RobinhoodHow much money has Robinhood Markets Inc. lost in the last week due to its retail customers' frenzied trading of popular meme stocks like GameStop Corp.? I don't know the answer, and I assume that with a large enough customer base it is not literally zero, but … I assume that it's roughly zero? Probably someone somewhere got a margin call, couldn't meet it, and left Robinhood holding stock that was worth less than the margin debt; that happens from time to time in volatile markets. But I have not seen any stories like that. Many of the meme stocks have performed surprisingly well so far, and Robinhood has raised margin requirements on some of the most volatile ones to limit its risk. (It's still early, though, and the meme stocks are having a rough morning.) If the story here was, like, "thousands of Robinhood customers have lost everything in their account and more, leaving Robinhood to bear the excess losses," you would probably have read sad interviews with some of them, and the tone on the WallStreetBets subreddit would be different. Meanwhile how's business? Its app was downloaded more than 600,000 times on Friday alone, according to analysts at JMP Securities. By comparison, the Robinhood app was downloaded around 140,000 times during its most active day in March 2020, when coronavirus fears sent stocks down sharply.
Hmm that seems good? Of course Robinhood doesn't charge customers for the app, or for trades, so adding more customers might just increase its costs. On the other hand it does get paid by market makers for customer order flow, and it is paid especially well for options order flow. The fact that we all spent the last week talking about GameStop because WallStreetBets posters have been buying tons of GameStop options to push up the price of the stock—that suggests that Robinhood got paid a lot for order flow last week. Robinhood also gets paid for lending out its customers' margin securities. A lot of its customers own GameStop stock, and borrowing GameStop stock has been extremely popular and expensive (because hedge funds have shorted it and Robinhood's customers are trying to squeeze them), which presumably means it is raking in money in that business line too. If you just tick through the list of "How Robinhood Makes Money," it does seem like last week would have been great for all of them. I am speculating here, but this is kind of how brokerage firms work. None of it is unique to Robinhood's customer base or business model. Last week was a time of huge volatility, heavy volume, massive retail interest in actively trading stocks and options, no huge big market crash. Those are the perfect conditions for brokers to make money.[1] Also though Robinhood has had a liquidity crunch and had to raise billions of dollars in emergency funding just to keep operating: Robinhood Markets Inc. raised another $2.4 billion from shareholders, days after investors agreed to pump $1 billion into the online brokerage to help it ride out a trading frenzy in talked-up stocks like GameStop Inc. The big infusion—the $3.4 billion brought in since last Thursday is more than the company had previously raised in the eight years since its launch—gives Robinhood a cushion to cover a surge in collateral requirements stemming from the trading boom. The cash should also allow the company to remove many of the trading restrictions that angered customers of the popular brokerage, people familiar with the matter said. The fundraising caps off the most tumultuous period since Robinhood's founding. ... Wild price swings in a number of stocks prompted the clearinghouse that processes and settles its trades to ask Robinhood for more cash to cover potential losses on the transactions. …
It's weird. "Robinhood's bailout being bigger than Melvin's bailout is pretty hilarious," Conor Sen pointed out on Twitter. Robinhood's customers have been buying GameStop and other meme stocks with heavy short interest, pushing up their prices. This has presumably been good for Robinhood, which makes money on their trading and on stock lending. It has been bad for hedge funds with big short positions in those stocks; one of them, Melvin Capital, was down 53% in January and had to take a $2.75 billion cash infusion from Citadel LLC and Point72 Asset Management. It was on the wrong side of this trade and was forced to raise $2.75 billion of emergency funding. So far Robinhood was on the right side—it wasn't even on a side, it was selling pickaxes to the people who were on the right side—and was forced to raise $3.4 billion. One way to read this story is, meh, it's fine. Like a lot of fast-growing consumer-facing tech-ish companies, Robinhood needs money to grow; if it had spent the next year or two steadily adding customers it would probably have raised more capital to pay for that growth; instead it packed a year's growth into last week and so had to similarly accelerate the fundraising. In a sense, Robinhood got to do that fundraising from a position of strength—"look at our user growth," it got to brag to its venture-capital investors when asking for new money—though, of course, given the time constraints, the VCs who were able to move quickly probably did get a good deal. But I don't know. It doesn't exactly seem like Robinhood enjoyed going out to raise that money. It happened so fast that the VCs got a substantial desperation discount. (They bought convertible notes that "will convert into equity at a $30 billion valuation -- or a 30% discount to an eventual valuation in a public listing, whichever is lower.") Meanwhile, Robinhood had to restrict trading in a lot of the meme stocks, entirely preventing customers from buying many of them while it raised enough money to meet its clearinghouse collateral requirements. This inconvenienced customers and led to rumors and conspiracy theories about Robinhood's motivations and even its solvency: In general, in financial markets, when a broker has to shut down trading because its counterparties are demanding more collateral that it doesn't have, that is not a great sign for the broker's future. Here it might actually have been! Here a very plausible story is that Robinhood had to shut down trading for a bit because its counterparties were demanding more collateral that it didn't have precisely because its business was so great. But, you know. You're gonna get rumors. (Also, retail brokers shutting down buying of the meme stocks was not good for the prices of those stocks: GameStop lost 44% last Thursday, when Robinhood first restricted trading. This enrages customers who are long those stocks, encourages conspiracy theories about Robinhood helping out short sellers, and increases Robinhood's market risk: If it had margin-loan exposure to those stocks, taking steps that will predictably drive down their prices was not a great idea.) The reason that Robinhood had to raise all this cash is that its clearinghouses demanded billions of dollars more collateral to keep clearing its trades. We talked about this last week; basically, as Robinhood trades more volume, and as the volatility of the names it trades increases, there is an increased risk that it will not have enough money to settle trades. The clearinghouses, which are responsible for keeping track of and settling the trades,[2] do not like this risk; they require clearing members (like Robinhood) to post collateral to mitigate it, and as the risk goes up the collateral requirements do too. "'The request was around $3 billion, which is, you know, about an order of magnitude more than what it typically is,' Robinhood Chief Executive Vlad Tenev said," to Elon Musk for some reason. This is, uh, good I guess, risks are bad, you gotta make sure people pay for their stocks. Here's Bloomberg's Larry Tabb: Cash and securities officially change hands two days after a trade. During those two days, a lot of things can happen. The problem is, what happens when a trading counterparty and/or a firm cannot afford to pay for the securities they bought? If that occurred, and if the clearinghouse didn't guarantee the other side of the trade, then the client would either not receive securities or not get paid, and the trade would have to be broken. That is very bad. Not necessarily for a retail client buying 100 shares or so, but what if it was a big fund or a major player, like Robinhood or let's say Lehman Brothers? So if Lehman were to default (which it did) on all of its trades, then all of the folks on the other side of Lehman's trades would send in their securities to Lehman, but wouldn't get paid. Then the brokers who didn't get paid wouldn't be able to afford to pay for the securities that they bought. So you would have cascading failures. So to ensure this doesn't happen, they have clearinghouses. The clearinghouse takes the other side of the trade and guarantees settlement even if someone like Lehman goes bust.
But there is another side to this argument. Here is Dan Davies, in 2014, calling the clearinghouses "the most powerful financial regulators in the world," and arguing that they increase systemic risk: The deep issue here is that clearing houses are the choke-points of financial trading. This is going to be even more the case going forward, as regulators have insisted that more and more markets should be centrally cleared. Given this, you can see why it's such a big priority for supervisors and market players alike that a clearing house should never be allowed to fail — they are the single points of vulnerability, so there have been an absolute raft of new regulatory measures for them over the last four years, increasing capital requirements, layering on cross-guarantees and bickering like hell about default funds, all aimed at making sure that something which has more or less never happened in the past — the failure of a major clearing house — should never ever happen in the future. Hurray for that &c. But I worry, quite a lot, that people are kind of missing the point. The problem with clearing houses is really not the remote, theoretical (although admittedly horrifying) risk that one of them might suffer a counterparty default which forced it into insolvency. The problem about clearing houses is that the ways in which they protect themselves against credit risk tend to have the effect of radiating liquidity problems out into the rest of the system. ... Collateral, margin and haircutting decisions are the responsibility of risk managers at clearing houses, which are themselves independent and profit-making private sector companies. In other words, a crucial parameter affecting the liquidity of the financial system — almost the antimatter equivalent of the central bank's Lender of Last Resort function — has been handed over to a group of people who only have utterly counterproductive incentives to protect their own institution.
(Emphasis added.) When volatility is up and markets are crazy, clearinghouses pick up the phone and call every bank and broker and trading firm and say "hey you need to give us a ton more money." The banks and brokers with the most risk have to put up the most money. When volatility is up and markets are crazy, that is a tough time to ask banks and brokers for more money! They especially need all their money right then. If you ask them for more, you increase the risk that one of them will fail. The clearinghouse, meanwhile, has no real incentive to be conservative in its collateral demands—the more money it gets, the better for it. And the banks and brokers have no real way to say no, since being cut off from the clearinghouse is pretty much the worst possible thing that can happen to them. I am tempted to ask: What if Robinhood had not been able to raise the money? Again I do not think this was a huge risk because Robinhood was probably having a great week, but coming up with billions of dollars in a few days is not always easy even for a company whose business is booming. Would Robinhood have been permanently unable to trade the meme stocks? Would it have been locked out of trading entirely? Something worse? Of course the collateral requirements were increased to reduce the systemic risk that Robinhood customers' trades posed to the stock market.[3] It is hard to evaluate that risk, since it hasn't come true; there have not been, for instance, mass defaults on retail purchases of GameStop stock. Perhaps it still will come true, or it could have if the clearinghouses had not stepped in. In general I do not think of retail traders losing money on self-consciously goofy stock trades as being a systemic risk, but I cannot entirely reject the possibility. On the other hand, would it have been a systemic crisis if a popular retail brokerage was effectively shut down overnight during a week when retail stock trading was the dominant story in financial news? I dunno. It doesn't seem great. There are going to be congressional hearings about the fact that Robinhood shut off GameStop trading for like a day. If the shutdown had been broader and more permanent, I do kind of think it would have undermined confidence in the financial system a bit.[4] SilverOver the past few days, a number of news outlets have reported that silver prices were going up, and connected the rally to posts about silver on the WallStreetBets subreddit that previously became famous for pushing GameStop's rally. In my column yesterday, I quoted Bloomberg News and Financial Times articles about this theory, and then I made some jokes about it, because the idea of a Reddit forum controlling the global price of silver is (1) objectively funny and (2) after the past week, alarmingly plausible. I also suggested that, compared to GameStop Corp. stock, silver has a longer history both of being valued purely for itself without any cash flows, and of being hospitable to cranks and conspiracy theories. I got a lot of angry email and tweets from WallStreetBets posters about this! Many of these responses were less polite than I am generally accustomed to in my dealings with Reddit boards, and some of them came from people who seem to have set up brand-new Twitter accounts purely for the purpose of calling me names,[5] but I have to admit: I think their objection is basically valid. Their objection is that the WallStreetBets subreddit is not actually pushing up the price of silver, and that "buy silver" is not, as it were, a "WallStreetBets trade." GameStop is a WallStreetBets trade; it has the collective approval of WallStreetBets; everyone—not everyone, but "everyone"—on WallStreetBets is long GameStop and rooting for it to go to the moon. Every popular post right now seems to be about that one trade. There is a sea chantey. Silver is not like that. There are some posts on WallStreetBets urging readers to buy silver and arguing that it is a potential short squeeze; there are other posts rejecting the silver narrative, urging readers not to fall for it, and questioning the motives of the people pitching silver. So here's one representative email I got yesterday, calling my column "a form of market manipulation": If you can find a single post on the 7 million subscriber r/wallstreetbets that speaks positively about silver and has more than 20k, 30k, 40k upvotes tops, then this could be called journalism. But there isn't such a post. Best I could find was 11k upvotes. In the entire 7 million subscriber subreddit.
The argument is that if a trade is posted on WallStreetBets and only 11,000 people like it, it's basically criminal to suggest that it was a trade posted on WallStreetBets. Or here is a representative tweet: WSB as a whole immediately and unequivocally rejected any association with the silver frenzy. That stunt was pure market manipulation which seeped in with no welcome on that forum.
The argument is that the posts pitching silver were just efforts to manipulate WallStreetBets' army of posters, and that "WSB as a whole" was not fooled. Now of course these objections can be right in a trivial no-true-Scotsman sort of way: No real WallStreetBets poster would have pitched silver, therefore the actual posts on WallStreetBets pitching silver come from people who are not real WallStreetBets posters. But I think that they're also right in a real, socially meaningful way: The mood of the board is wildly enthusiastic about GameStop, but seems broadly negative on the silver idea.[6] It's a trade that was pitched on WallStreetBets, but not by long-standing and beloved leaders of the community, and it is not a trade that united WallStreetBets behind it. Also, while no one seems to have much evidence on this one way or the other, I suspect the objections might also be right in an economically meaningful way: I am not especially convinced that the weird market moves in silver—the spike in futures, the inflows into the silver exchange-traded fund, the cleaning out of physical silver supplies—were driven mostly by WallStreetBets. In many ways this is a more interesting WallStreetBets story than "WSB is buying silver now" would be. Last week, when GameStop captured the public imagination, some people—mostly not WallStreetBets regulars—theorized that it was a pump-and-dump orchestrated by shady professionals who tried to dupe WallStreetBets readers into buying up the stock. This week, people—mostly WallStreetBets regulars—theorize that the silver trade is a pump-and-dump orchestrated by shady professionals who tried to dupe WallStreetBets readers into buying up the metal, to distract them from GameStop. I have no doubt that there are context clues that can help you tell which of those stories is true. If someone has been pitching a trade for months, and posting screenshots of her positions in a way that builds credibility; if she has posted ideas before in what seems to be a good-faith way, and discussed both her wins and her losses; if her posts get engagement from other well-known members of the community; if she engages with other posters and knows the lingo and generally behaves like a regular on the forum; if the post has enough upvotes—then you don't have to conclude that her trade is correct, or that her motives are pure, or that WallStreetBets unanimously agrees with her, but you can conclude something like "this is a trade that some people on WallStreetBets like." On the other hand if someone shows up with the handle "kg42069yolo" and posts once, saying "we have to buy silver, hedge funds hate it when you buy silver"; if no one engages with him and he engages with no one—then you can plausibly conclude "this is just some guy trying to use a huge community of stock traders for his own purposes." I bet that, if you are a long-standing active WallStreetBets poster, you can mostly tell those things apart. But one problem with an 8-million-member subreddit that has been adding a million members a day is that most of its members showed up in the last week, because they heard that WallStreetBets was a place that was making a lot of money.[7] Long-standing active regulars are, at this point, a small minority. Presumably the millions of new arrivals are not as well versed in the nuance and context and norms of the board, and will read pitches on their own (apparent) merits. Presumably some of them will say "ooh a short squeeze in silver, I've heard about short squeezes, better get in on that, that's after all why I joined this subreddit yesterday." And so an idea can both be "immediately and unequivocally rejected" by the community as a whole, and also get 11,000 upvotes. And, perhaps, can drive people to buy silver. One concern here is that if you have a fun quirky trusted close-knit community that exchanges stock ideas, and then you spend a week controlling the global financial system and being the only story in the news, after that you have a gigantic target for manipulation instead. If anyone wants to pump a stock (or metal) now, they are going to give it a try at WallStreetBets, because that's where the action is. Of course the long-standing regular WallStreetBets posters should feel aggrieved about that! (To be fair that's how social media always works: A thing is good, which causes it to become big, which causes it to become bad. Circle of life. "No one goes there anymore, it's too crowded.") I should also say that, while I did quote news articles asserting that WallStreetBets was behind silver's rise, those assertions were not actually the point I was trying to make. My point was that dabbling in silver could be fun because it lends itself to crankery and conspiracy theories, even more than a short squeeze in a small-cap stock. And, uh, I am going to double down on that one? Judging by my Twitter and email and WallStreetBets, a whole lot of people are convinced that nefarious hedge funds are running a false flag operation on the WallStreetBets subreddit to pump the price of silver, and that the entire financial media is conspiring to push that false narrative. Silver: It's fun! Oh one more thing: Part of why WallStreetBets posters were so mad at me was that they took me to be implying—and this is my fault, my headline did imply it—that they had abandoned the GameStop trade for the silver trade. (There is a view that silver is "a coordinated distraction to get them to drop their GME.") Like I said, if you are looking for cranky fun, there is a lot to be said for silver, but I myself prefer the GameStop trade, which is rich and interesting and existentially terrifying. I am happy to concede that it remains the favorite WallStreetBets trade, and part of me hopes that it can go on forever. Of course if it does then financial capitalism in its present form will end, as will my career analyzing it. Perhaps that will be an added incentive for WallStreetBets to keep it up. Oh right about thatI began my column yesterday by suggesting that maybe GameStop Corp.'s stock price can remain high indefinitely, not because the company starts making a lot of money, and not because anyone expects it to make a lot of money, but just … because. Because enough people want to buy GameStop stock at a high price that the price stays high. Just a pure social fact, divorced from any underlying corporate finance rationale. Just a trading token imbued with value because the people who trade it imbue it with value. "GameStop's stock price has reached what looks like a permanently high plateau," I almost said. I mean, not really; I recognized that this was not a very likely outcome. It would just be a weird and disturbing one. The likely outcome is that people get bored with pumping up GameStop's stock, so they stop. I had said that already—that was obvious—I just wanted to talk about a funnier and stranger possibility. Anyway nothing in this column is ever investing advice, in part for good regulatory-ethical-liability reasons but also because I am terrible at making investing calls: The wild run-up of trades popular with Reddit crowds is starting to come crashing down. GameStop Corp. sank 47% to $118.84 as of 9:42 a.m. in New York. It's now down 65% from its record close of $347.51 on Wednesday. AMC Entertainment Holdings Inc. slid 39% and Express Inc. lost 26%. Silver tumbled more than 5% after surging to an eight-year high. ... "The short squeeze momentum met its inevitable end," said Mark Taylor, a sales trader at Mirabaud Securities. "It seems reasonably clear that as the cheerleading and rage against the machine dies down, the man on the street is left holding the bag again."
My timing is just impeccable. Now I guess I should say "yep, that's the end, the GameStop thing is over, now back to a normal price," and then it will double again this afternoon. Should index funds be illegal?I do not write a ton about personnel moves at the U.S. Securities and Exchange Commission, but I want to point out that Harvard law professor John Coates has been named acting director of the SEC's Division of Corporation Finance. "I look forward to working closely with the staff both in daily mission-critical work and as we consider ways to address new challenges facing companies and investors as they seek to raise and allocate capital sustainably and efficiently," he says in the press release. I have mentioned Coates around here a bit recently because of his paper on "The Problem of Twelve," his term for "the likelihood that in the near future roughly twelve individuals will have practical power over the majority of U.S. public companies." (The Twelve are the people who run the biggest institutional investment firms, including in particular the "Big Three" index-fund companies, BlackRock, Vanguard and State Street.) I think it is fair to say that five or so years ago nobody talked much about this stuff, and "all the companies have the same big shareholders" was just not thought of as a serious issue in corporate finance that required regulatory consideration. Times have changed, and now a guy who specializes in this issue will run corporate finance at the SEC. "Should index funds be illegal" has always been a joking name for this section, but now you might expect the SEC to do something to regulate the power of the giant fund companies over corporate America. Wrong ClubhouseSure, sure, right, sure: The Elon Effect has reached Clubhouse. In the wake of Mr Elon Musk tweeting on Sunday that he would be talking live on the social media audio app currently taking the world by storm at 10pm that night, stocks in Clubhouse Media Group soared by more than 100 per cent in early trading on Monday, before easing back a bit to trade up a modest 83 per cent up on the day at pixel time. … The only problem is that . . . it's the wrong Clubhouse. The Clubhouse that is currently mooning is in fact pink-sheet Clubhouse Media Group Inc, ticker $CMGR, which according to Bloomberg "provides medical treatment, scientific research, teaching, prevention, and healthcare services".
So there are three separate things going on here. One is that if a private company gets a lot of buzz, and there is a small-cap public company whose name or ticker symbol sounds like the name of that private company, people will rush in to buy the stock of the public company due to some combination of (1) they are confused, (2) they think other people will be confused and they can sell it for a profit, and (3) they don't actually think anyone will be confused but it's fun to all buy the same stock for silly reasons. Another is: "If you are a smallish company and Elon Musk whispers your name, or a word that sounds a little bit like your name, your stock will double." The third thing going on here is that at any given time there will be some small public company with no real operations or income, usually a medical devices company for some reason, that is pivoting to something buzzier. Actually in this case it is not so much a "pivot" as it is a reverse merger: Clubhouse Media Group is an influencer-house management company that went public via reverse merger with a Chinese medical device company because financial capitalism is amazing. Clubhouse Media Group was named Tongji Healthcare Group Inc. two weeks ago; it had no revenue and a net loss of $45,341 in its most recently reported quarter. It was an empty shell of a former health-care company, but it had a U.S. public listing, so when a company that manages influencer houses wanted to go public, it merged with Tongji, combining the influencer-house business with the public listing. Then it changed its name: "As an emerging leader in the influencer-based social media marketing space, with extensive commercial interests and growing cash flows, we are now manifestly active under a business model that has no relationship to the Company's prior name and stock symbol," remarked Chris Young, Co-Founder of Clubhouse Media. "This shift, while superficial, is significant in that it will allow us to present a more cohesive picture to the investment community, which we believe will ultimately play a substantive role in delivering shareholder value."
Here is a New York Times article from November about this deal. The reverse merger is a well-known though sort of cut-rate way for small companies to go public. Anyway if you happen to have a moribund shell of a public company, or if you're able to acquire one, the business model seems obvious. Sit around monitoring Elon Musk's Twitter feed and, sure, Clubhouse. Whenever he mentions a thing, change your company's name to that thing. "Elon Musk Says He Wired Up a Monkey's Brain to Play Video Games," it says here. "He's a happy monkey," says Musk. You happen to control Hubei Cosmetic Dentistry Supply Inc., which happens to be a U.S. public company trading on the pink sheets for, in round numbers, zero cents per share; you own a lot of the stock.[8] Quick! Change the name to Happy Monkey Brain Video Games Inc. Weirdly the tickers HPPY and MNKY both seem to be available, take your pick. Then your stock rockets up to, like, I dunno, five cents per share, and you sell a ton of it. Then everyone forgets about Musk's monkey, the stock drops, you buy some of it back at zero-ish cents per share, and you wait for Musk's next stunt to do it again. If you get bored in the interim and need some money, it seems like the tickers ELON and MUSK are both available. Why not name your company one of those and see if it goes up? Things happenFormer JPMorgan Banker Acquitted in 'Sons and Daughters' Bribery Trial. FTX Exchange Lists WallStreetBets Futures to Capitalize on Investing Movement. GameStop Day Traders Are Moving Into SPACs. Scientists Have Taught Spinach to Send Emails. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] It's less clear, but they might also be the perfect conditions for market makers—who take the other side of Robinhood's customers' orders—to make money. "The wider spreads, higher volatility and big volume sparked by the Reddit-fueled trades are typically ripe conditions for market makers," the Wall Street Journal points out, and: "Shares of publicly listed electronic market maker Virtu Financial rose 12%, its best weekly gain since last March." (On Friday we discussed the fact that the retail flows in GameStop seem pretty *balanced*, which is also good for market makers.) [2] There are two at issue here: The National Securities Clearing Corporation (a subsidiary of the Depository Trust & Clearing Corporation, and sort of interchangeably called "NSCC" or "DTCC") clears U.S. stock trades; the Options Clearing Corporation ("OCC," but not the bank one) clears options trades. [3] I should say, the collateral requirements were not increased *for Robinhood*; the increases were market-wide, and several other brokers limited trading in some meme stocks. Still Robinhood seems to have been disproportionately troubled by the whole thing. [4] I concede that allowing the GameStop trade to keep going also, in its way, undermines confidence in the financial system. No right answers here! [5] Honestly: always flattering! Thanks, @NardDog81604219! [6] Here's one post pitching silver on Sunday that complains, "it appears someone may have created bots to downvote SLV posts because this got bombed immediately by downvotes. Mods can you look into this? Either that or we really have become a monotheistic sub where only GME can be mentioned." [7] WallStreetBets hit 3 million users on Jan. 27 and 6 million on Jan. 29; when I checked this morning the number was 8.2 million. [8] To be clear all of this is hypothetical and there is *not* a pink-sheet company with that name. But you can find one that's pretty close. | 
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