ELINA (Explain Like I’m Not Ape)

I’ve been seeing a number of posts that describe how I feel when trying to explain all of this to someone close to us. Namely that we come off as raving lunatics screaming about the end of the world and the one true path to salvation. Just typing that out made me scoff at myself.

The difference between us and some cult is that we have actual evidence to back up our claims. Not some fringe, poorly documented study on an amateur blog, but real documents and news reports from trusted sources. But even with definitive proof backing us up, it’s still nearly impossible to explain the GME situation (and the potential financial collapse hiding behind it) to anyone who doesn’t understand the stock market to begin with. The moment I have tried to go into detail with anyone in my family about this is about the point where their eyes glaze over more than Krispy Kreme doughnuts.

So what happens is that if we try to explain it in short sound bites, we come off sounding crazy. If we try to go into it in detail, we sound crazy and boring. So what’s an ape to do?

Well, I can tell you what I did between managing to squeeze two crayons up each nostril: I decided to write a form letter. Something that could be sent to anyone to try and sum up this shit storm we find ourselves clinging to our trees in as the winds bluster all about us. I knew it would have to be short, but not too short. Long enough to fill in a bit of background knowledge of what naked short selling is. It couldn’t include any references to Reddit, because while you and I know that we are getting some DD that is deserving of a Pulitzer prize, telling your friend that everything can be found at Reddit in a subreddit called ‘Superstonk’ is, sadly, going to subtract from whatever credibility you have left at that point. S Also, I knew that I would have to leave out all mentions of wives, their boyfriends, and those precious tendies waiting for us on the moon and beyond.

I also intentionally left out any links of any sort. You can add them if you like, but I wanted this to simply whet a person’s appetite, not stuff them to bloating with data. They need to become curious, to start doing research themselves. Apes help apes, but apes can’t make others become apes. They must choose that jungle path themselves.

So, without further ado, here is my proposed explanation. As always, this is not financial advice.

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You’ve heard about Gamestop in the news. You’ve probably also heard the term ‘shorting’ and maybe even ‘naked shorting’, but I didn’t figure out what these meant until recently. So if you’ve been faking that you know what it means like I was, it’s actually not that hard to understand.

Basically, imagine that I borrow your favorite necklace. It’s a nice vintage thing that you love, but I’m your best friend, so you loan it to me. Now, I know that this sort of thing is really hot right now, so I pawn it. Yeah, I’m a shitty friend, but I really needed the money. Besides, I’m pretty sure that this vintage necklace fad is going to pass, and when you finally ask for your necklace back, I’ll be able to buy it back for much cheaper than I originally pawned it for. And that’s what I do. The fad passes, I buy the necklace back for half of what I got for it originally, return it to its rightful owner, and everything is right in the world once more. Plus, I’ve got some extra cash from the whole ordeal.

That’s what shorting a stock is. You make money on a stock going down in price. The problem is when the stock instead goes up. You still have to buy that necklace back, but now it’s twice the price, so you’re losing money. The only thing that could make this situation worse is if the pawn shop sold it to someone else. Now it’s gone and I can’t buy it back to give it back to you, the owner.

This is called a failure-to-deliver (FTD) and is often the consequence of naked shorting, which is a little more complicated. But now that you know how shorting works, this should be an easy next step.

So, let’s say it’s the beginning of 2020 and you want to make some money. You find a company that’s dying. Has been dying for some time. Let’s call it Gamestop. The share price is down to the single digits. A pandemic has just hit and no one is going to stores anymore; they’re buying all their games off Amazon. Plus, you’ve done your research and know that Gamestop has hundreds of millions in debt that it must pay off next year in April, or it’s almost certainly going to go bankrupt.

What’s a savvy investor to do?

Well, you could short the company, just like I described above. You borrow shares that you don’t have to return for a whole year, sell them on the market, and wait for the death throes of the company before buying them back for pennies on the dollar, and then returning them to their original owner.

Problem is you’re greedy, smart, and have absolutely zero morals. So, it’s no longer a question of what a savvy investor would do, but what a bloodthirsty trader bent on sucking up the absolute most profit would do. And this is what they would do (and did).

Sell more shares of a company than they actually have. Now, I won’t go into how this is possible, but all you have to do is jump over to wikipedia to see that I’m not just pulling this idea out of my ass. It’s called naked shorting and it’s illegal and a quick way to make some serious cash. Infinite money, nearly, because what’s to stop me from selling hundreds of millions of shares that don’t exist if I know for a fact that I’ll never have to return them?

And how would I know this so assuredly? Because I’ll make sure of it.

When everyone wants to buy something, the price goes up. Just look at gaming consoles during their launch and the people who buy ten of them to resell for twice the price on eBay. Conversely, when everyone is selling something, the price goes down. Supply and demand. Basic economics, right?

So what happens when I flood the market with these shares? The price tanks. It drops and drops to $3 a share. $2 a share. I could get out now with a hefty profit, but I can make more. So much more. You see, if the company goes bankrupt before the due date when I have to sort out my naked shorts, then there are no more shares. They vanish. Like tears in the rain. Which means I don’t have to return shares. I don’t have to do anything except keep…

All. The. Profit.

But something unexpected happens. Gamestop turns around. Ryan Cohen joins the board (look him up if you don’t know who I’m talking about. He’s sort of a big deal). Regular investors notice this heavily shorted company and start buying up the shares. Lots of them. Because they see potential.

Now, remember what happens when everyone wants to buy something? The price goes up. And a position that was sure to gain you, the shorter, money is now going to see you losing everything. Because the potential loss is truly infinite.

What do I mean by infinite?

Well, let’s go back to that necklace story. I need to buy the necklace back from the pawn store to return to my friend, but let’s say that owner of the store figured out the trick I was trying to play. He knows I need this necklace back, at any cost, because there isn’t another one like it. Just like a person selling water to someone dying of thirst in the desert, he gets to name his price.

That’s where we are with Gamestop. The short sellers have naked shorted, lost, and now they need to buy shares to deliver them. They MUST deliver the shares that they don’t have, but since they can’t afford to right now, they keep using little loopholes to push the date back. They’re stalling, but eventually they will have to buy them back, and when they do, the price will rocket. This is called a Short Squeeze. It happened in 2008 with Volkswagen, pushing the share price from around 200 euros a piece to 1,000 euros a pop in just two days, making it the most valued company in the world for all of ten minutes.

This lead us to the world economy. Yeah, really.

The fact is that Gamestop isn’t a one-off. This naked shorting scheme happens all the time. Remember Toy-R-Us? Same thing, but they didn’t survive. And when shorter start getting overconfident and selling way more shares than actually exist, banking on the fact that they will never have to buy them back in the end, the house of cards starts to get very shaky. They are essentially writing more IOU’s than they could possibly ever hope to pay back.

The problem doesn’t end at the hedge funds (which are like investment groups), because the deeper you dig, the more you see that this system is rotten down to its very core. All the way up to the SEC, the DTC, and all those lovely acronyms that we all pretend to act like we know what they are. Basically, the government bodies that are meant to keep a handle on this sort of thing have all of their grubby hands in the same cookie jar. Everyone is liable, and the tipping point could very well be a colossal short squeeze, like the one Gamestop has the potential for.

With a short squeeze of enough magnitude, all those hedge funds that shorted Gamestop will have to buy back the shares AT ANY PRICE. If the shares go up in price enough, they get margin called (which is as good as going bankrupt for a hedge fund), and then their insurers will have to pick up the rest of the tab. If the insurers can’t manage, the buck then gets passed onto the government. The dominoes will start falling, and where that will leave everyone when this is all said and done is anyone’s guess.

I know this sounds like some horror story I pulled out of my ass to add a little drama to my boring life, but I’m telling you: read into this. Because I left a lot out here. Stuff like the LIBOR-to-SOFR transition that’s underway, which will uncover a lot of this nastiness, but the corrections will leave behind collateral damage. Then there’s Gary Gensler’s recent appointment as chair of the SEC (he was in the same position right before the collapse in 2008), and so many other moving parts that point straight at what I’m talking about.

I’m not telling you to go out and buy GameStop right now (though if you do, don’t use Robinhood. It looks cool, but they are a part of the problem). What I’m saying is instead of watching Netflix tonight, try and look up some of this yourself. If you’re going ignore me and watch a movie anyway, check out The Big Short. It’s got Christian Bale, Ryan Gosling, Brad Pitt, and even Margot Robbie explaining financial concepts in a bubble bath. It will give you an idea of what’s happening right now, though it’s different this time around.

This time, it's worse.