But how they reward themselves is remarkably insulated from risk.
Generally speaking, they work on the “2 and 20 formula.” The first figure refers to the 2-per-cent management fee for the assets under their care. The second refers to the 20 per cent they take of the profits after the funds reach a certain benchmark. Usually, the investors’ money is locked up for seven years, and all sorts of cute but accepted tricks that mere mortals cannot understand are used to flatter fund performance, including dividend payments, derivatives and dumping investments from old funds into new funds.
The formula is a thing of beauty if you are the guy running the fund because any losses are borne by the investors, such as the pension funds. If the fund is down 20 per cent, the managers don’t have to cover the losses. And they still collect the 2-per-cent management fee, which is usually more than enough to cover operating expenses.
The funds that shorted GameStop, including Melvin Capital Management and Citron Research, lost billions as GameStop went vertical and the funds had to close their short positions. By Friday, GameStop was up more than 8,000 per cent over a year, giving the retailer closing many of its stores a market value of US$20-billion.
Melvin got bailed out by other funds. It’s unlikely that any of the hedge fund bosses who got beaten up by the young traders will lose their jobs, though they must be embarrassed that they were taken down by a motley crew of amateur day traders. At worst, the blow to their reputations may make it harder for them to raise their next funds.
The brokers came close to victim status. Robinhood and other retail brokers came under financial strain earlier in the week as their cash demands soared – they had to pay customers who were owed money from their trades and also had to post extra funds with their clearing house. Robinhood put trading restrictions on GameStop and other high-flying companies Thursday while it raised US$1-billion from its owners and from lines of credit.
The trading restrictions, which enraged Robinhood’s users, were partly lifted Friday, allowing traders to pile back into the hot stocks. GameStop rose more than 70 per cent. All this madness, of course, will end in tears for the basement dwellers – and already has for the investors in the funds that got trampled by the Robinhood hit teams. The hedge fund bosses? They’ll be just fine.
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Eric Reguly