From: allin
Market disruptions, such as the GameStop phenomenon, highlight the complex and often contentious roles played by trading platforms and regulatory bodies. These events expose vulnerabilities in the financial system and raise questions about market fairness, transparency, and the balance of power between institutional and retail investors.
The GameStop Saga: A Case Study
The GameStop saga began in June 2019, when a Wall Street Bets user initiated buying long-dated January 2021 call options, spending 25 million [04:07:00]. This was supported by fundamental analysis, including Michael Bury (famous from “The Big Short”) disclosing a three percent position in August 2019, noting that 90% of GameStop’s stores were free cash flow positive [05:08:00]. The company, a retail video game store that had suffered from declining mall traffic and digital downloads, was seen by some as undervalued [05:44:00].
A key turning point was Ryan Cohen, founder of Chewy, taking an almost 10% position in GameStop in August 2020 [06:31:00]. A Wall Street Bets member then highlighted the company’s 120% short interest, predicting a “big squeeze” due to new console cycles, loyalty programs, a strong balance sheet, and Cohen’s involvement [06:44:00]. Cohen later urged GameStop’s board to evolve into a technology company [07:26:00].
As GameStop’s stock price surged in January 2021, driven by retail investors purchasing call options, institutional investors who had shorted the stock faced massive losses [09:17:00]. Firms like Melvin Capital, which had been synthetically shorting the stock for over four years, needed capital injections from other hedge funds like Citadel and Stevie Cohen [08:04:00], [11:40:00].
Platform Intervention: Robinhood’s Role
On January 28, 2021, several brokerage firms, including Robinhood and Interactive Brokers, prevented their users from buying GameStop and other volatile stocks, allowing only selling [12:34:00]. This one-way pressure caused a 44% sell-off, which later reversed [12:44:00].
The decision to halt trading sparked significant debate:
- Insolvency Claims: It was suggested that platforms like Robinhood banned trades because they lacked sufficient margin or capital to meet requirements from their partners, thus facing insolvency [13:23:00]. This was described as a “platform level decision” [13:08:00].
- Business Model: Robinhood makes money through “payment for order flow,” where they sell data about user orders to prime brokerage institutions like Citadel milliseconds before trades are executed [13:54:00]. Citadel, responsible for 47% of order flow volume, paid Robinhood almost $100 million in one quarter [14:26:00]. This model can create conflicts when the market becomes volatile, as Robinhood is exposed to losing money [20:52:00].
- Impact on Retail Investors: The halt prevented individuals with “hard-earned money” from participating in trades that could have been executed elsewhere, leading to “incalculable amounts of economic loss” [19:30:00], [22:15:00].
- Negligence vs. Unprecedented Event: Some argued that Robinhood’s actions were due to negligence, as they should have anticipated and prepared for such liquidity crises, especially after similar events in March 2020 [23:35:00]. Others suggested it was an unprecedented “black swan event” with the influx of millions of new retail investors [27:07:00].
- Poplulism vs. Elite: The situation was framed as a battle between “the pros versus the joes,” where retail investors organized to challenge powerful institutional short-sellers [09:17:00], [24:29:00]. The intervention by platforms was seen by some as favoring the elites against the upstarts, akin to censorship in other social media contexts [55:13:00].
Criticisms of the Current Market Structure and Proposed Solutions
The GameStop event amplified existing criticisms about market structure and regulation.
Market as a “Synthetic Casino”
It was argued that modern stock trading, with its emphasis on shorting, margin, and derivatives, no longer primarily serves to capitalize businesses but has become a “synthetic casino” where people bet on price movements [33:10:00]. The enormous volume of trading ($121 trillion in 2020) suggests that only a fraction of this provides capital to businesses [34:05:00]. This system allows trading firms and hedge funds to extract significant wealth without necessarily driving innovation or job growth [33:21:00].
Issues with Hedge Funds and Leverage
Hedge funds are seen as “apex predators” who short companies to destroy them, often engineering outcomes through PR and disinformation [24:34:00]. The Long-Term Capital Management (LTCM) crisis in 1998, where a fund leveraged 125 billion of borrowed funds and $1.4 trillion in trading positions, causing systemic risk, illustrates the dangers of unregulated leverage [37:17:00].
Proposed Solutions for Regulation:
- Modernize Infrastructure for Ownership: Use technology (potentially blockchain) to ensure that one share of stock isn’t loaned out multiple times, preventing scenarios where more than 100% of a company is shorted [36:08:00].
- Implement Leverage Limits: Just as banks have strict oversight and leverage limits post-2008, similar limits should be imposed on hedge funds to prevent systemic risk [37:05:00].
- Improve Disclosure: The SEC should force all entities to publish their holdings on a weekly or monthly basis to increase transparency and allow watchdogs to identify risks faster [39:26:00].
- Allow Open Trading: Question why platforms can decide who is “financially literate” or what can be traded, arguing for open trading similar to casinos or lotteries [39:53:00].
- Short-Term Trading Tax: Implement a 0.1% tax on every share sold, replacing capital gains tax. This would reduce high-frequency trading, encourage long-term investment, and generate significant revenue for the federal government ($777 billion incrementally based on 2018 data) [41:02:00]. This would shift focus from momentum trading to investing in businesses [41:52:00].
Market Volatility and Collective Belief
The event highlighted how collective belief, amplified by social media, can significantly influence market prices, detached from underlying business fundamentals [53:23:00]. This was compared to Tesla, where belief in Elon Musk’s vision drove the stock price, enabling the company to raise capital and build its business, despite initial skepticism about its profitability [53:30:00]. This phenomenon, enabled by social media, creates “movements” which can be positive, but also “mobs” (mob behavior/diffusion of responsibility) leading to negative outcomes like “cancel culture” or the Capitol riots [01:05:24].
In conclusion, the GameStop event underscored the need for platforms to understand and manage risk effectively, and for regulators to adapt to the new dynamics of retail investor engagement and social media influence in financial markets.