Stopping margin trading, absolutely. Stopping short selling, of course. But we’re not talking about either of those things. We’re talking about cash-funded limit Buy orders on a duly listed publicly traded stock.
See [1].
Long story short: Robinhood lets you buy and sell a share instantly. In the real world, those trades take days to settle and clear. To bridge the gap, Robinhood loans you the difference. And Robinhood, in turn, is "loaned" [2] some of that difference by the DTCC.
So when the cost of that loan goes up, their costs go up, and they responded to that cost pressure by turning off trading. (There are other options.)
[1] https://news.ycombinator.com/item?id=25950361
[2] In quotes because it's technically a collateral requirement. If you sell $100 of stock, DTCC may tell Robinhood it only needs to put up $2 of stock as collateral while Robinhood gets the rest from wherever it's getting it from so it can pass it along to the next person. The $98 is "loaned," as in it's owed to DTCC. If Robinhood fell down, DTCC would sell that collateral and buy the rest of the shares in the market. In this case, DTCC said "these shares are super risky, and may lose all their value in a heartbeat, I need you to hand me 100% of the shares you say you are selling when you sell them." And Robinhood said no. Because that's expensive.
[a] DTCC says put up $100 per share because DTCC is not a lender either! It has lines of credit with various banks. And the banks bear the risk of the loan defaulting. So they're setting their rates and then DTCC draws from the cheapest line.
Question, why are we operating near-real-time settlement systems for securities if it doesn't eliminate such risks? I don't understand why these transactions aren't being netted and conducted as close to real-time as possible.
This aspect of the economy seems like a significant vulnerability.
I don't see the lack of real-time-settlement as a vulnerability so much, but more the mismatch. But I'd suggest fixing it not by increasing the frequency of settlement, but by decreasing the frequency of trading (Tobin tax (which, funnily enough, is also called Robin Hood tax [1]); replace continuous trading with a couple of auctions a day; ???).
Side note, I am against the Tobin Tax. I think public markets are more important than most folks believe.
I do believe that frequent trading is a good thing, as is retail participation in markets. One of the amplifiers of income inequality, I suspect, in the past few decades has been the fact that high-growth companies that normally would have gone public sooner have stayed private for longer, denying participation from the public market.
For example, a well chosen index of Dot Com stocks that included Amazon, Google, E-Bay etc. picked in 1998 would have, provided there was continuous investment and a long-hold, injected a large amount of capital back into the public and retirement systems, which would have helped lift all boats so to speak.
AMZN was originally at around $4/share (adjusted for splits, provided this data source is correct, https://www.macrotrends.net/stocks/charts/AMZN/amazon/stock-... ), if you had bought 1k stocks of the company in pre-2000, and held until now. Your originally $4k position would be worth 3.2M.
That's quite crazy. And it's retirement money for a lot of people.
Amazon's growth has occurred in the public, giving retail investors the ability to tap into the formation of new wealth. SpaceX's, AirBNB's, DropBox's etc hasn't. They're playthings of the well heeled. Not the gumshoes.
We need to re-orient public markets in such a way that everyone gets to participate in wealth creation. Not restrict it even further.
On the frequent trading, let's agree to disagree.
On retail participation, agreed. But I don't think that the Tobin Tax would inhibit it, but rather HFT and maybe day trading.
Fully agree that this new thing of companies staying private longer and longer is a bad development, with the best deals available only to the few connected and wealthy.
The firms that provided instantaneous-seeming settlement got the orders. And settlement failures were rare and correlated enough that avoiding them wasn't a differentiator. Then we got centralized clearinghouses and deposit insurance and the risk fell so far into the background that it's entirely novel to many market participants today.
> why these transactions aren't being netted and conducted as close to real-time as possible
It is technically difficult. It provides less room for correcting errors. And because real-time payment rails are fundamentally more expensive than batched rails, and if your payments aren't in sync with your settlement you've got a credit component somewhere.
> seems like a significant vulnerability
It does, but I don't think it is. Clearinghouses spread risk across a lot of people. They also help early identify daisy-chains, e.g. a single broker sold ten shares to ten brokers who then sold it to ten more fifty times and that single broker hasn't settled yet, and loops, e.g. I owe you and you owe Larry and Larry owes Bob and Bob owes me, of settlement risk. That's why Dodd-Frank moved many derivatives onto centralized clearinghouses.
That said, we've only had these since the 1970s. Counterfactual: we didn't have the technology to do this until the 1970s.
A part of the reason why the Automated Clearing House system was setup was the collapse of Herstatt, which was a settlement failure that led to the global push for RTGSes.
It is not that difficult to imagine another such storm. A heavily shorted stock, where retail traders "rally" to stick to the man and buy + hold on to the majority of the stock in circulation. And then the shares left in pools + the open market aren't enough to cover everyone's position. Creating a cascading failure.
I’ve been looking at settlement also and am particularly interested in overnight Interest rates. https://en.m.wikipedia.org/wiki/Overnight_indexed_swap
This past years changes at the Fed for Central Bank Interest Rate Swap Lines and 9 new banks, which included Sweden and others. https://www.federalreserve.gov/newsevents/pressreleases/mone...
The dollar is running the world right now. Lots of demand even as, or maybe why, the value has been weakening. https://www.marketwatch.com/investing/index/dxy
Curious when the dollar running the world will begin to change. The US dollar and CN Yuan are the only countries keeping us with positive, basically zero, interest rates globally (See IMF SDR) https://www.imf.org/external/np/fin/data/sdr_ir.aspx
Lastly, Power to the Players! Still looking for more short squeeze on the GME shorts, would like to see them get pushed down to a reasonable level of the float (5-20%?). I’m holding.
I don’t think the problem here was with too many trades. Very few Robinhood accounts overall have over $25k balance.
I guess I can’t see where the risk is. Shares are moving electronically between different ledgers as orders are fulfilled. Shares aren’t being created or destroyed, nor is money.
I can definitely see how you could end up with large net cash flows that need to settled over the next 48 hours, if Robinhood accounts are collectively gaining or losing huge percentages of their value from one day to the next. But I don’t see, absent allowing margin or naked options, how they could ever end up owing more than they actually have on hand in their custodial accounts.
I would possibly believe that Robinhood didn’t have the technical controls the fix the problem that they were having the “right” way, and had to resort to their “least worst option”.
For example they should have the technical controls to flag specific sales to prevent those funds from being reinvested until the particular sale settles. By free and clear settled cash should be able to buy any publicly listed share it wants.
Ah, this is the disconnect.
They're not. Shares and payment for them move within two business days [1]. In the meantime, both sides must post collateral as a guard against their failing to deliver.
You're a broker. Suzy has $20 in her account. Suzy sells a share for $10. She buys another share for $10. With the first trade, you have to post--today--collateral against that $10 for two days. With the second trade, you have to post--again, by close of business today--collateral against that $10 for two days. To keep things simple, let's assume Suzy did not use the proceeds from the first sale to finance the second. That leaves you with $20 of liabilities and $20 of cash.
Next day, Suzy sells all her shares for $40. Now you're putting up collateral against that $40 for two days. The $20 from yesterday still hasn't arrived from JPMorgan--they have until tomorrow. You now have collateral against $60 of liabilities. At the end of the day, Suzy makes a withdrawal request because she's a little shit. So now you have $80 of liabilities from someone who deposited $20 in her account and never had more than $40 of assets.
Clearinghouses use the last day's closing price to determine how much collateral you need to post. They then multiply that by some value that ranges between 2% and 100%, depending on what their line-of-credit lenders offer them. That is leverage. To manage that risk, the clearinghouse adjusts that multiplier. Going from 20% to 100% in the above example would mean going from $16 of collateral required to $80. That's $64 of cash you need to come up with before the end of the day or you're out of business.
If Robinhood operated with zero clearing leverage, they would not be able to offer the instant-trading experience their competitors have offered since the 1990s.
[1] https://www.investor.gov/introduction-investing/investing-ba...