Robinhood is Innocent: There is No GameStop Conspiracy

On January 28, amidst the GameStop mania, Robinhood Markets, Inc., the online brokerage favored by many individual, nonprofessional investors—or retail investors—restricted trading of GameStop and other similarly volatile “meme stocks'' such as AMC Entertainment Holdings. GameStop’s stock closed down a whopping 44 percent that day. Some retail investors interpreted the restrictions as an organized scheme to bail out the group of hedge funds that were suffering losses due to GameStop’s rapid rise. Naturally, leftist firebrand Alexandria Ocasio-Cortez (AOC) had something to say about it. She branded Robinhood’s actions “unacceptable” and vowed to “support a hearing” concerning the trading restrictions “as a member of the Financial Services [Committee].” Then things got weird! Right-wing firebrand Ted Cruz retweeted Ocasio-Cortez’s remarks, adding “totally agree.” Elizabeth Warren and Donald Trump piled on for good measure, likewise asserting that hedge funds and Robinhood conspired against retail investors. Wait, what? Cruz and Ocasio-Cortez agree on almost nothing—so they must be onto something, right? Well, not exactly. So why did Robinhood restrict meme stock trading? The answer involves the reality of brokering on the stock market, an old mechanism called T+2, and has nothing to do with hedge funds conspiring against small investors.

Stock trades require an extension of credit. Buyers see a price on the stock exchange, tap a button, and instantly receive confirmation that they bought the stock. However, they only get and pay for the shares two business days later. This is called a T+2 settlement. Normally, there aren’t any issues; the buyer and seller agree to a certain price and they both deliver two days later, regardless of what the stock is currently trading at. However, sometimes things don’t go according to plan when significant volatility is present. For example, imagine a stock trades for $500 on Monday, someone buys a lot of it, and on Wednesday the stock has dropped to $20. The buyer might try to avoid paying for the stock on Wednesday because he or she is unwilling to pay the original price for a stock that is now worth far less. He may even be bankrupt (having miscalculated the trade). Thus, the seller assumes a risk that the buyer may be unable to, or refuse to, fulfill his or her end of the deal, and that risk increases as volatility rises.

Stock markets mitigate this risk through clearinghouses. Matt Levine of Bloomberg elaborates: “The members of the clearinghouse are big brokerage firms—“clearing brokers”—who send trades to the clearinghouses and guarantee them. The clearing brokers post collateral...to guarantee that they’ll show up to pay off all their settlement obligations.” There’s a lot more to it, but essentially brokerages have to post collateral according to the risk of buyers failing to fulfill their end of the deal. Since that risk tracks with volatility, more volatility means brokerages have to post more collateral. GameStop’s stock is wicked volatile—it fell from $483 to $112 at one point on January 28. Accordingly, Robinhood has to post a ton of collateral to guarantee the trades centered on GameStop’s stock and similar meme stocks. That’s where Robinhood ran into trouble. It couldn’t afford to continue guaranteeing the transactions at the same rate. Consequently, it restricted the transactions altogether. Bloomberg intelligence analyst Larry Tabb concurred, stating, “It’s not really Robinhood doing nefarious stuff...it’s the Depository Trust Clearing Corporation (or DTCC, which operates clearinghouses for U.S. stock trades) saying ‘this stuff is just too risky. We don’t trust that these guys have the cash to be able to withstand settling these things two days from now.’” The Chief Executive Officer (CEO) of Robinhood, Vladimir Tenev, was similarly straightforward. He declared that Robinhood “had no choice in this case,” since the funds needed to post collateral were “about an order of magnitude more than...typical.” In other words, Robinhood didn’t restrict trading due to any wild conspiracy. Rather, it reacted to an integral part of the stock market, which requested that Robinhood post more collateral than the brokerage could afford at the time. And it seems like the DTCC was right to ask for more. GameStop’s stock has cratered from its brief, absurd run in the high 400s; it’s down around $50 as of Friday, February 12.

America’s politicians are set to make a big show anyways. Some Democrats promised to investigate what role hedge funds might have played in the trading restrictions. Tenev is set to testify before the House Financial Services Committee, which is led by Democrat Maxine Waters. Rest assured, there will be more hand-wringing, more gesticulating, and more unfounded (probably wrong) accusations. But hey! Who knows. Maybe some crazy conspiracy will trickle out of Congress. Maybe everyone really is being duped! Still, I wouldn’t bet on it.

Comments

There are 0 comments for this article

Leave a Reply

Your email address will not be published.