A lot of Redditors hate the Reddit IPO | Reddit warned us that its users were a risk factor, and boy do they sound excited about shorting its stock.::Reddit seems like a likely candidate for a meme stock. But the actual reaction suggests that r/WallStreetBets isn’t going to send the stock to the moon.
For anyone that’s fallen for the “{wealthy person} doesn’t actually have ${huge number} because it’s stock” thing, here’s how it works.
You might be wondering, why do they get this cheap credit? Because it’s a very safe bet for the financial institute, they are acting as a sort of time arbitrage mechanism for the person they are extending credit to. Since they perform this function they can be relatively assured that this will allow their client to sell their stocks, not because they have to cover expenses, but because capital gains protections and the market is favorable. It also aids in fostering a positive relationship with someone with a lot of wealth which is something financial institutes have an interest in doing.
All the actors are doing what’s in their rational self-interest. The end result is that Spez can access a large part of that $200M as liquid cash right now through credit with one hand and with the other wave you off and say “those are stocks I actually only got paid $400k”
How do they pay back those low-interest loans? I’ve always been curious.
Eventually they do need to pay back the loan, the low interest rates just make it so that they can choose to sell their stocks in the most favorable way.
This is why it makes sense for the financial institute to give out the loan in the first place.
So here’s the scenario. Let’s say you wake up tomorrow and somehow find yourself with $200M worth of stock. You are now “worth” $200M so you’d like to start living like it! You want to go buy a mansion and a nice new car and a private chef. Problem is, none of those people take stock, they all want money.
Goldman Sachs goes, “hey, I’ll loan you the money really cheap, you have to pay me back with interest, but since you have $200M in stock you can sell some of that later and pay me back”
This is great for you because you get to enjoy the mansion and new car and private chef right now. If you sold the stock right now you’d get taxed as if it were income at 38% but if you hold the stock for a few years when you sell it it will be considered capital gains and only taxed at 10% (or 15%, whichever the rate is). In addition, you don’t have to go to the stock market and sell for whatever they want right now, you can wait until the value of your stock is really high and selling is very advantageous for you.
So you do have to pay back the money, but this is still a really sweet deal because you can enjoy all the nice things right now and you get to avoid that extra ~30% you would pay in taxes if you sold it right now.
As long as the amount you saved in taxes outweighs the amount you pay in interest, this is a great deal for you. And for the financial institute it’s low risk (they extended you $10M backed by $200M in assets) and when you repay they make back enough in interest to make it worthwhile.
You get more money in your pocket, the bank gets more money in its pocket, from their point of view this was a win win. The losers are the market suffering a higher price for the stock because the supply was artificially constrained by you having access to this credit (otherwise you’d have sold shares to buy a mansion and nice car and private chef) and the taxpayer who was to shoulder a heavy tax burden because you converted your income into capital gains.
The one thing that definitely isn’t happening is Bezos or Musk or any of these other “they are only rich on paper” people clipping coupons to make ends meet. They live like rich people because the have access to plenty of money secured by their less liquid assets
This was a very informative read I understand things better now. Thanks!