The allure of making money fast has long drawn people to Wall Street hoping to make a fortune. For a long time, investing in the stock market has been for the wealthiest people, with ample money to put at risk along with the ability to pay the necessary fees. This all changed with the advent of the internet. Now, stock trading is as simple as buying something from a store. Create an account, pick a stock, pay, and you are now a shareholder in a company.
These new online brokers have changed the way people invest. No longer do you need a human broker to execute trades for you. You simply need an app. These online firms don’t charge any fees or have any account minimums. Low costs and a game-like format have especially enticed young people. In the realm of brokers, one online brokerage has dominated them all: Robinhood.
Robinhood, whose mission is to democratize trading, created a whole new type of retail investors. One of Robinhood’s biggest fans are members of a subReddit called “Wall Street Bets.” So, what is Robinhood and Gamestop? What happened? Why does it matter and what can we do about it?
To understand this event it is necessary to get to know Wall Street Bets. Wall Street Bets is an internet forum where amateur day traders share investing tips and information. Wall Street Bets are famous for their signature move, the “YOLO,” where an investor would put all of their cash into an option such as a Tesla call. Wall Street Bets traders are also famous for their impressive losses. There are many situations where members have lost tens of thousands of dollars investing in risky options. They existed in relative obscurity. Until they discovered that Gamestop had been shorted millions of shares. Gamestop stock has taken a beating in the past few years. With most video games being bought and played through the consoles it rendered Gamestop obsolete. The pandemic too further declined the remaining sales. They realized if they could generate enough interest and money, it would create a short squeeze increasing the cost of Gamestop shares dramatically.
A short is where a person borrows shares of a stock from a broker with the promise to return the same number of shares to them after a certain period. They then go and sell those shares on the market anticipating the price will drop. They then buy shares at a lower cost, return the borrowed shares to the broker and take the profit. However, there is one vulnerability in this model: a short squeeze. If there is enough interest in the stock, the price will rise, but those funds have to buy shares no matter the cost driving the price up. Since the shares are borrowed, the hedge funds could lose an unlimited amount of money. Each time a contract expires the funds have to buy more and more shares sending the stock price skyrocketing. The hedge funds unknowingly added fuel to the fire. They shorted more shares than existed. Thus increasing the amount the price could go up. The Wall Street Bets traders knew this and started to spread the word on this possibly lucrative investment. More people started to hear about Gamestop and started to buy billions of dollars of shares. Gamestop got to a point where the stock was trading at around 500 dollars a share. A sharp increase from around 30 dollars a share. Celebrities, politicians, and regular people all got caught up in this frenzy where it seemed the retail investors beat Wall Street at their own game. Soon, a major obstacle to the retail investors would happen: Robinhood stopped allowing users to buy Gamestop stock.
This decision was one of the most consequential decisions in the whole saga and was met with lots of resistance from everyone from Ted Cruz to AOC. People were up in arms and called foul play on Robinhood. Politicians were calling for inquiry, others calling for the head of the CEO of Robinhood over this decision. People thought that some of Robinhood’s investors are connected to the hedge funds and they ordered this to happen. In reality, the truth of this decision is a lot more complicated.
When a person buys a stock, they first go through a brokerage such as Robinhood, which exercises the trade for them. The trade is then sent to the NSCC or the National Securities Clearing Corporation who prepares a report. That report is then sent on to the DTCC or the Depository Trust & Clearing Corporation who acts as an intermediary for the buyer and seller of the security.
When a person buys a security the broker gives some collateral to the DTCC for their service. The collateral they ask for is dependent on how risky the stock is. Stocks such as Apple or Microsoft have low collateral amounts due to their relative stabilization, while penny stocks might have much higher collateral amounts.
On that Friday, when Robinhood stopped trading, the DTCC increased the amount of collateral needed from their members. The collateral needed jumped to $33.5 billion, up from $26 billion. Many of the firms could not afford the extra collateral for those trades. One reason for this is that many of the buyers on Robinhood were buying on margin. Buying on margin is when a person borrows money from someone else to buy a stock. This practice is risky as a person could lose more than 100 percent of the money they invested with should the security go down. Since so many people were buying on margin on platforms such as Robinhood were strapped for cash and could not afford the extra collateral needed. These brokers also do not charge a commission, thereby limiting their cash on hand.
Critics point out that they allowed selling, but this explanation accounts for that. Collateral, is put up by the seller, not the buyer. While many people believed that there was some form of a grand conspiracy to hurt the retail investors. In reality, there is a simpler explanation: The brokers ran out of cash for collateral.
So why does this matter? This moment marks one of the most significant moments to happen on Wall Street. Millions of retail investors rose and caused serious harm to the hedge funds for some time. There is a more sinister side to this as well. Wall Street Bets has shown just how easy it can be to manipulate a stock price. Silver, a few weeks ago, saw massive growth, but no one was sure why. Wall Street Bets members claimed it wasn’t them and blamed the hedge funds. Much of that information was spread on the forum; silver rose more than 30 percent in just a few days. This growth pales in comparison to the rise of Gamestop or AMC but still is a sizable payday. What proved is that any company, individual or foreign power could easily manipulate the market and have massive real-world results.
For example, hostile foreign powers such as Russia could put millions of dollars into a shorted stock and then use their tried and tested bot army to go on forums such as Wall Street Bets to create a clamor, driving banks down with them.
Foreign powers or bad actors now could have a lot of power over some of the largest public companies. Should something like this happen again it could cause irreparable damage. If a major bank closed because of this type of market manipulation, it would cause havoc where millions of people could lose their savings and livelihoods. These fears should be taken into consideration by regulators to create ways to prevent things like this from happening again. They could implement regulations about how much anyone can short a company, create limits for the number of trades that can be executed on a day, make shorting information public, or other actions to help prevent this amount of instability in the global financial market.