Here are some things I think I am thinking about. Actually, they’re all basically the same thing and they’re all GameStop, of course. But whatever.
1) The Short Sellers Did It! The GameStop saga has been a nearly endless stream of bad narratives. And the one narrative that no one is discussing, the one that actually makes sense is “YOLO gambling is reckless”. But we’ll come back to that in a minute.
The bad narratives started with evil short sellers. You know how it goes – short sellers are bad and need to be destroyed. Luckily for us a Reddit Forum of day traders was just the right hero. Of course, anyone who fully understands how short selling works knows that that narrative was nonsense. Yeah, it’s kinda cool to see a big high fee hedge fund get caught up in a retail trading frenzy, but it’s weird to see a huge pump and dump going on while people scream about a supposed short and distort scheme. I mean, what makes the pump and dumpers better than the short and distorters? These are all just gamblers trying to push a stock to a place it shouldn’t be for their own personal gain. Who cares whether it’s on the upside or downside? It’s all a form of distortion in the end and as GME now implodes on itself we’re seeing a lot of retail investors caught on the wrong side of things.
Of course, I am not defending short sellers. I am a regular critic of high fee funds and short-termism. Most short sellers feed on both. They kind of have to remain viable. And while they are easy to criticize you can just as easily criticize firms that charge high fees and pump stocks on the long side. And as I already described, there’s nothing inherently evil about selling things.
2) RobinHood Did It! It didn’t take long for the GameStop narrative to evolve. By late last week the DTCC had raised collateral requirements on RobinHood and almost every other large firm trading GameStop because there was increased counterparty risk because GME had become so volatile that the firms involved couldn’t manage their credit risks. A number of people came out blaming RobinHood, who, of course bore some of the blame because they invite this sort of irresponsible trading. So, firm that promotes irresponsible activity on their platform gets hurt by irresponsible activity. Shocker. But RobinHood, contrary to popular opinion, didn’t halt trading because they wanted to protect hedge funds and hurt retail investors. The DTCC raised collateral requirements. RobinHood had no choice but to halt the buying because they knew they couldn’t meet the collateral requirement.
So, the big media narratives are 0-2 so far. One more strike and you’re out.
3) T+2 Did It! The latest and greatest narrative is this idea that T+2 caused all of this. T+2 refers to the 2 day settlement for equity trades. This is a big and messy concept, but the gist of the story is that firms use T+2 because credit and derivative markets create a good deal of discrepancy in cross asset settlements. It would be great if all of these assets settled in one nice clean location using nothing but paper certificates, but that’s not the world we live in. The financial system is a big messy network of differing markets, different credit instruments, differing derivative instruments, different locations and different times. Settlement is complex because the financial world is complex.¹
Anyhow, I’ve noticed a growing number of people now blaming this whole thing on T+2 and the way that RobinHood had to cut off trading in GME because the DTCC didn’t trust their ability to meet clearing requirements. But this makes no sense. RobinHood didn’t have $5B in cash sitting around to settle trades even if it was a T-0 situation. Would they have had that cash if it was that kind of environment? I seriously doubt it. More likely, RobinHood would have found themselves with a lot of cross asset exposure and temporal settlement issues directly tied to the highly volatile price of a handful of instruments.²
Unsurprisingly, the DTCC has discussed this issue in some detail. And yes, while T-0 is certainly feasible in some instruments it’s a very messy situation given how complex the financial system has become.³
That’s strike three.
Who Dun It?
What we have here is a good ol’ fashioned WHO DUN IT? So. Who dun it?
Gamblers dun it. That’s who. People often ask who the culprit is when the financial system goes through a period of turmoil. It’s pretty much always the same answer – gamblers. In this case you had gambling short sellers who were unhedged and caught on the wrong side of a trade. And you had a stock trading application that entices their users to act like gamblers. You had a Reddit forum filled with gamblers who want to make non-diversified “YOLO” bets on stocks. And then the gamblers using that application created order flow problems that not only led to problems with the application, but also caught a whole lot of people on the wrong side of a bad trade. There isn’t just one bad guy in this story. There is just a whole bunch of people trying to get rich quick in a system that is inherently designed to hurt people who try to get rich quick.
In the end we come back to a few common narratives here. Short-termism kills. And the stock market isn’t where you get rich. So yeah, it’s true. You Only Live Once. Don’t blow it running with the market mob over the cliff.
¹ – This is usually the point in the convo where someone says “Bitcoin fixes that”. No. Bitcoin is a single asset that has an extremely simple peer to peer settlement process. When you apply credit and derivatives to Bitcoin you’ll end up with similar counterparty and centralization issues.
² – This is usually the point in the convo where no one says “this sounds like banks in 2008”. That no one is right. Yes, banks didn’t have enough capital in 2008 because banks don’t like to hold capital because it’s expensive. So now we’ve changed the rules to force them to hold more capital. Will that stop banks from being reckless in the future? I doubt it. Why? Because greed is inherent in financial systems. RobinHood likes to make money and they can make more money by making their users act greedy. Just like banks can make more money in the mortgage market by getting homeowners to act greedy. It’s not really that different and as long as you have greedy people doing greedy things then financial markets are gonna get weird some times.
³ – This is usually the point in the convo where someone says “we need a new simpler system”. That sounds nice. Are you going to ban derivatives contracts? Are you going to ban insurance products? Are you going to ban credit contracts? The system didn’t become this complex because we enjoy complexity. The system became complex because we created things that serve a rational purpose inside a world that is increasingly complex. And there’s no putting the toothpaste back in the container at this point.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.