My son told me the following story:
A hedge fund manager is having his monthly breakfast with an old friend, who happens to own a gold mine.
Miner: Things must be going well for you this month. You’re looking awfully chipper.
HF Manager: I couldn’t wait to see your face when I told you how easy it was to make a cool six million bucks. A lot easier than digging gold from one of your stupid mines.
Miner: Okay. I’ll bite. How’d you do it?
HF Manager: All I had to do was dump a million shares of GameStop on a bunch of losers for $10 a share.
Miner: Where’d you get the money to buy all those shares in the first place?
HF Manager: Didn’t have to buy them. I borrowed $10 million from my broker. Then I short-sold the stock.
Miner: How do you sell something you don’t own?
HF Manager: Easy. There are millions of amateurs out there. Mostly kids who remember how much fun they had when they were children, buying videogames at GameStop.
Miner: You didn’t answer my question.
HF Manager: Here’s how it works. Once I saw how eager these kids were to own shares in GameStop, I just called my broker and told him I wanted to sell a million shares of GameStop.
Miner: Even though you didn’t have any of that stock?
HF Manager: That’s the beauty of it. My broker let me borrow a million GameStop shares and sell them all for $10 a share, which was the market price this week. I get to keep all that money, so long as I return a million shares of GameStop to my broker when he decides he wants them back. And get this. They’re all about to be worthless!
Miner: Wait a minute. You’re telling me you borrowed a million shares you know full well are about to be worthless? Forgive me, but I don’t see how anyone can make money that way.
HF Manager: Just follow the bouncing ball. These kids have already handed their broker $10 million to buy the stock, and that money is now in my pocket, so long as I eventually return a million shares of GameStop stock to the broker. Of course, I have to pay interest while he waits, but it’s chickenfeed compared to the profit I’ll be making.
Miner: Explain the profit.
HF Manager: All I have to do is wait a few days for the GameStop share price to drop back down to $4 a share where it was a few weeks ago. That’s when I buy up a million shares to return to my broker. That transaction will cost me only $4 million. So my profit will be $6 million. Like I said, it’s a lot easier than digging gold out of some foreign mine.
Miner: Won’t the poor kids lose their shirts? They bought stock at $10 a share when it’s about to be worth only $4.
HF Manager: Poor schmucks! Serves them right for thinking they can play Wall Street games with the big guys. They should have stuck with video games.
Miner: How did your broker talk someone into lending their shares to you? For all they know, you might be bankrupt yourself.
HF Manager: Poor fools. The broker isn’t required to tell them anything. They don’t even know their shares are being lent to short sellers like me.
Miner: But if you go bankrupt, you won’t be able to give them back their shares.
HF Manager: That’s the broker’s problem not mine. And ultimately it’s the kids who will be left holding the bag when this stupid stock goes to zero.
Miner: What if the price doesn’t drop?
HF Manager: Oh, it’ll drop. Trust me. And even if it doesn’t, I’ll just repeat the transaction a month from now. But next time, I’ll borrow 2 million shares. I can keep doing it all year. Eventually I can “make” the price go down. And when they finally panic, it’ll be like watching rats fleeing a sinking ship.
Miner: What if the price goes up? Say, way up?
HF Manager: Never happen. We’re talking GameStop. Just a small box store trying to stay in business when most of the big box stores have already gone bankrupt. Share price might even go to zero, in which case I’ll make an even bigger profit.
Miner: But let’s say, just to play devil’s advocate, that the share price goes up to $400 per share. How much could you lose?
HF Manager: You know what? This diner is terrible. Tell you what. I’ll short-sell you the check. You pick up the bill and I’ll pay you back when we meet again a month from now. Keep the receipt and I’ll pay you line by line based on whatever the menu price happens to be next month. You might make money because of inflation, but I’m betting this lousy place will be out of business, in which case I’ll owe you zero. Deal?
Miner: Hey. Wait a second. Who’s that talking with the owner? Isn’t that the football star who’s been buying up restaurants all over town?
HF Manager: Buying up restaurants?
Miner: You haven’t heard? Anyway, about the check. Don’t you recall? It’s your turn to pay. HF Manager: Um. Sorry. Gotta go. Forgot my wallet. Anyway, I’m not feeling so great.