CORNERING IS ANOTHER EXAMPLE OF HOW MARKETS CAN REGULATE THEMSELVES

Cornering a market is like a forest fire - the event is a threat, but the aftermath brings growth to the ecosystem.

Published

April 12, 2022

All those interested in the stock market sooner or later come across the expression “cornering the market” — a term inevitably associating with market panics, crashes, heavy losses, large and small investors going under. So, with subsequent attempts to introduce new regulations to ensure any cornering won’t happen again. But new restrictions encourage new ideas to bypass them, which is valid for corners. So maybe it would be wiser to let the market forces intervene instead of governmental bodies?

Northern Pacific Railway historic stock price.
Northern Pacific Railway historic stock price.

But let’s start with the basics. What does to corner the market mean? In short, that’s accumulating enough a company shares — or commodity — to be able to manipulate its price. Hence the name — the market is backed in a corner where there is no room to move.

The corners are as old as trade itself and originate from savvy business moves. One of such corners was executed by Thales of Miletus — yeah, the same Thales — a Greek mathematician, astronomer, and philosopher. According to Aristotle, Thales of Miletus once cornered the market in olive-oil presses.

Thanks to his knowledge of astronomy, Thales was able to predict an upcoming large crop of olives correctly and decided to make the best of it — he raised a small sum of money. He paid deposits for the whole of the olive presses in Miletus and Chios, which he hired at a low rent. When the season arrived, there was a sudden demand for presses. By letting them out on his terms, Thales made a lot of money.

But what worked for Thales (and supposedly many others) doesn’t have to work in other cases. Or rather, it seldom does.

When launched at a larger scale, the corners are nothing else but Pyrrhic victories. They are usually accompanied by panic, stock market crashes, and ruined investors. There is other bad news for those few who manage to survive: sooner or later, the corner triggers a reaction from appropriate bodies. It either leads to evoking existing rules or setting new, more restrictive ones.

Look at the Northern Pacific Railways and the first panic at the New York Stock Exchange in 1901. It all started with the fierce rivalry between E. H. Harriman and Jacob Schiff on one side and J.P. Morgan and James Hill on the other. Both parties struggled to control the Northern Pacific Railway, orchestrated by the First National City Bank and financed with Standard Oil money.

The crash involved a stampede sale of railroad shares, namely Burlington, soon followed by St. Paul, Missouri Pacific, Union Pacific. The casualty list included such big names as Amalgamated Copper, Sugar, Atchison, and United States Steel. Only Northern Pacific came out unscathed and even managed to advance. The Northern Securities Company was established to control the Northern Pacific, the Great Northern, and the Burlington railroads. But that had not lasted for long — the company was shot down under the Sherman Antitrust Law passed in 1890, and aimed to maintain a competitive marketplace.

One of the significant shortcomings of the corner attempts is that new laws are being adopted, and further restrictions come into force. Thus, the market becomes more and more regulated, with various watchdogs who seek the slightest manifestation of insubordination.

Subsequent and documented breaches of the antimonopoly regulations result in new restrictions. For example, in the late 1950s, two Chicago Mercantile Exchange traders were accused of attempting to corner the onion market. The attempt led to the Onion Futures Act that bans trading in onion futures in the United States.

Or like in the late 1970s and early 1980s, when the Hunt brothers, Nelson Bunker and William Herbert, tried to corner the world silver markets. At one point, the Hunts held the rights to more than half of the world’s silver, while the metal price rose from $11 an ounce in September 1979 to nearly $50 an ounce in January 1980.

In response to the Hunts’ activity, the regulators changed the rules regarding leverage. The commodity Exchanged passed “Silver Rule 7”, which placed heavy restrictions on purchasing commodities on margin. As a result, the price of silver began to fall. The Hunt brothers, who had borrowed heavily to finance their purchases, were unable to meet their obligations, causing panic in the markets known as Silver Thursday.

A similar fate was shared by Yasuo Hanamaka, also known as Mr. Copper. In the mid-1980s, Hanamaka, in some aggressive and illegal trade in copper futures and options, accumulated 5% of the world’s copper supply. For a while, the 5% secured control of the commodity prices. However, all changed in 1995, with an increase in copper supply and subsequent market correction.

What happened to the Hunt brothers and Hanamaka is an excellent example of other corner-related dangers: anyone attempting to corner the market becomes highly vulnerable to market risk. That’ is because cornering the market means purchasing at artificial prices and encourages other investors to get their share through arbitrage. And that’s terrible news to the cornerers because such investors take positions opposite the cornerers. Consequently, the price moves against the cornered, and any selling attempts cause a significant price drop.

These two examples show that the market forces are strong enough to act and calm down the market without waiting for a regulator to step in and intervene.

During the financial crisis of 2007–2010, Porsche cornered the market in Volkswagen shares, pumping the share price and making Volkswagen the most valuable company in the world. But here as well, the investors reacted: to corner the market, Porsche relied on naked shorts — short-selling an asset without first borrowing it or making sure they can borrow it.

Unfortunately, that resulted in a counterattack known as a short squeeze — a rapid increase in the price of a stock due to its excessive short-selling. As a result, Porsche’s coup failed spectacularly.

Today, small investors have new, practical tools to protect themselves — they are called social media. What has recently happened to GameStop, a publicly listed video game retailer, makes a vivid example.

During the pandemic-induced lockdown, the retailer, operating from physical outlets, found itself in a tough spot. Its share price plummeted, and the troubled entity became the subject of massive, obviously orchestrated short-selling to take control of the market.

However, short-selling is a gamble: any positive news about the stock can push the price up, putting short-sellers in a difficult spot. And that’s what’s happened with GameStop: small investors — users of online service Reddit — via one of its subforum — wallstreetbets — started to widespread news suggesting the company is ripe for a ride. As a result, thanks to its fans, GameStop shares began to recover. That convinced the investors to change plans, which, in turn, accelerated the shares’ swell. In three sessions, the valuation rose 243 %, and in a month — six-fold.

So, maybe it would be better to let the markets deal with cornering the same way it deals with other phenomena?

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Got hookd’?

Here are some recommended readings to follow this topic:

Books:

Fay, Stephen (1982). The Great Silver Bubble. London: Coronet, 1983.

Lefèvre, Edwin (1923), Reminiscences of a Stock Operator, Chapter 19.

Articles:

https://www.businessinsider.com/hunt-brothers-trying-to-corner-silver-market-2016-5?IR=T

https://www.americanheritage.com/jacob-schiff-and-northern-pacific-corner#2

https://www.cinemonic.com/the-biggest-short-squeeze-in-history-volkswagen-short-squeeze-of-2008/

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