Bogleheads on Investing-Episode 42 transcript

Spencer Jakab is the Editor of the “Heard on the Street” column for the Wall Street Journal and the author of two books. His new book is “The Revolution That Wasn’t: GameStop, Reddit and the Fleecing of Small Investors,” which is the topic of our conversation. Previously he wrote “Ahead of the Tape” published in 2015. Prior to joining the WSJ, Spencer was an analyst and later a director of emerging markets equity research at Credit Suisse.

Back in 2020, when millions of mostly young people opened brokerage accounts for the first time while sheltering from the Covid-19 pandemic, it seemed like they could do no wrong, even as some legendary investors could do no right. But that all changed after a climactic battle between the haves and have-nots during January 2021. In this surreal interview, we look back over the rise and fall of meme stocks, young and wild Robinhood traders, COVID checks and easy credit, and the Reddit revolution that wasn’t.

Episode 042- guest Spencer Jakab

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Rick Ferri, January 27, 2022

Rick Ferri: Welcome to Bogleheads on Investing, podcast number 42. Today our special guest is Spencer Jacob. Spencer is the editor of the Wall Street Journal “Heard on the Street” column and the author of a new book “The Revolution That Wasn’t: Gamestop, Reddit, and the Fleecing of Small Investors.”

Hi everyone, my name is Rick Ferry, and I’m the host of Bogleheads on Investing. This episode, as with all episodes, is brought to you by the John C Bogle Center for Financial Literacy, a 501(c)3 nonprofit organization that you can find at boglecenter.net. Your tax-deductible contributions are greatly appreciated.

The Bogleheads were formed in 1998 on the Morningstar message board before moving to its current site at bogleheads.org. The founder of the Bogleheads is Taylor Larimore. Taylor is a highly decorated World War II paratrooper from the 101st Airborne Division, where he fought in the Battle of the Bulge. He is 98 years old this month and on behalf of all the Bogleheads, we wish you a happy birthday and many more.

One year ago this month something phenomenal happened in the stock market, that was called by some the Reddit revolution. Millions of individual investors, mostly young men, banded together on a Reddit message board called Wall Street Bets to take down a couple of large hedge funds who had gone short companies that they thought were down and out. The phenomenal story of what happened next, and the ultimate demise of many of these small investors is a fascinating tale. Here to tell us about it today is Spencer Jacob.  Welcome to the podcast Spencer.

Spencer Jakab: Thanks for having me Rick.

Rick Ferri:  It’s a real pleasure to have you on this podcast.  I’ve been following a lot of your work, including your previous book, and this book is really interesting.  I put it up there with Roger Lowenstein’s “When Genius Fails” which talks about Long-Term Capital Management [LTCM]. Here we are twenty-five years later and  something new on Wall Street, but before we get to your newest book, “The Revolution That Wasn’t” talk about your background and your past. How did you get into the Wall Street Journal and writing books? And tell us a little bit about yourself.

Spencer Jakab: Well first of all, thank you very much. I’m blushing to be compared to the author of When Genius Failed. It’s one of my favorite financial books, a great account of the whole LTCM debacle. Lowenstein takes this really complicated thing and puts a human face on it and simplifies it. And that’s what I always try to do when I write. And so if I accomplished anything on that scale that’s great.

Back when LTCM happened, when that story happened, I was a director and later became a managing director in equity research at an investment bank. I was working in emerging markets. A year or two in emerging markets is like a dog year. You see a lot of stuff; so what you might see once or twice or three times in a career on normal Wall Street you’ll see ten times in emerging markets.

You saw panic and euphoria and all kinds of crazy stuff. And crime and whatever, and that’s what I spent the first ten years of my career doing. I ran a team of emerging market analysts at Credit Suisse and I just got bored with it. You know, I found all this stuff really interesting and more and more I just found myself managing people and talking to clients. And I had saved money. I was pretty frugal.  Said what I’d really like to do is write about it and I wondered how I could do that.

And I met a woman on a plane who was a long time Wall Street Journal reporter. Two days later I was in the office speaking with her. Three days later I was writing my first column for Dow Jones newswires. I wrote several pieces for Barron’s magazine. I worked for the Financial Times, and the last ten years I’ve been a columnist at the Wall Street Journal where I run the Heard on the Street column, which is our financial analysis and opinion column. It’s fourteen people around the world. I love my job. It’s much more interesting than being an analyst. Unfortunately, it does not pay as well, but yeah, I get to write books on the side which is also nice. And then this is my second book and the latest one.

Rick Ferri: One of the things that interests me about you is you were heavily involved in the dartboard contest, basically Burton Malkiel saying,” You know, monkeys throwing darts at a dart board would outperform most of the active managers.” Can you tell me about that whole contest at the Wall Street Journal.

Spencer Jakab: Well Burton was very kind to write a really nice blurb for this book, and the dartboard contest is something that ran for many, many years. When I was in graduate school at Columbia University I was introduced to it, and that was towards the tail end of the original dartboard contest.

So he said in “A Random Walk Down Wall Street” that monkeys throwing darts at the dartboard would do as well as mutual fund managers and he’s basically correct. They actually do better because monkeys are free, or don’t cost very much, and so we decided to revive that. And you might be aware that every year there’s a big hedge fund conference in New York city called the Ira Sohn Investment Conference, where people pay five thousand dollars to be there. And they’ll invite journalists for free, but five thousand dollars to be there sitting in the room when Bill Ackman and all these other people– and a couple of characters who show up in this book by the way–go and give their best ideas. And they’ll say “I like this stock” or “I don’t like this stock,” and the stock will move immediately.

I wonder how those do in the long run, and I wonder how we would do throwing darts at the stock listings. And those don’t exist in very many papers anymore. Barron’s magazine, our sister publication, still does it. So I got my whole team and bought darts at Modell’s [Sporting Goods] on 42nd Street for $9.99. They had no monkeys, so we had to do it. And yeah we did it two years in a row. Both years we beat the pros by an embarrassingly large margin. I remember the first year it was 22 percentage points and not only did the pros not beat us but they didn’t beat the market in either of those years, and they generally do not. And it just illustrates a deep truth about investing, which is that there is such a thing as expertise but it’s very, very hard to find and you’re better off usually not really chasing it.

Rick Ferri: And also, why would they invest your money if they’re really that good, right.

Spencer Jakab: And for that matter, why would some stranger with a pseudonym on a Reddit message board, which is the whole phenomenon that I’m writing about in this book, have any good advice, and it might even be self-serving advice. You don’t know who that person is.

Rick Ferri: Well, before we get into the book–and we’re going to go through the book because it is a great story– we need to define some terminology and define who the players were, who the companies were, who the characters were in the story because listeners may not be familiar.

Spencer Jakab: Yeah.

Rick Ferri: The first thing that comes up is a mem stock: m-e-m-e . What is a mem stock? Did I say that? By the way, is it a meme stock or is it a memstock? Pronunciations vary. I think meme might be the more common. I think mem is technically correct and meme is the more common one.

Spencer Jakab: What is a meme? First of all, meme is something where it’s a picture from a movie or some cartoon or just some humorous illustration that instead of words you use that picture perhaps with some text attached to convey something. So like you’ll take a movie poster and you’ll change it to make your point, or to make a joke. And so memes or mems are something that young people love to descend around. I’ve got three sons and my youngest recently informed me that I can’t make a meme because by definition I’m just too old. I showed him some funny thing on my phone. He said that can’t be a meme because you said you showed it to me. It’s therefore not a meme.

But people on these message boards love to exchange memes. They love to kind of convey messages in them, and so the meme stocks were a bunch of down and out stocks, companies on the ropes, some going bankrupt that star in this episode.

Rick Ferri: Okay now Elon Musk sort of made a famous quote in this book and I recall him calling one of those stocks, the stock was Gamestop, but he called it Gamestonk, s-t-o-n-k. What is a stonk?

Spencer Jakab: Let’s say you’re a young person and you don’t think that the stock market is very cool but you think it’s kind of fun to dabble in it. Then you call it a stonk, and a stonk is something that you kind of buy as a joke that you don’t take too seriously. And there is a meme about people buying stonks. It’s like a really crude drawing you might see if you just google it. Do stonks, you’ll see it’s like a computer graphics circa 1993 or whatever, you know of a guy standing there with an arrow going up and the chart behind him and that’s where the stonk thing comes from. And he — that tweet of his which was I remember what it was it was 4:08 pm on January 26, 2021 set the financial world on fire. This episode was going on, it was already a crazy, crazy story and because he’s so widely followed, especially among this cohort, it was like there was this forest fire and then he just dumped a ton of nitroglycerin on top of it. That’s kind of what his tweet did.

Rick Ferri: Okay the next couple are I’ve been around a long time. There’s a lot in the book and a lot of the story is about the shorts. The people who are shorting this stock, or did short the stock. And so, just for listeners’ clarity, what’s shorting a stock? What does that mean?

Spencer Jakab: Well, shorting a stock. I’ll tell you what it is and I’ll tell you why it’s especially important here. Shorting a stock is the opposite of what most people do, you and I do with funds or with stocks. We buy them and we hope that they’ll go up in value and pay a nice dividend. They do the opposite, and they’re not evil because they do that, but they’re basically making a bet that a stock will go down in value and the way to do that generally is to not own the stock but to borrow it from somebody. Usually you’re borrowing without them even knowing it. You just go to their broker–it doesn’t, it’s not illegal or nefarious– and you then sell it to somebody else. So you benefit from the price going down.

Rick Ferri: But like if I go out and buy a share of IBM the worst thing that can happen is tomorrow IBM is mired in an accounting scandal and the share price goes to zero and I lost all my money. The best thing that can happen is that it’s worth a trillion dollars tomorrow and I make a lot of money. But they [shorts] face the opposite situation, where if a stock starts to go up they start to lose money. And since they tend to move in packs, if a stock goes up unexpectedly for no reason, or for some reason, there’s something called a short squeeze, which happened here, and that’s probably an understatement here. It’s like a bunch of people being in a theater and there’s one door where they can get out, except this theater was on fire and some people lit the fire on purpose. It wasn’t something that just was in the news. They doused the whole place in kerosene. They agreed to do this on the internet, and these guys all have to go out, and there was only one exit door and they all trampled each other and one– some funds lost billions of dollars– like some of the most respected funds on Wall Street lost massive amounts of money and it was all part of the plan. And they had to buy the stock no matter what.

Rick Ferri: Right. You either buy it back or go to prison.

Spencer Jakab: Correct That’s the old saying. Yeah he would sell what isn’t his, must buy it back or go to prison.

Rick Ferri: Okay now one more thing. I mean, so we talked about shorting stock and thank you for that explanation. And let’s talk about call options. What are call options and how do they affect the price of a stock?

Spencer Jakab: So call options play a big role in this story too. And call options are basically a contract between you and somebody else. A call option is saying let’s say the stock is at a hundred dollars that you are interested in. You say, “I’m going to give myself the option of buying it at 110 dollars in a month. I’m going to write a contract with you and it probably won’t get to 110 dollars in a month, and you sell me a contract” You say, “Okay that’s a deal, I’ll sell it to you at 110 dollars a month.”

Let’s say that this company cures cancer and it goes to 500 dollars. Well I still get to buy it for 110 dollars because I signed that contract with you. So I make the difference. I probably put down a tiny amount of money for that contract and I get all the difference in price, so it’s almost like a lottery ticket, at times, that you can buy. Now that’s not the main way that they’re used, but it is the main way that they are used by this newest class of investors as a purely speculative instrument.

There are also put options which do the opposite. It gives you the option to sell, but the person who sells you the option is taking a pretty big risk, right? That company cures cancer? They have a big problem. So they have ways of protecting themselves. They’re not in the business of taking that risk, so they do things. And the things that they do play a role in this story as well.

Rick Ferri:  And the seller of the option gets a small premium, and most of the time these options just expire worthless, correct?

Spencer Jakab: Options are seen as the ultimate retail investor sucker’s bet. And during the time that this story takes place, tens of billions, record-shattering amounts of call options were purchased by people who were mostly not very sophisticated at all.

Rick Ferri: Okay ,so we did mem stocks, we did what a stonk is, shorting stock call options. Now we can get into companies involved in this story. And the first company we have to look at is Robinhood. Who is Robinhood?

Spencer Jakab: So Robinhood steals the rich to give to the poor. Great name if you want to be a financial services company for young people. It’s a great name for a company. It’s a great idea for a company. They have a great app. The year that it came out, in 2015, it won app of the year. It’s slick, it’s intuitive. It’s a brokerage house, but it’s really an app with a broker attached to it. That’s how I see it, as opposed to whatever broker most people on this might use, where they have a brokerage and then there’s also an app that they can use for convenience. The story is backwards. They designed this app. They showed it to people, and they had a huge waiting list before they even had it going. Mainly college students and people in that age group.

Rick Ferri: Somebody mentioned it as the gamification of stock trading.

Spencer Jakab: It is. That’s the criticism that this company has come under. They said, “We want to make investing fun.” 

But I don’t think that it’s any accident how fun they made it. For example, when you use Robinhood you’ll occasionally get confetti on your screen. And that they’ve disabled this since, because of criticism, when you open a Robinhood account –and they still do this– you get a free share of stock. What stock? Well could be a five dollar stock, could be a $200 stock. Who knows? It’s like a lottery ticket and some people go in and open accounts with 20 bucks or 50 bucks. So you put 20 bucks into an account and you’ve got a $200 stock. That’s a pretty nice gift, especially if you really only have 20 bucks to your name. You just made ten times your money. So usually you don’t, but it’s like a free little lottery ticket, like a scratch-off card, and there’s a psychological lure to that. And you open up Robinhood and see what’s trending. Like hey these are the ten things that people are talking about. That these are the stocks that are up a lot or down a lot.

Now why is that important?  Because especially if you’re a young person, something that everybody else is doing and into– just like when you go on YouTube and you see what’s trending, right, you kind of fear missing out. You’re going to see what the whole excitement is about, right. Things go viral and things go viral in the stock market too, and that virality is a big, big part of what’s going on.

Rick Ferri: Now, Robinhood from what I understand, they don’t charge commissions on these trades.  So how do they make money?

Spencer Jakab: So these two young men, and their names are Vlad Tenev and Baiju Bhatt, who got together to start this company. They had a little business helping hedge funds trade. And they said, ”You know what? It’s incredible that trading costs almost nothing. It basically has become free. You know, you just hook up to a computer. We could do that for people.” And they weren’t the first company to realize that you could do this. There were a couple of companies that came before them that said, “Hey we’ll have zero commissions.” But they were the first to really make a success of it.

That sounds crazy, right, because there’s the old story about well how much did you pay for that watch? Well I got it for below wholesale. How does a guy make money? So he sells a lot of watches. That is kind of what their business sounds like because they’re giving away trades for free and trading still costs something. It costs a lot less than it used to but it still costs something, so how on earth do they make money?

And the way that they make money is part of the problem here. The way they make money is that they get money for those trades – instead of sending it to a stock exchange they send it to a wholesaler or a market maker that takes the trade and executes it. Doesn’t rip off the customer by any means. They do it legitimately and then they will pay the broker who sends them the money because the market maker can shave some fractions of a penny off for themselves and then they’ll pay something to the broker that sent them the order and the vast majority of Robinhood’s money has been made that way. By getting paid by the broker.

And what does that mean? That means that they’re not making money doing other things, providing other services to you.They’re making money mainly in two ways. They’re lending you money on margin, so lending you money so you can borrow against your stock portfolio and speculate more, and they’re selling your orders so they want you to trade a lot, and they like it when you trade a lot and so the whole app is, according to lawsuits filed against Robinhood, is just designed to get you to trade a lot and we know from many, many, many studies that the more you trade the worse you do. The more you check the worse you do. People on Robinhood check their account eight times a day on average – on average – and some people are constantly on the app, they can’t put it down.

Rick Ferri: And I also read in your book that they trade forty times as much volume of shares based on the amount of shares they have in their account as somebody at let’s say Schwab or Fidelity would.

Spencer Jakab: Yes that’s right.

Rick Ferri: Yeah, well okay let’s go to the next one which is this middleman who they sell trades to.

Spencer Jakab: And here’s where some confusion comes into the story and many conspiracies have been hatched from this. There’s a company called Citadel LLC. So Citadel is a hedge fund founded by Ken Griffin, who’s one of the richest men in America. He started trading from his dorm room in Harvard University. So he’s precocious and he actually made money in the 1987 stock market crash, believe it or not, from his dorm room. Very, very savvy guy. And he had this business that was pretty small some years ago, that after the financial crisis started to get bigger and bigger, which is called Citadel Securities, a separate business from his hedge fund, but also called Citadel. And it is now the biggest middleman– like this not a stock exchange– but executing orders mainly for retail investors, not just at Robinhood but at other brokers too.

There are other companies in the business you’ll hear too – Susquehanna – but they’re they’re number one and Ken Griffin is kind of– especially by the people who felt a bit bitter about this whole story that I tell– is kind of the Darth Vader of the episode. He’s kind of some kind of dark lord who has his hand in everything, supposedly, and made this whole thing happen. Which is not true, but you know it’s easy to see how that story was concocted because he did make a lot of money. This business, Citadel Securities, is private. It recently got an investment valuing it at 22 billion dollars and he is by far the largest shareholder of this company. So it has been a very, very profitable venture for him.

Rick Ferri: Last is Reddit. What’s Reddit, and what is Wall Street Bets?

Spencer Jakab: So Reddit is a social media company. It got started by two young men in a college dorm room– and so many tech companies do– at the University of Virginia. It’s Steve Huffman and Alexis Ohanian. They call themselves the front page of the internet. It’s different than other social networks in a lot of ways. To just to be clear, I like Reddit as a user because there are about a hundred thousand communities on there, but anything you might be interested in. Reddit is one of the kind of the few things in social media that I really sort of think can be good, and a good sense of community, but it also was the perfect breeding ground for this crazy story.

It has a bunch of subreddits where people with very narrow interests and very similar mindsets can gather and exchange advice, exchange stories, using pseudonyms so you don’t know who anybody is. It’s not like Facebook or Twitter where you use your own name, or usually use your own name, and then people follow you. Or Linkedin, or something like that. You have this pseudonym and the comments that you see are the ones that are upvoted, where humans say, “Yeah I like that” or “No I don’t like that”. They down vote it. So something that gains the approval of these groups moves up. And in this particular case there is a one subreddit called Wall Street Bets that found itself at the center of this, it found itself at the center of the investing universe as a matter of fact. Stocks that it was talking about, Gamestop in particular, became the most traded stocks in the world, and these are not big companies, and they became the most traded stocks in the world.

Rick Ferri: So we have the terms. We have the companies involved, we have some of the people–the timing of all of this is important too with covid and stimulus checks and so forth. But go ahead and now start the story, ready to go.

Spencer Jakab: So as you know I’m an editor at the Wall Street Journal. When something happens in the stock market I tend to see it at least out of the corner of my eye. Starting about a year before the story took place I became aware of Wall Street Bets, and you know you would see some stock go up 100% in a day, and let’s see what news happened. Well there’s no news. The news was that they were talking about on a Wall Street Bets and particularly if it was a  smaller, less traded stock that surge of interest where everybody kind of jumped on the bandwagon at the same time for a few hours could send a stock up. It was just all seen as a joke at the time, at least around where I work it was seen as a joke. I think it was seen as a joke on Wall Street too. Of course there were probably some people who were trying to ride the coattails, who were in the business of managing money, but you had to be pretty quick to get ahead of these guys.

Then the pandemic happened. And stimulus checks and the lack of sports, and the lack of sports gambling, all happened at the same time that supercharged the number of accounts, and the activity level of people who were new to investing primarily. And those people were getting their advice on Wall Street Bets. So let’s fast forward though. Let’s go past all the things, the ingredients, that made this possible.

It’s the morning of January 25th 2021. I have three boys, my oldest was a senior in college at the time. His return to college was delayed by Covid. I was at home editing an article for the next day’s Wall Street Journal, at home because of Covid. We’re all at home and he comes over and says, “Dad, are you going to write something about Gamestop?” It’s like, “well why would I write something about Gamestop?” I think I’ve driven him to Gamestop about a billion times in his life. I mean why would I write something about it? So I take a look at it. GME is the ticker. I put it in oh it’s up, it doubled in the last two days.

“So what made you ask about it?” 

He said,”Well my friend Sean bought it. It looks like Wall Street Bets is talking about it and that’s why it’s up.” 

I said, “Well that’s great. Well this usually kind of lasts a day or two. I think he should sell.” 

He said,”No, no he’s not going to sell.”

“So what do you mean he’s not going to sell.”

“He’s not going to sell because these people online are all agreeing not to sell.”

And it took me about ten minutes of research to see that something extraordinary was going on. Now we mentioned earlier in the show what short selling is. Well people on this bulletin board had, on Wall Street Bets, had figured out that this was one of the most shorted stocks out there, with good reason, you know, based on how the business was going. But there was so much short interest, that it was more than the number of shares available to trade – to purchase – which is possible and for that reason they had devised a scheme, and it wasn’t even a simple scheme, to basically buy the stock, not sell it no matter what. Keep on buying, and hundreds of thousands of people were joining this forum every day and seeing this message and that they were seeing what was happening to Gamestop, and there was this avalanche of buying by young investors on Robinhood and other brokers. but Robinhood was the biggest one that played a role.

And Rick, if you and I both had investment funds and we were to try to do this – you know we talked on the phone or whatever and agreed to do this to a third fund – the SEC would show up at our door. You can’t do that, creating a squeeze through collusion is not legal anymore. It was in the old days, you know, the Vanderbilts and whatever, before there was an SEC. It’s not legal now, but what these people were doing was a huge loophole to that because they were doing it way out in the open. They had been talking about it, just nobody was – nobody put a suit on every day was reading about this plan you could go back and look at the messages and see that they were very specifically talking about it and really understood what they were doing because a few sophisticated people on this board explained to them how to cause this thing to happen.

And it just built on itself and became huger than they even could  imagine. You know they called it “bankrupting institutional investors for dummies” and it is the craziest thing that I’ve ever seen. And I do tell the story bit by bit in the book. I mean it’s not just a crazy story, it’s also a lesson in finance, and a lesson in economics and it’s a lesson in generational attitudes.

Rick Ferri: One of the main characters in the story, one of these people on that message board, was a fellow by the name of Keith Gill ,who goes by the name of Roaring Kitty. Plus another name, but I won’t use any derogatory names on this show.

Spencer Jakab: That’s right.

Rick Ferri: But how does he get involved in all this?

Spencer Jakab: He is the most interesting person here, and in a book full of interesting people. Keith Gill, 34 years old at the time that the events take place, is of that generation but very, very different from it in many ways. He’s a chartered financial analyst, which is a difficult financial certification to get, takes about a thousand hours of study for most people. He worked for a financial firm, MassMutual. You can track his online presence and his video presence on Reddit and on YouTube way back to the beginning of this story.

But at the beginning he was kind of ignored and ridiculed even. So he decided that Gamestop was worth a lot more than it was, and you know he made some pretty good arguments. He is financially sophisticated and you know when there’s a value investor that makes an argument that says, “I think the stock is going to go up .” They’re never sure, right, and he wasn’t sure. But he had a pretty good feeling that the stock that he was buying for four or five dollars was worth more like ten. And he was making an argument to anybody who would listen.

And Michael Burry, the famous value investor, saw it at almost the same time as him and jumped in. Michael Burry became famous through Michael Lewis’s The Big Short, another fantastic book which tells the story of a handful of people who made a bundle by betting that the housing bust would happen and that mortgages would implode. And so yeah a very, very smart guy and and so the first message that we see, the first public mention, the first public appearance of Keith Gill, is being upset that Michael Burry had bought into it because he was buying these call options in the stock, very long dated call options that would pay off a couple of years in the future and Michael Burry had shown up and publicly said he was buying the stock and then it made the stock go way up.

It doubled the value of the account of this guy Keith Gill. Well, if you’re a guy on Wall Street Bets and you just doubled your money in a couple of months what do you do? You’re like, “Hey I doubled my money. I’m going to sell this and move on to the next thing.” And Keith Gill did the opposite and people were making fun of him like, “what, you know what’s wrong with you. Remind me when you lose all your money.”  And he had bought call options that could lose all their value. So he could have wound up with zero.

Rick Ferri: And he called this by the way “yolo,” an acronym.

Spencer Jakab: And yolo stands for “you only live once”. It’s really a rallying cry of this new generation of investors. Like let’s take a huge, huge risk and he was taking a huge risk because he’s not a rich guy, and he’d gone from having 50 something thousand dollars to 100 something thousand dollars. So he had more than doubled his money and people are like, “You idiot, why aren’t you selling?” and he said,”No, no no that’s not how you do it.” And he was writing like a basic behavioral finance professor and these guys just did not – he was just pilloried for the most part on this bulletin board and he would make videos later and then maybe twelve people would watch the video. He’d talk about Benjamin Graham and stuff like that. Like it was his references were going over everybody’s head.

He was just a guy who was pushing the stock for a long long time until other people discovered him. Discovered that the stock was prone to a short squeeze and they did it during a very particular moment in history when all the ingredients came together in a perfect storm. And he went from being this sort of, this you know, seen as this fuddy-duddy, to being a hero. And nobody knew his name. Nobody knew it was Keith Gill or who he was. They just knew him by this obscene name that he used on the bulletin board and by the Roaring Kitty name that he used on YouTube. They had, there’s no connection to his expertise or who he actually was. He was just a guy.

And he changed his message, too, from being cerebral to being to posting memes to posting all kinds of you know change movie posters. He was really kind of hip and cool. And after a while all he did was just post a screenshot of his E-Trade account which every time he posted it he still hadn’t sold and he went from having 50 grand to 100 grand to a million to 2 million to 3 million back to a million, so he’d lose a couple of million dollars and he just stood pat and people couldn’t believe it. They couldn’t believe how – how gutsy he was – and by the time our story ends at one point he had in excess of 50 million dollars in this account. Life-changing money, a thousand times what he started with, and he was just a hero, just for holding on, and those posts, by the way, had an important psychological effect too. Because it’s called social proof. You know you want to follow somebody who’s made a lot of money. They must know what they’re doing.

Rick Ferri: And so also during this period of time, as you mentioned, sports betting went down the tubes. March Madness was canceled. In March, at the same time, stimulus checks started coming out. I think there were three rounds of stimulus checks. One of them came out for $1200 in April of 2000, and then there was another $600 in December of 2000, and then in March when March Madness was canceled there was a distribution of another $1400 and that caused some people to – some young people to do some kind of wild and crazy things. Talk about John Motter. Who Is John Motter?

Spencer Jakab: So John Motter is somebody who I introduced in my book. He was interviewed during the peak of this squeeze because some reporters in the Los Angeles Times went out and they were looking for real people, not just people with the screen name, who were doing this. And this guy, John Motter, is pretty interesting because of just the way that he talks about it. He represents a certain not very small subset of this group. He said that he bought the stock, he didn’t have a lot of money and he didn’t care if he lost at all. They said he would buy magic beans for a man on the street if they could be used to bankrupt some hedge fund billionaire. That was the goal. So this is a group where – and especially the people who are late to this, not early to this but late to this – so he bought in that week, not weeks or months earlier, who wanted to use Gamestop and the other new stocks as a weapon to weaponize it to harm Wall Street. To hurt these hedge funds.

And it sounds strange but you have to understand. I do have kids in this age group. What’s their experience? I did not lose my house when the financial crisis happened or my job, but a lot of people did, and my kids don’t have burdensome student loans, but a lot of young people do, and they struggle to pay them back, and they see Wall Street as a bad place full of bad people. And so hey here’s a chance to hurt some rich guys on Wall Street you know that it’s a hedge fund or whatever. Like what they fail to understand is Wall Street’s a very big place, and Wall Street will gladly accept their business, including John Motter’s business, for however many shares he bought of Gamestop and say thank you very much.

So he exemplifies this group that – it’s like any movement,a religion or political movement, the people who join it on the late side are the most enthusiastic. They’re real believers in the mission and so this went from a way to make money to a way to hurt Wall Street and for a lot of people that’s what it was and that’s when it moved into the political realm.

Rick Ferri: As we move along here the stock is going up, more people are jumping on, more people like John Motter are opening up millions of Robinhood accounts with a little bit of money, a thousand bucks and then they’re able to borrow money and buy a little bit more stock. So you’ve got this huge influx of new investors – very unsophisticated investors – who are just buying just to buy because everybody else is buying and maybe it’s their opportunity to either make money or to punish those who they think should be punished. Whatever the reason is, at the same time the shorts are getting squeezed and so they have to buy and at the same time you’ve got people like Keith Gill – Roaring Kitty – who was out there buying options and when you buy options, as you described earlier, the option seller, the people who are selling you the right to buy it from them at a higher price have to hedge themselves so they’re buying stock. So everybody’s buying stock. But there’s only so much stock outstanding.

Spencer Jakab: That’s right, that’s right.  There’s only so much stock and so when you have a short squeeze, which also turned into a– it’s called a gamma squeeze when you affect it through the options market– then their buying goes crazy. Now Keith Gill, just for the record, he had bought his options long before. He was not buying more during this time. It would hardly have mattered because there was just so much buying going on. But he was the hero, he was the exemplar and he had bought options. And so a lot of people bought options and options are like, you know Warren Buffett called them weapons of mass destruction, just tongue-in-cheek, but they really kind of were weapons of mass destruction in this case because it’s like a suitcase bomb.  You could take something very, very small – a small amount of money in this case – and you could have a really outsized huge impact if you wanted to just use it as a weapon. If you bought an option on a stock that was way out of the money, so basically had a very small chance of paying off and also that the date that that option would expire was very, very close then it’s like you’re buying a lottery ticket.

But once the stock starts going up the person who sold you that lottery ticket all of a sudden turns around and says, “Oh my god, I need to, my computer says I need to go buy this many shares of the stock.” And the higher it goes the more and more share every dollar of increase is a greater increase in the number of shares they have to buy to cover themselves and some smart people on the bulletin board knew this and that gave these young people way more bang for the buck.

Rick Ferri: This stock starts kind of creeping up, it never has its ups and downs but it’s going up generally, so there’s a short squeeze. More people are piling on.

Spencer Jakab: It had been going up and in the fall another person showed up, another young cool person whose name is Ryan Cohen. Ryan Cohen was the founder of Chewie.com, where – I’m a happy customer of Chewy.com, buy things for my dog. It’s a pet goods retailer – he was no longer associated with it at the time but he had a big pile of money from selling it and he showed up and said, “ I bought you know five percent of Gamestop then it was 10%, then it was 12%. I want the board to change this, and his appearance really set things off further. Where they saw this guy who had deep pockets who knew a thing or two about e-commerce and about retailing. Maybe he actually could come in and turn the company around.

And first the company was kind of humored him, and then they gave in to him and then he, in January 2021, he put himself and two of his former colleagues on the board of Gamestop and caused a bunch of other people to step down. That kind of really, really lit the fuse for this. That’s when the stock really started going up. And then you had this very high level of short interest and the short sellers started to really notice and to panic and there was a real deer in the headlights moment.

And then one short seller in particular showed up and did not help his cause at all. There are some short sellers who are dedicated to the business, but fewer and fewer. It’s like a sort of  Last of the Mohicans kind of thing. He is one of the Last of the Mohicans, he is an activist short seller. He specializes in finding companies that he thinks are overvalued or perhaps even fraudulent and sells the stock short and then writes a report and tells the whole world about it and why he did it. And he’s done quite well for himself doing this. And he miscalculated in this case. He went out and he sold Gamestop stock short when he saw how much it got up. And then went on twitter and told the people on Wall Street Bets that he understands short interest and they don’t and they’re quote-unquote “the suckers at this poker table.” Well what do we know about poker? Let’s say you’re a really good poker player and some five drunk tourists with way more money than you show up and start playing poker and throwing money around and doing unexpected things like playing hands the way that they shouldn’t be played. You know you might lose all your money if you really put all your chips into the pot even though you technically know more than them and that’s what happened. Basically five million people showed up to this poker game, not five, and he got run over.

But it was like waving a red flag at a bull, what he did he really set them off by saying this. And he became public enemy number one. First the public enemy had been a guy named Gabriel Plotkin, who was a hedge fund manager, who was the one person who they knew for sure through some securities filings, had heavily sold the stock short and he was like a normal hedge fund manager. He also owned stocks mainly, but a really successful guy. One of the highest paid people in the financial world period. He made over 800 million dollars personally in 2020 so he was a real star.

But then the attention turned to this other guy who was more hateable I guess, and they had already had a couple of run-ins with him on the message board, so he became the public enemy and that’s when it went beyond the point of no return, when it absolutely went crazy.

Rick Ferri: Just for a point of reference, on December 31st 2020 the stock closes at 18.84 and realize it was like trading at three dollars at the beginning of 2020. So it went from like three dollars something up to 18.84 and now we’re starting the year 2021 at 18.84 and by a few days the stock goes up to 65. So it basically doubles again within a couple of weeks. But then it really starts to take off from there.

Spencer Jakab: And mind you nothing had changed for the company. The company actually was having a terrible time.

Rick Ferri: They were announcing this, too. I mean they were putting their earnings out there and they were not good. If revenue was going down, earnings were not good. Fundamental standpoint, this company was in trouble.

Spencer Jakab: Yeah, but Rick, who cares, right. I mean it’s a meme stock so you know it’s like, so yeah and it went to 40 and 50 and 60 and that’s when the fuse was lit. First of all you had a tremendous upsurge of interest on this message board and a lot of people joining it every day. That’s when my son’s friend got into this for example. He was lurking there. My son, a couple of my sons, were lurking there too. Thank god they weren’t they weren’t buying this stuff. And then it took off. Then it went up and up and up almost every single day and it, that from there, it’s, it’s … the SEC wrote a report on this. It’s hard to disentangle whose buying made what difference. There was a lot of buying.

Rick Ferri: But in the end the peak price ended up being $483. So this stock went from – what did I say?

Spencer Jakab: You said three. It actually got down to two dollars and seventeen cents at one point less than a year before to 483 dollars. Same company not doing any better, doing worse as a matter of fact.

Rick Ferri: But on December 31st the stock was trading at a little less than 19 dollars. And within 27 days, the 28 days excuse me, it goes from 19 dollars to 483 dollars and the fundamentals were getting worse for the company.

Spencer Jakab: That’s right.

Rick Ferri: What happened to the efficient market here by the way?

Spencer Jakab: Well the markets are efficient in the long run, isn’t it? I mean what did Benjamin Graham say, and I think it’s kind of Benjamin Graham is quoted by the way by Roaring Kitty or paraphrased, but it’s, you know, the market in the short run is a voting machine, in the long run it’s a weighing machine. But it was a voting machine during this period for sure.

Rick Ferri: So all the short squeeze and these people buying call options and the option writers having to go out and hedge their position and buy stocks and all of these speculators coming in – millions at a time with small accounts – just jumping on the bandwagon, the stock gets all the way up to 483 dollars. And by the way, on that day 128 [dollars], who is it that does a feature story on who Keith Gill is? It’s the Wall Street Journal.

Spencer Jakab: Yes, that’s right, yep, yep, we were the ones who found him. Not me, a couple of my colleagues. They had done the detective work and figured out who he was and they found Keith Gill’s mom who’s a Wall Street Journal reader thank goodness. And she likes the Wall Street Journal and put them in touch and they interviewed him that day. It’s an incredible story. To me he’s a really sympathetic character. And so the next morning he was unmasked as Keith Gill from a suburb of Boston.

Rick Ferri: And the stock skyrockets even more, but there’s a problem that develops with Robinhood.

Spencer Jakab: Yes, that day is a problem.

Rick Ferri: All this trading when the stock going up and a lot of people doing it on margin, and doing it using options and everything else. It develops at what at that point was an unknown problem for Robinhood. And at three o’clock in the morning somebody gets a phone call, I understand.

Spencer Jakab: That’s right. So you know when you buy or sell a stock you know you say I sold 100 dollars worth of stock and the hundred dollars is in your account. Well it’s not really in your account because the brokers have a broker too so there’s a bunch of plumbing behind the system that has to to work and if it doesn’t work then the system fails. So it’s very important that everybody be liquid in that system. And if one broker fails then every other broker basically has to chip in and cover their shortfall. It does happen from time to time, but very rarely these days. Your accounts are insured by the way up to a certain value, but those other brokers still might have to chip in. So basically the agency that does this and looks at the risk said, “You have all these clients buying the same handful of stocks, buying not selling; they all have positions in them. A lot of them have borrowed money, some of them just opened accounts and you allowed them to buy the stock before their checks even cleared, and they bought options. They bought all the stuff. Now if this stock goes down sharply, which it did, if it goes down sharply you could be out of business. You could basically not have the money to pay us.

Rick Ferri: And that would’ve caused a domino effect on Wall Street – just like when Long Term Capital Management failed was the same thing, only this was with Robinhood.

Spencer Jakab: That’s right, this could be a totally different book. If that had happened this would be about like an LTCM or Lehman type moment, maybe not as big but pretty big. But can you imagine and this company had never raised a billion dollars in its entire history and they got a call in the middle of the night, 3:30 in the morning California time so it was 6:30 in the morning, three hours before markets open east coast time and they said, “Hey can you please send us three billion dollars?”

There’s no way they could send them three billion dollars so they panicked. They called in all their bank credit lines and they called their investors and asked for more money, but that was going to take at least a few hours and they went back to – it’s the Depository Trust & Clearing Corporation [DTCC], the agency that does this – they said, “Look, what if we don’t allow any more buying of these stocks. This list of stocks that everyone has been buying, or options in those stocks.”  And DTCC said, ”Okay, we’ll crunch the numbers again. Okay, it’ll be about 700 million dollars that you need to pony up.”  Which they could just about do. So it was a scary day for them and that’s what they did.

Now I don’t know what I would have done differently. Vlad Tenev is the CEO and he sent out some not dishonest, but not totally forthright messages to his customers about why they couldn’t buy the stocks. And what wasn’t completely clear is that they would be out of business, you know, if they didn’t do this. Later he spelled it out in great detail. He wasn’t lying, but he just wasn’t being totally open, and I guess when there’s a kind of a run on the bank in a sense you don’t want to panic people.

And so that’s what he did. But he instantly went from being this Robinhood hero, robbing the rich to serve his poor customers to having done a terrible thing. Basically there were – it’s to this day there are conspiracies that hedge funds called him up and told him he had stopped the buying because they were all about to be bankrupted.

Well Andrew Left and Gate Plotkin, just for two people who were known in the story, they had been out of the trade for days.They took their lumps. They lost a ton of money and they had skedaddled. They were no longer there and it just happened the system couldn’t get buckled, it couldn’t couldn’t deal with all the buying. Robinhood did too good of a job encouraging all this buying and Robinhood and social media made for a pretty potent combination that the system couldn’t handle.

Rick Ferri: Did anybody actually go short the stock on the 20th?  Because by the 29th this lost what, more than three quarters of its value, correct?

Spencer Jakab: Yeah and within a week it had lost 90 percent of its value and there were other people shorting the stock. We just don’t know who they are. You don’t have to say who you are when you short a stock, just like you don’t have to say if you buy a bit of a stock, you don’t just say who you are either. So there were a lot of people out there shorting the stock. I know people who were involved in this on the investor side, the individual investor side, and I know people who work on Wall Street, I’d send them a note saying, “Hey, I have this book coming out.” And a surprising number of them, like “oh yeah I saw that – I bought put options that day and I made whatever, hundreds of thousands of dollars personally.”

So people who were financially sophisticated were aghast and some of them leapt at this kind of once in a lifetime opportunity to make money on the back of these people. So rich, already rich people who I know got a lot richer. Bill Gross, who’s the bond king, made ten million dollars. He’s retired now. He’s a multi-billionaire and he sent out a memo, a public memo, that any of these people could have read explaining why they weren’t going to succeed. But then for good measure he just couldn’t resist, so he sold call options to these retail investors on the open market and he made ten million dollars and there are a lot of people like that.

That’s the story of this whole thing–is that Wall Street did great. Wall Street did great in many, many, many ways. Citadel did great. Robinhood had, after almost going bankrupt, had a pretty good month, right, and so did other brokers. So did Goldman Sachs. So did Morgan Stanley. So did everybody on Wall Street basically. Except for a few guys who were big losers.

Rick Ferri: And they did it on the backs of these millions of small investors who had a few thousand dollars, who were just chasing what they read in the revolution that wasn’t. Basically the Reddit Wall Street Bets board.

In the end, the aftermath, the House Financial Services Committee comes in, investigates. Did anything come of that?

Spencer Jakab: Well no. But the rules that might come out of it might be kind of unhelpful rules. So for example, payment for order flow which is how that kind of makes all this possible. You’ve got to pay for trading somehow – there’s nothing evil about it, it’s just how Robinhood exists – that came under a lot of scrutiny.  The SEC might crack down or change some rules about that. And the other thing is short selling– and the short sellers, you know, they’re just the victims here–and so they’re also likely to face some more stringent rules. So nothing, as usual, nothing helpful will come out of these congressional hearings and possibly some counterproductive stuff too.

Rick Ferri: Let me pivot here to a different topic, and that is: what’s the story, what’s the moral of the story here for investors? Because you do get into that in the last couple of chapters.

Spencer Jakab: Yeah. So I think there is a positive takeaway here. First of all, I’m not going to get into anyone’s politics in terms of whether they don’t like Wall Street or want to stick it to Wall Street, or don’t trust Wall Street. That’s fine you know, none of my business, but let’s say that that’s your attitude and you have this dual goal of making money and sticking it to the man. Well the moral of the story is that all of the financial and technological innovations that made this story possible– being able to trade for zero commission, being able to buy funds that cost 0.03% a year in terms of their expense ratio– all those things that have made investing so easy, so cheap, so transparent, all can work to your advantage too. All the things that the technologies that armed this group to do what they wanted to do actually arm this group to really do what they want to do.

Because – make a lot of money and to stick it to Wall Street. You know, if you don’t like Wall Street taking big fat fees out of  your account. If you don’t like them making a lot of money off of you period, there’s a perfect way to do that, which is just to basically buy a handful of index funds, check them infrequently, trade them infrequently, and just kind of be a free rider on the whole system. It’s like you can be a free rider in so many things in life, and you can on Wall Street too. I think that’s the moral of the story is that you can if you really feel strongly about accomplishing what these young people want to accomplish, this is the way. Not the way they did it.

Rick Ferri: Index funds, you know, I’m an index fund investor myself, and a lot of people listening to the show are index fund investors. They actually benefited from this in how – well there’s an awful lot of money that maybe that wouldn’t have come into the stock market from before, now that all these young millions of young people for the first time you know came into the stock market – all that money is coming into the stock market and if you own a total stock market index fund you owned Gamestop back when it was three dollars a share. I mean no more stock was issued so it went up in value in the index fund. All these stocks went up in value, all these meme stocks went up in value, and you actually benefited from that with this money coming in.

That’s really fascinating that all these young people lost money but you know actually I made money on it too, just being an index fund investor. Because all this now new money is in the market. But I’ll also want to make one comment on all of this. I’ve seen this before. By the way this is like a replay, if you will, of toys and Enron and you know things that happened during the late 1990s early 2000s during the the dot-com boom where people were just crazy, quitting their jobs buying stocks didn’t even know what the company did or where it was located or who the competitor. Didn’t matter, the stock is going up. That’s all they cared about.

This is like a replay of that, but where are those people now and I’ll tell you because I talk with them all the time. They’re buying index funds. They learned their lesson from this and hopefully if there’s a silver lining in this storm that occurred it’s that these people, these young people who are now, you know got burnt, who lost money and yes Wall Street made a bunch of money because of what they’re trading and what they did, whether it was altruistic or whether they were just trying to make money, however it was, the bottom line is these young people, I think hopefully if they’ve learned something, they’ll become index fund investors and long-term investors in investing the way they should be investing. So it’s a cheap lesson, a very painful lesson, but it’s spread across millions of young people. So my message here is I’m not so upset that this happened. I think it’s actually a good learning thing for a lot of people. Now I realize that a lot of people did get burnt pretty badly, but how do you feel about that message?

Spencer Jakab: Yeah. No, I basically agree with it. I’d give a little bit more of a nuanced answer to it. I think that there are people who are going to have a very positive outcome from this because they, maybe they weren’t interested in investing or finance at all, as many young people aren’t, and they don’t save enough and that’s the root of the retirement crisis is, it starts young, right, when you’re young and you don’t start putting money away. So some of them will have learned kind of a painful, but in the scheme of all the money they’ll make and save in their lives, not such an expensive lesson. And they’ll see the light and they’ll invest more conservatively and in forty years or whatever they’ll be, you know, fat and happy.

I think that there are a couple other groups that unfortunately might be larger. The hardcore of this group have attempted to make lightning strike a second and third and fourth and fifth time by doing all the things they did the first time around except now everybody sees them coming. You know these hedge funds are all, they’ve written computer programs to monitor these  message boards and so they’re not going to get caught with their pants down. And then there are people who are just going to sort of be bitter and throw in the towel. I mean don’t forget  when something traumatic happens to you, you might react the wrong way. I mean you think about people during the Great Depression, for example. That whole generation didn’t touch stocks again ever. It took a new generation.

So if it’s traumatic enough then you’re like: “the market’s crooked, I’m out of it.” And just say you would come back and be able to, you know, haven’t had a job during the Great Depression, and been able to save a bit of money. What a great time that was to invest. Right, I mean if you started investing in 1932 – 1933 you would have had really, really nice return, and you did the wrong thing by just walking away from the market overall. And so I’m afraid that that will happen. I hope it doesn’t. It’s important to be in the market, it’s a way to compound wealth. You know the stock market’s the obvious vehicle to do that.

Rick Ferri: Well, it’s been great having you on Bogleheads On Investing. The name of the book is “The Revolution That Wasn’t: Gamestop, Reddit and the Fleecing of Small Investors” by Spencer Jakab. I wish you a lot of success with the book. I highly recommend it. It was very entertaining, great book. So thanks for being on the show today.

Spencer Jakab: Thanks so much. I love your podcast. It was a pleasure to be on with you.

Rick Ferri: This concludes Bogleheads on Investing, episode number 42. Join us each month as we have a new guest and talk about a new topic. In the meantime visit Bogleheads.org and the Boglehead Wiki, check out the Bogleheads new Youtube channel, Bogleheads twitter, Bogleheads Facebook, and find out about your local Bogleheads chapter, and tell others about it. Thanks for listening.

Investment adviser, analyst, author and industry consultant

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