Quote (Thor123422 @ Feb 18 2021 01:38pm)
Thor buys 1 share of GME at $20. The broker that holds my shares (Robinhood) loans my share out to Melvin. Melvin pays Robinhood 1% of the share price every week until they give it back. Melvin sells the share for $20 to John, who is also a Robinhood customer.
Melvin borrows John's share from Robinhood at $18 and sells it. So now there are 2 shares shorted, but it was the same share.
This process repeats enough times, with Robinhood's customers buying shares from Melvin and Robinhood loaning them out to Melvin, that Melvin owes Robinhood twice as many shares as exist in the market. The process of selling more shares than actually exist (by borrowing them from Robinhood) has driven the stock down to $4.
(In reality Melvin is multiple firms and Robinhood is multiple brokers)
Several weeks go by and GME is at $30 because retail investors are buying and Robinhood has raised its fee to 5% per week. Melvin has to give Robinhood 5% per share, and the price is double what its borrowed its shares at, so they are losing 10% of their short profits every week, and if they wanted to buy it back they would be paying twice as much.
Next week GME is at $300. You buy a share at $300 and hold.
Melvin is now paying 5% of $300 per share. One week eats all of their profit. Next week eats into the rest of their portfolio.
3 weeks go by with GME above $100, and Melvin has virtually exhausted all of their reserves. They can't pay Robinhood the interest on the loaned shares, but they also can't buy them back for 10x the price they sold them at. They're sunk. Melvin files for bankruptcy.
Robinhood gets a letter saying Melvin no longer exists. Melvin owed Robinhood 300 million shares of GME.
Everybody who has shares of GME being held by Robinhood owns shares, but Robinhood doesn't have them. Uh oh.
Robinhood now has to buy 200 million shares of GME. Only 100 million shares of GME exist. They start putting in buy orders at $200, but nobody sells.
They put in a buy order at $500 and get some hits, but the price moves up.
They put in a buy at $1000 and get some more, the price moves up.
They still need to cover 150 million shares NOW.
Robinhood's books are showing that they owe 150 million shares at $1000 each. <-- This is where everybody sells, and Robinhood has to continually buy it at whatever price the market sells it for.
The banks who have loaned them money, who gets to see Robinhood's books at any time to assess risk, call them on the fact that they owe their clients more in GME shares than they are worth as a company.
Robinhood can no longer get a loan because they are worthless as a company.
Robinhood owed the bank 100 billion dollars it was using as operating funds.
The bank shows a loss of 100 billion dollars because Robinhood is definitely not going to pay that back.
That bank owed another bank 80 billion dollars. That bank sees an immediate loss of 80 billion.
Continue down the chain with everybody taking losses.
The financial system basically collapses because all of the brokers defaulted on their loans all at once
We were almost at the bolded step, which would have destroyed the system. The little guy gets paid or the system crashes around them.
But instead they changed the rules.
never responded, ty for the long form explanation. at the end of the day im a bit glad the system didnt collapse, especially as most likely scenario is a govt bailout.