Not all hedge funds are caught in the short squeeze vice. Some have clean books, meaning, they don’t have any positions that are bleeding them out.
Those funds are now watching the GameStop price action, running their own calculations, and realizing “You know what, this infinity squeeze should actually work. We should join in — on the long side.”
For many hedge funds — those that aren’t bleeding and reeling, that is — contributing to the squeeze is a rational calculation at this point. They are doing the math, and the risk versus reward calculations favor participation if the squeezers can ride along.
Hedge fund managers, after all, are not a monolithic group. They are more than willing to turn on each other, especially when an opportunity for substantial profit is involved.
And when a large hedge fund, or better yet a group of hedge funds, is forced to unwind a losing position, other hedge funds tend to swarm like sharks in a feeding frenzy, or hyenas on a downed wildebeest.
We saw this with the famous multi-billion-dollar meltdown of Long-Term Capital Management (LTCM) in 1998. As LTCM bled out, other hedge funds up and down Wall Street figured out what LTCM’s positions were — and bet against them heavily, knowing LTCM would be forced to capitulate.
The Downfall of Long-Term Capital Management
Due to Long Term Capital Management’s highly leveraged nature, coupled with a financial crisis in Russia (i.e., the default of government bonds), LTCM sustained massive losses and was in danger of defaulting on its own loans. This made it difficult for LTCM to cut its losses in its positions. LTCM held huge positions, totaling roughly 5% of the total global fixed-income market, and had borrowed massive amounts of money to finance these leveraged trades.
If LTCM had gone into default, it would have triggered a global financial crisis due to the massive write-offs its creditors would have had to make. In September 1998, the fund, which continued to sustain losses, was bailed out with the help of the Federal Reserve. Then its creditors took over, and a systematic meltdown of the market was prevented.