Hey Robinhood, Use This Apology
Last night on the Clubhouse app I listened to Elon Musk talk about Mars, artificial intelligence, and the future of humanity.
The best part of the conversation came at the very end when he called Vlad Tenev, CEO of Robinhood, to the stage and greeted him with “It’s Vlad the stock impaler.”
Elon asked the perfect questions, and Vlad went on to recite the same generic PR answers that he gave on TV last week. This was confounding since Robinhood themselves posted great explanations of what happened. Does he think we wouldn’t understand?
I already wrote about why Robinhood was not the biggest culprit in the “scandal” involving Robinhood. Here’s a better explanation (Robinhood, take note).
Robinhood is an umbrella company that has two main subsidiaries: the introducing broker and the clearing broker. The app on your phone is the introducing broker, that’s where you buy and sell stocks. The clearing broker is what settles the trade on the back-end.
Here’s the first stumbling block. Many people think that trades happen instantaneously. Sure, you can click “buy” on GameStop and then click “sell” minutes later, but the trade hasn’t been finalized. One of the features that Robinhood offers is being able to instantaneously use the buying power in your account acquired from buying or selling. How about what happens behind the scenes?
Robinhood as a clearing broker is beholden to the NSCC, not Citadel (as Elon asked). The NSCC “provides centralized clearing, risk management, information, and settlement services to the financial industry.” They make sure trades are settled. In the United States, trades settle at T+2, meaning two days after the trade. Robinhood is fronting you the ability to use trade proceeds instantaneously when it hasn’t settled yet.
Robinhood has to follow the NSCC’s rules when it comes to settlement. The NSCC has rules in place to mitigate risk. Think about this situation: someone buys a share of GameStop for $300 on Monday. On Tuesday, the share price drops to $20. Whoever bought the share at $300 is not keen on handing over $300 on Wednesday when the price is now $20. They can even tell their bank to cancel the payment to Robinhood.
The NSCC has to worry about these situations. As a result, they require Robinhood to post collateral ahead of settlement as a form of insurance. There is no magic formula to determine this number, but there are several factors. Volatility is one. If the stock price keeps shooting up or down, there’s higher risk. Concentration is another. If many of the trades across Robinhood are taking place in a single stock or two ($GME & $AMC), that’s risky. Finally, the cherry on top, VaR.
VaR (value-at-risk) is “a statistic that measures and quantifies the level of financial risk within a firm, portfolio or position over a specific time frame.” An example output would be that over the course of two days there’s a 2% chance of losing 3% of portfolio value. In other words, there’s a percentage chance of losing a specified amount of money. As Taleb says, it’s a terrible way to measure risk. Remember the principal of power laws. Finance lives in Extremistan, not Mediocristan. Measures like VaR and standard deviation are useless because everything happens in the tail events, and these measures minimize them.
For example, if there’s a 2% chance of losing 3% portfolio value, that tells me nothing about maximum losses. Robinhood and the NSCC were blind to this. As Vlad explained last night, they received a call last week from the NSCC asking for $3b in collateral. Robinhood didn’t have anything close to that. After rounds of negotiations, they settled on preventing people from buying shares of volatile stocks and in return got the requirement knocked down to $700m.
No conspiracy there. While we’re at it, let’s debunk another mistaken sentiment.
The recent short selling strategy is a self-fulfilling prophecy based on a lie. I came across this in-depth post on r/WallStreetBets and was disgusted. Not because of the tenor of the post, but due to the lack of common sense. Don’t bother getting tricked by the article, I’ll summarize the argument here.
The author of the post (allegedly an engineering PhD student) went over SEC filings and other publicly available data and claims to have unearthed a massive conspiracy. If you add up all the $GME shares hedge funds own, and add that to the estimated shares belonging to r/WallStreetBets, you get a startling number. It’s greater than the amount of shares that GameStop ever issued. Here’s the trick. They forgot to read my article on how short-selling works.
Tl;dr If I own a share and lend it to someone for them to short it, they sell it to someone else. I’m still long the share. The new owner is now long the share. We both own a share. It’s exactly like our fiat money system, stocks don’t operate on the gold standard.
There’s no conspiracy here either. There are not tens of millions of counterfeit shares that are driving down the price. For every buyer there is a seller. Somehow this post got 55k upvotes!
For anyone at Robinhood, yes, I’d gladly help your PR efforts.