Wall Street Bets
March 2021
Introduction
The Congressional hearings about the GameStop, WallStreetBets and Robinhood case give us some additional evidence about the way that financial markets work. You can read through a summary of the hearing here:
The Guardian Report on the testimony
Let’s look at all the major players here:
WallStreetBets
This is a subgroup of the Reddit discussion board. You can get a flavour of the discussion here:
https://www.reddit.com/r/wallstreetbets/
There are a variety of themes (I am sure that you know more about most of this than I do):
- GME is the stock ticker for GameStop.
- Rocket ship emoji and moon themes are where the stock is heading
- Railing against Wall Street (where the New York Stock Exchange is based) establishment conspiracies. Young vs old.
- “I know nothing” is the disclaimer. This is not financial advice.
- Diamond hands: holding on to the stock (GME etc) and refusing to sell.
Short Squeeze GME
Roaring kitty (aka Keith Gill)
One of the main instigators of the short-squeeze against Melvin Capital and others.
Roaring Kitty
Keith Gill started his Congressional testimony with the comment: “I am not a cat”.
Melvin Capital
One of the main hedge funds to have lost money in the short-squeeze. It is said that this hedge fund lost 53% of its asset value as a result. You can read more about Melvin here:
Melvin is symbolic or representative of the Wall Street Establishment, though hedge funds tend to be the outsiders and they are the heros of The Big Short
The hatred of shorting stocks probably comes from the battles between Elon Musk and the hedge funds that unsuccessfully attacked Telsa.
GameStop
The firm at the centre of it all. A quite video game seller, trying to rotate away from selling in conventional shops to a greater on-line presence. You can get the latest quotes here:
Not really a big player in this drama.
Robinhood
This is the app which has revolutionised trading by removing commission. In the 1990’s Dotcom boom, online brokerages like Charles Schwab, E-trade pioneered low cost brokerage for online investors. This was in the region of $5 per trade. Competition has gradually reduced this until Robinhood cut commission to zero in August 2017. In October 2019 other brokerages such as Charles Schwab and E-Trade also cut fees to zero due to the competition from Robinhood.
Robinhood
Brokerages traditionally get paid in three ways:
- Commission. Clearly this has now declined to zero.
- Net interest. This is the difference between the interest on the money that customer deposit for trading (traditionally zero percent) and the interest that the brokerage gets from depositing this money. Though current deposit rates are very low, brokerages hold large amounts of money that add up to substantial funds. Patrick McKenzie details how Charles Schwab earns 57% of its revenue from net interest. You can read the article here:
Suppose I were to give you $200 billion dollars. Now I’m the American middle class and you’re Charles Schwab. You would earn something like $5.8 billion dollars in net interest income. This would entirely pay for your sideline business in running a brokerage. Stocks, bonds, mutual funds, branch offices, call centers, blah blah blah, it all exists to justify the only pricing page that matters, and all the verbiage on the pricing page is about how much you pay the customer.
This is an exaggeration, but not much of one. 57% of Schwab’s revenues are from net interest. The firm could literally give away every other service; discount the mutual fund fees to zero, do away with commissions, etc etc, and they would still be profitable.
Citadel
Citadel is a hedge fund that is a market maker. The market maker takes orders from brokers like Robinhood and put them in the market. Robinhood allows people on its app to trade fractions of shares. That means that instead of paying \124 for a share in Apple, you can buy half a share for $62. Citadel will group small orders together so that they are sufficiently large to be put into the market. This will be 5000 or 10000 shares at a time.
Traditionally investment banks were the market-makers but new regulations have reduced their importance. Hedge funds like Citadel now have a large market share. You can read more about Citadel here:
National Securities Clearing Corporation (NSCC)
This is the body that clears trades. Clearing means making sure that the money is received and the securities are delivered. Clearing happens at T + 2. That means two days after the trade was agreed. This is a function of the time when physical securities were delivered by hand and money was sent on the banking wire. There is a big risk for NSCC. If institutions do not deliver the securities of money that was promised, NSCC will lose money. Therefore, NSCC will require brokerages to put up collateral to cover that risk.
As a result of the increased price of GameShop and the increased volatility, there is an increased risk that NSCC would lose money. As such it required Robinhood to increase the collateral posted from $300mn to $3.0bn (subsequently reduced to $700mn). Robinhood had to borrow money from banks and raise new capital to meet these requirements. Before it raised the funds and as a way of reducing the requirement from $3.0bn to $700mn, it refused to take any more orders for the most volatile stocks like GameStop.
Questions
Who are the winners and losers?
What regulatory changes should be put in place?