American Capitalism May Be Broken, But the Reddit “Bros” Are Not the Ones to Fix It

Richard Paul Pasquier
4 min readJan 30, 2021
Photo by Austin Distel on Unsplash

One of the more maddening features of the whole GameStop controversy is the confusion around which side is defending the integrity of the “free market.” Most journalists reporting the story seem to give credence to the idea that it’s the “finance bros” in the WallStreetBets sub-reddit who are defending the markets against the nasty hedge-funds who have rigged it. And in conversation with those reading the headlines and skimming the rest, you hear all sorts of things about the evils of “Wall Street” but the speakers are vague about what that term means, often mixing up hedge funds, with private equity, investment banks among other “evil-doers.” The most hilarious aspect is the degree to which such speakers also see the populists as somehow championing the “integrity of the free market” or “capitalism” against Wall Street insiders.

The answer is no one in this story is on the side of the angels; neither the “populists” pushing up the price of GameStop and other shorted stocks nor the “finance professionals” shorting them. Looking only at whose strategy promotes “the integrity of the free market” in the sense of being more likely to prevent speculative bubbles from becoming dangerous, it is actually the hedge funds who are acting “more responsibly” in this scenario. Yes, the compensation structures of hedge fund managers are horribly skewed and allow them to potentially walk off with disproportionate compensation if their investors make money. But by taking short positions in stocks who are potentially overvalued, hedge funds are acting the way market theory says they should. The GameStop populists are swimming against the inevitable tide of fundamentals, and in the end are pumping up a bubble which when it bursts inevitably will cause more pain in the end.

Finance theory teaches that overvalued stocks should attract the attention of investors who are able to act on their hunch that their value will fall in the future. The quicker these mis-pricings are “arbitraged away” the better for the market. Short selling is a market adaptation that permits the correction to happen more quickly than it might otherwise if only long-term holders of stock were relied upon to sell overvalued shares in their portfolios. With short selling, nimble investors can borrow shares from brokers and sell them immediately, betting that they can buy back shares later at a lower price to fulfill their obligations to repay the lenders. If the value of the underlying shares rise, the investors lose money because they have to acquire more expensive shares to pay back. If the prices fall as predicted, short-sellers profit as they drive the stock back down to more “correct” valuations.

In the case of GameStop, a group of investors who visit several chat-rooms including most famously the WallStreetBets sub-reddit, decided to try to foil short-sellers by working together to buy shares and drive up its value. This would create a “short-squeeze”, forcing the liquidation of short-sale contracts at a loss. If the scale of the hedge-fund losses is large enough, it can trigger a broader liquidation of hedge-fund assets as creditors demand that other positions be liquidated in order to limit credit exposure. The increase in the value of shares leads to higher “market capitalization” of the subject companies. But it is important to remember that this increased value does not add to the cash that the issuer corporation can use to keep stores open, pay employees more, reduce debt or make pension contributions. All of this increase is in the paper-value of the holdings of stockholders, value that remains unrealized until the stockholders find buyers willing to pay cash to take the stock off their hands. In the end, if the stock proves to be overvalued — and no rational person can conclude that underlying value of GameStop or Nokia or the other names targeted by the “short squeeze” online populists can match the implied expectations of 1500% increases — it will be the “johnny-come-lately” investors attracted by pure speculative fervor who will ultimately bare the biggest losses.

Seasoned observers such as Elizabeth Warren are using the furor over GameStop to call for broader scrutiny of Wall Street. This is welcome. However, the simple-minded populism that can unite “Stop-the-Steal” Ted Cruz and Alexandria Ocasio-Cortez in common cause against dousing the speculative fires, is not going to lead to the right reforms.

The biggest problem on Wall Street today is that it has failed in its mission of raising capital for the next generations of businesses. Initial Public Offerings (IPOs) happen less-frequently and later, excluding retail investors from the opportunity to profit from the huge growth in IT, biotech, new energy and manufacturing and fintech. The GAAFM (Google, Apple, Amazon, Facebook, Microsoft complex) are acquiring rivals, tamping down competition because they can use their overvalued stock as currency to buy out private investors in rival start-ups. The IPOs that happen raise more money for insiders selling their stake than they raise from the “primary issuance” of new company shares. It’s all good for the insiders, but it’s bad for the public, whether understood as citizens, employees or investors. American capitalism has structural problems that will require careful reforms to restore competition and to reduce the compensation gap between insiders and the rest of the population. These issues are not addressed by cheering on a speculative bubble in a few nearly “forgotten” stocks who are the target of short sellers.

Turning these losers into speculative darlings, will not fix American capitalism or save our capital markets. It will only create a bigger hangover later.



Richard Paul Pasquier

Partner at Practus, LLP, a law firm. Rick advises clients on issues at the intersection of business strategy, law and political economy.