There is a lot of noise and misinformation regarding the Robinhood/GameStop debacle that happened last week. A lot of people are concerned that this is an example of Wall Street being “dirty” and the rich just getting richer. Basically, people think that the reason Robinhood suspended buy orders for certain stocks (GameStop, AMC, and Koss), is because they had pressure from market makers or market participants (like hedge funds).
In my opinion, the temporary halt on trading was caused by an outdated settlement process involved in trading stocks. At the time, the cost of clearing those trades increased by three-fold and companies like Robinhood simply couldn’t afford that expense.
Here’s how it works: Robinhood is a brokerage firm that then routes trades through a clearing house. This is why the investor feels like they own the stock right away even though it takes a few days for those trades to settle (that’s where the industry term “trade plus 3 days” comes from). The clearing house is acting as an intermediary that helps the broker facilitate a trade forward. Thus, the clearing house has to post collateral on behalf of the broker. The problem is that the cost of clearing can become extremely expensive when the stock has a lot of movement within those settlement days. And firms that can’t afford it, have to suspend trading.
What does it all mean: Wall Street may be overcomplicated and some of the processes are antiquated, but don’t jump to the conclusion that it’s dirty. Even when we see bad things like Ponzi schemes, it usually represents a small percentage of the investment universe. Keep in mind, people that really wanted to buy GameStop stock could have gone through another brokerage firm instead of Robinhood without any issues even if they weren’t rich and famous.
In fact, this might be the opposite of the rich getting richer. There is a lot of talk that retail investors drove up the price of those stocks because of recommendations by online blogs (like Reddit) and subsequent purchases of that stock through online brokerages (like Robinhood). Because there wasn’t enough institutional (“rich”) money to short the stock, the retail investor caused an imbalance in the market which then resulted in extreme volatility in stock price. Under that theory, it was the retail, online investor that caused their own plight.
Unfortunately, the story about an obsolete clearing process probably won’t get as many eyeballs as the “Wolf of Wallstreet” headline. If more people got their financial advice from credible sources – instead of social media and online blogs – situations like this wouldn’t happen. The real story should be about financial education for the common investor, so they understand all their options and opportunities.