What is happening with GameStop? TU’s Babu Baradwaj explains

By Cody Boteler on February 2, 2021

Last week market watchers had a blast from the past as early 2000s video game darling GameStop suddenly saw its stock skyrocket to nearly $400 per share.

Retail investors—Internet traders who play the stock market without a broker’s advice—declared war on traditional Wall Street investors who had spent years betting against GameStop. According to CNET, Redditors from the forum r/WallStreetBets have increased the retailer’s stock value by as much as 14,300% before also turning their attention to AMC and Blackberry.

For years hedge funds bet heavily that GameStop would fail, engaging in a tactic called short selling. That’s when a buyer borrows a share or shares of a company at a higher price and immediately sells it. After the stock price drops, the short seller buys back the borrowed stock, returns it and keeps the profit.

On Jan. 11, retail investors called the short sellers’ bluff by investing in GameStop, causing Wall Street to lose billions.

The TU Newsroom sat down with Babu Baradwaj, PhD, a professor in the Department of Finance, to learn more about what’s happening.

What is your understanding of what we saw happen last week with GameStop stock?

There is a group of investors who have decided they are going to make their money by profiting off the failures of companies. It is not illegal. They pick companies that are not doing well or are not going to do well. These investors took a look at GameStop, a struggling retailer, and decided to bet on that.

But then another group of investors noticed this, took a look at it and said, “No, we like GameStop,” even if they haven’t been inside one of the stores in years. It’s like your local ice cream shop. You might only go there once a summer, but you still want it to be there; you don’t want it to go out of business. So these investors decided to prop up GameStop and word spread. People started to buy shares, and, as they started to buy shares, the value of the shares started to go up.

It became an “us vs. them” situation, between the retail investors taking on the institutional investors.

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Has this sort of thing happened before?

We saw something like this in the last couple of years with Tesla. People bet against Tesla. Elon Musk, the CEO of Tesla, had the wherewithal to buy shares in the company, which brought the price way up, and those guys who bet against Tesla lost billions of dollars.

So is this the same situation? Or are the retail investors taking on a bigger risk?

If I’m a retail investor, and I put my savings, say $3,000, into GameStop, that could be 100% of my wealth. For a hedge fund, they could be putting in $2 billion and that still wouldn’t be all their money. They have access to more capital and more loans to prop up their positions.

So the retail investors are taking a huge risk. I would love to see them win. But logically and practically, I don’t see that happening. The retail investors might have to pay rent soon or a student loan they have to pay out. Can they cash out their shares and pay their bills before losing their money?

There is a sentiment to hang onto the shares to continue to cause the hedge funds and institutional investors to lose money. It’s a sentiment now, and you might like the sentiment, but you can’t live on sentiment. These retail investors are people who might not be able to afford to lose $1,000 on this bet.

I would say buyer beware. Know what you’re getting into. I think some people are going to get hurt. The consequences of investing like this are real.

To be clear, this isn’t like traditional investing, right?

No. Investing in a stock traditionally meant that money goes to the company. Companies raised capital to invest money into the company, that is for the growth of the company.

But now there are different mechanisms. These investors are simply churning money in the markets. It’s not really affecting the value of the companies, and this money is not going to GameStop.

Part of why this took off is because retail investors have greater access to the stock market through apps like Robinhood. Do you think that expanded access to the market is a good thing?

Why shouldn’t it be? Why shouldn’t everyone have easy access to the financial market?

Years ago, I walked into a brokerage office, and they would not talk to me. They said I was not a big enough customer. They were saying I could not have access to those services that others with more money were having.

Now, what Robinhood and others have done is opened up an opportunity. Why should I take my $10 and put it in the bank and get nothing for it, when I could buy even a fraction of a stock and watch it grow with a broker? That opportunity is something that should be available to everybody.

Every semester, I ask my students how many of them want to become millionaires. Some people put their hands up. Then I ask them, “Well, how many of you are inheriting a million dollars?” Most likely, nobody is. So how are you going to become a millionaire? [One of the only ways] to become a millionaire is to invest in the stock market.

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To set up an interview with Babu Baradwaj, or any expert from Towson University, contacted Matt Palmer at mpalmer@towson.edu