The Legend of Robin Hood (2021-Style)

Categories : Financial, News
February 3, 2021

No one seems to know for sure whether “Robin Hood” ever existed, and there is no verified story. Whether truth or fiction, here is the way I learned the story. Robin Hood supported King Richard while the King was away defending the English Throne. That made Robin a British loyalist, and not necessarily the self-righteous wealth-redistribution legend. He took what interlopers stole from the Crown and returned it to the rightful owners, therefore not robbing from the rich to give to the poor.

Update Robin Hood to Wall Street 2021, where we find a stock trading service dubbed Robinhood. What Robinhood and other similar platforms do well is to allow novice investors without a great deal of money to purchase fractional shares in good companies. Not only do I like the concept, but it is also educational and interesting for investors. But there is another side to the concept. Robinhood was recently fined $64 Million for misleading customers as to the cost of its service, which is advertised to be free.

This week brought Robinhood to the forefront of Wall Street’s news coverage. On Wall Street, “Selling Short” (read: selling shares you do not own) is legal. Conditions are simple; shares must be legally borrowed from a consenting owner, with a money-backed promise to return the same number of shares borrowed. For that privilege, the lender (stock owner) also gets a payment from the Short Seller (consider it rent). The lender also continues to collect any and all dividend payments paid during the rental period.

A Short Seller believes that the market price of the borrowed stock will fall. When it does, the seller will buy more shares on the open market, and simply return newly purchased shares to the lender. The Short Seller then pockets any positive difference and moves on.

That assumes the stock price actually went down.

What happens when the stock price rises? At some point, the Short Seller will generally get fed up, buy new, more expensive, shares to return to the lender, absorb the loss, and lick his or her wounds. If the stock rise is fast and furious, the Short Seller’s losses skyrocket. At that point, the Sort Seller can experience a “Short Squeeze” (run out of his or her own “guarantee money”). The brokerage, having conducted the Short Sale transaction according to a written arrangement with the Short Seller, issues a “margin call,” meaning “pay up now.” The Short Seller must come up with enough cash to cover the margin call, or get caught in the “Short Squeeze.” Even if a personal loan is required, the cash must be paid, under penalty of law.

What if Short Sellers “borrow” more than 100% of outstanding shares? Impossible, you say? Mathematically, you are correct. Legally, you are correct. Morally, you are correct. But it is done frequently. And illegally. It is done so frequently it has a name, “Naked Short Selling.”

Here’s where the recent GameStop (GSE) story begins. In last week’s case, many of the GSE shares “borrowed” did not exist. The number of shorted shares was at least 40% higher than the total number of shares available. That illegal Naked Short Selling activity caused a panic when buyers began to bid up the market price. Similar to a “run on the bank,” the Short Sellers were required to execute panic share purchases to cover their short positions. Ironically, their purchases enhanced the price runup, and they lost billions.

As you might imagine, many of these self-important Wall Street Insiders were not about to take that lying down. So, who was the object of their ire? The “little people,” who talked and traded on Robinhood, Reddit, etc. My premise is very simple. The losers have only themselves to blame. (Note to the SEC - Stop allowing illegal activity in the market. Note to the Short Sellers who lost a fortune or two – no one feels sorry for you.)

The bottom line on the GSE/Robinhood story is simple; “little people” made lots of money legally, and Wall Street Insiders lost that money through illegal practices. Karma? Redistribution of wealth sometimes looks more like poetic justice.

Van Wie Financial is fee-only. For a reason.