Real time equities settlement and clearing is a terrible idea. It sounds great. But it breaks a lot of good stuff. I'm surprised the CEO of a brokerage is advocating for it. (The article is a bit loose with the terms settlement and clearing. Again, surprising from the CEO of a company that almost got taken out by internal clearing failures.)
If you only think about the American stock market from the perspective of a domestic retail day trader, sure, real-time clearing sounds easy enough. When you expand it to institutions, real-time settlement means having to warehouse all the funds they might need to trade with in a day with their prime brokers as cash. Not Treasuries. Cash. Because their broker has to be able to wire out that $1bn instantly. (That's what real-time settlement means. Real-time payments.) For market makers, this effectively requires removing their buyer of last resort obligations since they would be practically capped by their cash on hand. There are additional complexities when one considers foreign investors. Options exercises and expirations. ETFs. Futures.
Historically, the loudest advocates for shortening settlement times have been global money centre banks. A switch to real-time settlement and clearing would require every market participant either (a) have flawless payment rails to every other market participant or (b) put all their cash with a global bank who can provide that guarantee.
End-of-day or overnight clearing, on the other hand, isn't too much to ask for. It preserves the robustness and extensibility of delayed settlement. But it removes a few days of collateral requirements. Pushing for EOD clearing would be a smarter play for Robinhood, from a government relations perspective. (If this is solely PR then whatever.)
110% agreed. This is a near-textbook example of "just because you can doesn't mean you should".
The simple reason in this age of high frequency trading and massive amounts of money being moved around, a tiny arbitrage opportunity could instantly be magnified and trigger a system (market) crash. Whereas these crashes can and do occur today, the non-realtime aspect of settlement and clearing mitigates to a large extent. See the 2010 flash crash example: https://en.wikipedia.org/wiki/2010_flash_crash
In addition, I'm dubious of how "real time" this proposal will turn out to be. For one there are a number of dependencies and steps that need to be fully aligned to expedite from end of day to something faster. True real time systems are a rarity - most of the time the latency is still measured in minutes or hours. A flashy term that tech companies like to throw around.
Also this feels like a diversion tactic from the implosion of Robinhood of the company from last week's debacle. For those unaware, RH also put limits on AMD stock to be traded - what the heck?!
> Whereas these crashes can and do occur today, the non-realtime aspect of settlement and clearing mitigates to a large extent. See the 2010 flash crash example: https://en.wikipedia.org/wiki/2010_flash_crash
How so? I'd argue that the SEC policy of breaking "clearly erroneous" trades before settlement exacerbates that kind of flash crash: market-makers can't step in to prop up prices and then hedge their exposure, because their trades will be broken and their hedges won't. If settlement was real-time, preventing flash crashes would be profitable and people would do it.
> Also this feels like a diversion tactic from the implosion of Robinhood of the company from last week's debacle. For those unaware, RH also put limits on AMD stock to be traded - what the heck?!
It's not a diversion, it's a genuine explanation - the collateral requirements were why RH had to impose a bunch of limits.
> I'd argue that the SEC policy of breaking "clearly erroneous" trades before settlement exacerbates that kind of flash crash: market-makers can't step in to prop up prices and then hedge their exposure, because their trades will be broken and their hedges won't.
I'm a bit lost on your response. Are you advocating against SEC or stock exchange intervention? Remember that trading can be halted by stock exchanges also in order to decelerate massive movements. If the settlement happens on even a by-minute increment, then there is no effective recourse for these interventions. Flash crashes are black swan events and as such there's little incentive (as of now) for companies to build safeguards against it.
> It's not a diversion, it's a genuine explanation - the collateral requirements were why RH had to impose a bunch of limits.
It's an explanation but doesn't explain why other stock brokers didn't impose the same limitations, nor why RH is tapping its credit lines. I say it's a diversion because it's an attempt to deflect blame for its own poor business practices and policies - e.g. if my server can't handle the load, I can't just say "well, if I had a faster load balancer...." to my users.
> "It's an explanation but doesn't explain why other stock brokers didn't impose the same limitations"
Other brokers did impose trading restrictions on GME (and other stocks) around the same time as Robinhood. Webull, M1 Finance, Public, and E-Trade all halted buys of GME.
Others, including Interactive Brokers, TD Ameritrade, Schwab, and Trading 212 implemented restrictions such as halting options trading and greatly increasing margin requirements.
> Are you advocating against SEC or stock exchange intervention? Remember that trading can be halted by stock exchanges also in order to decelerate massive movements. If the settlement happens on even a by-minute increment, then there is no effective recourse for these interventions.
Yes, I'm advocating against them. My position is that SEC and exchange intervention makes flash crashes more rather than less severe. (Also they're harmless; artificially suppressing the volatility of the stock market makes everything more fragile, we'd be better off embracing them and making sure all market participants are equipped to handle volatility. It's like how decades of suppressing forest fires has made forest fires much worse)
> It's an explanation but doesn't explain why other stock brokers didn't impose the same limitations, nor why RH is tapping its credit lines. I say it's a diversion because it's an attempt to deflect blame for its own poor business practices and policies - e.g. if my server can't handle the load, I can't just say "well, if I had a faster load balancer...." to my users.
If your hosting service suddenly cuts your server capacity down by 2/3, I think it'd be fair to complain about that to your users.
According to Robinhood, they didn’t want to put limits on anything, it was the cleaning house that made them, so there had to be something that triggered AMD restrictions?
It looks like that because it's complex and technical and people don't understand it, but it also saved retail investors a bunch of money. I don't understand how a jet engine works, but I don't feel any urge to advocate for jet engine policy changes.
For those who don't understand your comment about HFT saving money for retail investors, several well-regarded published studies suggest that the narrowing of mean bid-offer spreads since the introduction of HFT can be attributed to HFT.
There are actually a variety of HFT strategies, but there's good evidence that the high-speed market-making variety are good for small volume investors. Those in favor of getting rid of HFT should be specific about exactly which sorts of HFT they want to ban.
The narrowing of mean bid-offer spreads isn't surprising, since many HFT strategies are essentially faster versions of traditional market making. They're able to offer narrower spreads (better prices) than traditional market makers because they're faster at widening spreads (worsening prices) when the market starts to move in one direction. On average, this means better prices for people trading small amounts of stock. However, for large institutions that trade market-moving volumes, low-latency market making means worse prices, since the market makers are faster at noticing and widening spreads when there are large market-moving trades afoot.
Also, the ETF arbitrage variety of HFT strategies reduce the amount that ETF prices differ from the prices of the individual stocks within them. This results in fairer prices for people who primarily invest in ETFs.
On the other hand, low-latency market-making results in less liquidity being offered when the markets are moving quickly in one direction, which is when it's most important to have liquidity.
Also, for the average person, a very large portion of their exposure to the stock markets is through pension funds and mutual funds, which tend to make the sorts of large-volume market-moving trades that are hurt by HFT's ability to notice and quickly get out of the way to avoid being run over.
Disclosure: I've never worked for an HFT fund, but I do work in the financial services sector. I did some work on systems designed to reduce market impact of large institutional trades, part of which is breaking up patterns so that HFTs are worse at noticing and widening their spreads.
> I'm surprised the CEO of a brokerage is advocating for it.
settlement is a necessary but undesirable part of the business of a brokerage, because it locks up capital, which is costly, for a business model whose margins are shrinking rapidly. it used to be that brokerages could earn something from the overnight repo on the balance sheet in order to compete aggressively on fees but nowadays overnight rates are so low and zero-cost execution is the cat let out of the bag. maybe prime brokerages can comfortably rely on the bank's overall B/S to manage this risk but specialist and retail brokerages are all aggressively shrinking capital to stay competitive at the cost of not doing business on days like these. how much is robinhood paying for drawing down those credit lines over the last week just to tide over the 2-day mismatch in trading and settlement? how close was it to getting stopped on doing business in all the other tickers that aren't GME and AMC? I honestly think robinhood would rather not have done that wsb business at all.
edit: immediate settlement is profoundly beneficial for a brokerage. imagine a single trade on the robinhood app, there is counterparty risk between the retail trader and rh and there is a separate counterparty risk between rh and the marketmaker. the two risks perfectly offset at the point of trade, but deteriorate as the market moves further away from the trade price. over several days, the loss probability can become completely lopsided. under instant settlement conditions, the counterparty risk is neutralized immediately.
as a side note, the ficc (which is the fixed income part of the dtcc) already does intraday matching. this is not, as i understand it, exactly settlement, but a pure flow brokerage, lets say, can net down their two-way exposures to reduce margin. this mollified the margining requirements surge in march 2021 when gov bond vol increased 3-4x.
Which comes first? The trade or the settlement? Are you going to instantly reverse the trade too if they payment doesn't come through? What happens when there is a fiber cut or other network issue? Trading halt because one broker can't connect? Or just that broker's clients get stuck?
> When you expand it to institutions, real-time settlement means having to warehouse all the funds they might need to trade with in a day with their prime brokers as cash. Not Treasuries. Cash. Because their broker has to be able to wire out that $1bn instantly.
I see two solutions here, either they sell the treasures (with also instant settlement) and then buy, or they could trade on margin backed by the securities. Or am I missing something?
> either they sell the treasures (with also instant settlement) and then buy, or they could trade on margin backed by the securities.
Treasuries don't instantly settle or clear. They clear next day. We could discuss changing that, but it's about nine hundred times more complicated than overhauling the entire stock market.
> or they could trade on margin backed by the securities
This shifts the entire market's credit risk to the banks. Which banks love. (Getting away from that is why we built clearinghouses.)
> the U.S. the Federal Reserve is already planning to support it
The U.S. has a real-time payments system. (One of the oldest in the world.) It's called Fedwire [1].
It's artificially kneecapped–Congress set a minimum fee of pennies on the dollar and many banks charge retail clients $10 to 35 for wires. But the rails are there and used and understood.
(Detour: my "abolish the penny" issue is expand Fedwire's market hours, enable it on weekends and remove all Fed fees for wires under $250,000.)
> the $10-20 fee for a fedwire is no longer much of a factor
That is almost entirely your bank charging a mark-up.
The Fed charges its members between 3.3¢ and 84¢ per wire, depending on things [1]. (It can go as high as $1.20 for a $100+ million wire from a bank that handles fewer than 14,000 wires a month.)
My bank, for instance, doesn’t charge anything for wires.
Not OP, but Fidelity is the only financial services firm I'm aware of that doesn't charge inbound or outbound wire fees (exceptions apply if you're a high net worth individual at other firms).
> When you expand it to institutions, real-time settlement means having to warehouse all the funds they might need to trade with in a day with their prime brokers as cash. Not Treasuries. Cash.
You are seeing this change in terms of the existing system ("100% collateral parked at intermediaries!"). But ultimately it might be possible to get rid of (some of) the intermediaries altogether, and move to direct atomic exchange of bearer instruments.
The Ethereum "defi" phenomenon is showing us a glimpse of what's possible. It would require an upgrade of the dollar to a CBDC though, or perhaps just wider use of stablecoins such as USDC.
What collateral can be transferred in real time that would not also get caught up
in market issues that would likely cause counterparty risk of some sort? Even US treasuries vary in price on a day to day basis, based on market conditions.
Cash is the only thing with an agreed upon fixed value
I agree, what I personally think needs to change is high speed/algorithmic trading on the millisecond (microsecond?) level. It should be humans trading, not machines. Sure they can listen to the machines but at the end of the day it should be on human time, say at least 10 minutes for transactions to complete without possibility of any changes to the transaction
When humans did all the trading, it cost drastically more to trade, all that money went directly into the pockets of market insiders, and the whole market was crooked as a barrel of fishhooks. Google "odd eighths scandal".
You can't access this high speed trading. This is the toy of billionaires that can afford microwave link between New York and Chicago and have dedicated teams of FPGA developers to write high speed network stacks with trading logic embedded in them.
This is what the parent comment was talking about.
I have friends who work for such firm, both are FPGA designers, the company has a microwave link because speed of light in fiber is only 2/3c. Hundreds of people are working there for the sole benefit of the private owners.
It's possible I was confused.. I thought you were complaining about the inequality between high speed traders and mere humans clicking on web pages..
The market was designed as a system for human interaction. I think the atomic unit of time should be at the clock speed of humans. It increases the transaction cost, but in a more responsible, sustainable way imo.
The entire operating procedure of security exchanges is a series of terrible ideas that exists in it's current form because it allows the most wealthy participants to maintain advantage. Latency arbitrage shouldn't exist, as one example. There are no sound explanations of why it must be allowed, which leaves greed as the only plausible one. We dedicate a lot of talented people and expensive equipment to fleecing each other at high speed when there are better problems to be worked on. On a societal level it's idiotic.
I like the IEX method of introducing a minimum latency and don't see why every exchange shouldn't do this. Selling retail trader order flows should be regulated out of existence, too.
You don't need to hold and transfer the cash immediately with T+2 settlement because effectively your broker is lending the cash to you for 2 days with the shares as collateral, hence the margin requirements and the RobinHood debacle.
But there's no fundamental reason that loan must be made by your broker, aside from the historical T+2 convention. You could just repo the shares for two days while you wait for the cash to arrive.
To build on this, I was wondering while reading the piece why is it we’re at T+2 today. It can’t just be from old standards when computers/networking was worse, otherwise we wouldn’t have only gone from T+3 to T+2. It would give them a lot more credibility in their argument if they illustrated the roadblocks, and why they’re not immutable.
I know the industry moved to T+2 settlement for equities a few years back and will make a slow progression to shorter. I would love to pick your brain if you had a way to reach you
The way it should be. The quicker we do away with interest bearing and yielding assets, the better. It's the cause of the vast majority of the economic mess we're in today. We've literally known about this issue for thousands of years, interest and usury have been prohibited in Islam, Christianity, and Judaism. We still think we're smart and not going to be bitten by the dangers of interest, yet that won't happen.
I had an interesting conversation with someone who took the view that all short positions were ursary. They had well thought out & logically reasoned from their premises arguments to back that up. I was really glad to hear their position.
It filled me with dread because it would destroy our current agricultural industry. And as much as I recognize the problems with it, “a large percentage of the population starving rapidly” was not an outcome Id endorse because of injunctions from pre-industrial wisrmen.
> who took the view that all short positions were ursary
It's more than usury. There is usury involved because "lending" the stock is done with interest. However, the problems don't stop there.
Stock shorters, as you point out, actively bet against a company or industry or economic structure in general, it's their benefit to see a company collapse or not do well. This isn't how a stable society should be set up.
Furthermore, stock shorting exposes three parties to risk: the original owner, the shorter, and the new owner. There is risk being created in the market that does not justify the value that comes out of it. Let alone the fact that it's possible to short more than 100% of the total stocks, on what planet is this even acceptable? In a normal stock trade, risk is transferred from one party to another equally.
The conclusion is that shorting is a heavily immoral, predatory, and dangerous practice. It's quite ironic that when ** hits the fan, the government has to step in to limit certain trades or practices that we've known all along to be dangerous (e.g. they lower interest or ban shorting).
This simply doesn't make sense. When nobody is incentivized to correct stock prices downwards, you just get injustices in the opposite direction. You can look at the private markets to see what this looks like: Theranos.
The law of supply and demand doesn't require shorting in order to "correct" prices downward. The counterpoint to your Theranos example is the fact that Enron existed too. Both of them were fraudulent. Both collapsed after some number of years. One privately held, one publicly-traded and shortable. Same outcome, no?
I can't (directly) short the price of strawberries at my farmer's market, or the cost of rent in my small town, or the prices of artwork at an auction house. Price discovery seems to work reasonably well in all these venues. What is with this canard that shorting is necessary for price discovery to occur? There is no such requirement in the law of supply and demand.
Short and long positions are important for things that a) have a future value of money component and b) have risk that can be mitigated in a cost effective way.
Artists would take advantage of this in the form of working on commission. Large enough commissions do in fact allow shorting in the form of insurance. The same is true of strawberry farmers & landlords at various places on the size distribution.
One of the complaints my farmers market strawberry vendors have is that they don’t have access to the same finance agreements that large producers have. Part of that is because it’s not cost effective enough to short them.
This is a fallicious argument. Just because we don't allow people to engage in predatory practices, does not automatically mean that everything else is being run correctly. We don't correct one injustice with another.
For those injustices in the opposite, we need to set proper rules and hold people accountable. I mentioned several times in this thread that the current financial system is fundamentally broken, big part of which is because it heavily relies on interest, which pushes people to commit even more injustices like the example you mention.
I responded to your comment because I follow Kasey's comments; I didn't notice your comment upthread suggesting that you believe the entire concept of debt needs to be eliminated. I apologize for replying to you, because I don't think there's any productive conversation we can have.
> Stock shorters, as you point out, actively bet against a company or industry or economic structure in general, it's their benefit to see a company collapse or not do well.
Companies that have inefficiently deployed capital or have problems like a Theranos or Enron should collapse. People keep acting like shorts show up to a company like Apple and take it down. That's not at all what happens. Shorts are a lot like vultures. We may not like to see what they do, but they provide a service by cleaning up dead carcasses.
If you want to argue that shorters spread (dis)information in a company and should be more closely looked at, I might agree. My immediate counter though would be that I see way more positive information spread in general, and people rarely seem to check that until it so blatantly false things collapse.
The shorts don’t take money from the company, they take money from people unfortunate enough to invest in a failing company. In some cases that money could have helped the company land, in others it was going towards something doomed and possibly fraudulent, but either way it doesn’t come from the companies coffers directly unless the company does a buyback from the shorts. The people losing money are other investors.
What if smart money had to bet on a competitor or growing some other investment instead?
That’s a fine position to take so long as you recognize the vast majority of long money also doesn’t go to the companies coffers unless the do another offering.
Much long money is absolutely used by the company indirectly; they can use their stock like a currency to raise funds with debt, pay employees, acquire companies with stock, etc. Thats hopefully a virtuous cycle where people do more stuff that creates value.
I don’t mean to make a moral argument, just question the need for short positions. If the company is truly bad their shares should deflate as demand deflates, no short seller position necessary. I think, from the perspective of the needs of society, punishing bad investors who fail shouldn’t be as rewarding as finding the right investments to grow.
Theranos collapsed without any shorting involved. Isn't this a counterpoint to the argument that shorting is required for "price discovery" and the unmasking of fraud?
> This isn't how a stable society should be set up
and why not? antifragile systems gain stability as they endure shocks. why not cyclically generate then destroy business? makes it easier to funnel resources to the top, because only the biggest - i.e., the most moneyed, hence the most liquid, hence best reactive to risk, hence most stable - firms can survive.
you may not like it morally, but two centuries of corporate history leave little to gainsay empirically about this notion.
Because we already have systems that are already superior and much more stable, we don't have to endure any artificial shocks due to inherent instabilities in the system (caused in large due to interest and other immoral practices).
The 2008 crash was just one manifestation of what happens when the system is taken to its logical conclusion, it all comes crumbling down eventually because it is not sustainable. We saw it these past two weeks with GME, however, the big players stepped in to put a stop to it because they can't allow the market to play by their own rules (because they're unstable).
I have no issues with businesses going under because they can't compete, that's how a free market operates. I have issues with lending money with interest and other predatory practices, such as shorting, because they destroy economies and/or exploit one class, causing the lender to gain an unfair and immoral advantage simply because he has money.
Gain wealth, but do it morally and without exploiting others. I'm all for that.
If investors believe shares of these companies are a ripoff, they can sell any holdings and / or abstain from buying. Just like they can do in nearly every other type of market.
If a used car salesman is trying to rip me off, I walk away from the deal. I don't need to be able to short his inventory! And the supply / demand dynamics of the used car market will trend toward equilibrium without any such shorting.
ok, but what incentives does anyone have to actually look at potentially fraudulent situations, especially if the stock is ripping, as in the case of Valeant Pharmaceuticals? In fact the incentives are so perverse that it pays _not_ to state your research on why the company is not worth what it is. Even the time value spent on research is non trivial.
Your example would make more sense if the car they were selling a what may seem as a perfectly fine Lambo, but in actuality it was a lemon. And the only way to find out if it was a lemon or not is to tear it apart piece by piece.
How does that make any sense? If the stock was growing 15% year over year without any indication that there are any issue, why would any investor want to provide any information or do any research on why that isn't the case? If an investor knew that there was fraud going on they would probably keep it to themselves and simply invest in the company anyways, because the financial incentive is there.
In your hypothetical example, a stock is going up and up, and I suspect it might be fraudulent, and you believe I have no incentive to pull my money out before the house of cards collapses?
Getting my money out is all the incentive I need! I bet plenty of Theranos investors would've loved to do exactly that. And there was no shorting involved in that company.
Sorry, but fixing one wrong with another is not the way. Are you honestly saying that stock shorting is the only incentive someone has to look at fraud? I don't buy that one bit.
You answered it, fix regulators, and heavily punish fraud, don't let people get away with a slap on the wrist. This is literally the job of the justice system. You may as well say what benefits do police or FBI have for catching criminals. The reward is a stable and just society, on top of their salaries.
On a side note, this is one aspect that religion addresses. Ripping people off is not going to end up well when facing God.
that's because it wouldn't do you any good. if, however, the used car salesman is engaging in fraud and selling expensive cars way under their market value while buying inventory at inflated prices, you could expose this by borrowing a friends mercedes, selling it for USD 100000 (then buying it back at USD 1000, so you can return it to your friend) making a nice profit along the way.
I also don’t think short selling as it is currently practiced is a net social good, but I don’t know anything about it’s importance in the agricultural sector. What does short selling provide there?
All futures contracts contain a “short” position. In its most basic a producer of the commodity agrees to sell in the future at a certain price now. This locks in their profit but is only useful to them if they are trying to hedge the price being worse in the future. They are borrowing a future position to make it tenable to produce now.
Without it most agriculture would be too risky to engage in (without a governmental entity stepping in and doing the same activity as the futures market).
I am not an expert but this seems different from the short selling we're talking about. In short selling of a stock, the stock is borrowed and sold immediately for profit. There is no productive action the short seller engages in to recover the stock, they just rebuy it on the open market, or not at all if the company has gone bankrupt.
If you are really stretching it, they can produce research that shows the stock should be worth less in this time, without committing any crime- which means it is based entirely on public information the market already has. Bashing a company could be considered a productive activity we are incentivizing from a certain point of view. But their incentives are all towards tearing down the underlying security.
In the agricultural example, the person selling the futures to their goods has to actually produce the goods. While someone might be borrowing the stock to resell it, ultimately the end farmer has to produce new value to deliver on their future contract. Otherwise, they would just sell futures to their crops, and then take their money to do nothing! But this is exactly what someone who short sells a stock does. They take the money, and they just sit around waiting for the stock to drop, no doubt resisting the urge to make it drop themselves through legally gray methods to increase their profits.
If I’m a farmer that has corn crops to sell, I receive immediate renumeration for production in the future (in the simplest contracts) if I don’t produce anything at all, I literally take the money and run, it what happens? What about if hail destroys my entire crop? What if it destroys half my crop but I claim it destroys all of it?
There are definite moral differences between those cases but in operational terms it’s better for everyone if I just payout everything as efficiently as possible. Presuming it’s all equal anytime I spend holding real claims because fraud might happen is a net bad. Now expand that to more complicated valuations of future value of money? Should I impede farmer John’s payouts to Farmer Bill because the rain was ever so slightly different on his acres than the other? What if farmer John is willing to forego that expedience for future consideration on his plot?
Multiply this by a billion. We have a complicated market where producers and consumers need to a) set a first price and then b) change their price as both the market conditions change _and also my own as an investor, decisions change_.
It is dramatically more efficient for everyone to just take positions in the market even if some of them are pessimistic.
The same thing is true of any product that had future value and also it’s efficient to make risk management easy. Stocks clear both hurdles trivially.
> I literally take the money and run, it what happens?
That can happen regardless, there are many scammers who did this with or without shorting. Shorting is not required to keep things in check, that's the job of law enforcement.
Taking a step back it's really quite simple. Shorting is literally a bet that provides no value other than that some people will profit at the misery of others. This is unethical and immoral. Furthermore, done at a large enough scale, it will cause harm to specific companies or firms. You bring up scammers that will take the money and run, yet don't discuss what happened with GME where the shorters piled on it like sharks to drive it down, it's literally a scam in the opposite direction. We shouldn't fix one wrong with another.
I accept that you and I have different moral positions. Mine is that a market without shorting is a fallacy.
That said, you are required to explain crop insurance in your world view. It is a fundamental part of modern agriculture. One I think of as existential. It’s a short position. If your religion doesn’t allow it I won’t argue. Similarly I won’t argue with Shakers who don’t believe in procreation.
From what I understood from his comment, he was worried about how shorting would cause the collapse of the agricultural sector, so agreeing with you that it's a bad and dangerous practice.
This is absurd. Capitalism is predicated on the ability to loan out money. No debt means no credit for new businesses. No mortgages. Governments can't issue bonds to raise capital.
For all it's evils, our modern society and advancement as a species comes from capitalism. Society would literally collapse if we "do away with interest bearing and yielding assets."
That being said, we can still work to create better finance regulation.
> Capitalism is predicated on the ability to loan out money.
If that's true, then it's fundamentally broken (assuming interest bearing loans of course). You will never have a sustainable economic system that is based on interest bearing loans, we see it all the time with people waiting for the next crash to happen.
> No debt means no credit for new businesses
Not true. There are moral alternatives. If you want to start a business, pitch your idea to investors who are willing to put in money in exchange for a portion of the company. If it works out, everyone profits, otherwise, everyone takes risk equally and the holder of the idea is not left with crippling debt. This is just and fair.
> No mortgages.
Mortgages artificially increase property prices, continuing the cycle. There are alternatives that don't involve interest. You see it all the time in the auto industry where they have 0% loans. Do the same with houses. We already did that historically in Muslim nations.
> Governments can't issue bonds to raise capital.
Raise capital in an ethical way. The government can invest in its society and businesses for example. Obviously there are other solutions but that's for the specialists.
> Society would literally collapse if we "do away with interest bearing and yielding assets."
Except it didn't when people followed the teachings of their religion (specifically Islam). Great empires were built without interest. It's possible, it's just that it isn't as easy or perhaps convenient to those who stand to benefit the most from interest.
>Mortgages artificially increase property prices, continuing the cycle. There are alternatives that don't involve interest. You see it all the time in the auto industry where they have 0% loans. Do the same with houses.
If your perspective is that artificial bubbles in asset prices will be reduced by lowering the cost of borrowing (i.e. no interest) then you're going to have to explain that, because it's the opposite of what normally happens.
EDIT: Shariah-compliant mortgages are generally constructed so there's no interest, but the cashflows between the parties often look very similar. e.g. a Musharakah loan where you only initially own the home in the proportion of your downpayment but gradually buy more of it over time by paying the bank off over time, as well an element of rent. Interest rate is replaced by return rate because the form of the contract is different.
When did we have 0% interest on houses in modern times? I said that mortgage interest contributes to bubbles, not that it's the only cause. Interest is more insidious, because it allows people who have wealth to gather even more wealth without putting in the appropriate risk to balance it, giving them the luxury to purchase assets easily, contributing to those bubbles somewhat indirectly.
However, because of interest, those same wealthy people have an even bigger advantage. They take out mortgages, and after a while they can take out loans on said mortgages to acquire even more assets. It's genius really (in a very evil way).
These things are very interconnected. Just banishing mortgages won't solve the issue. The economic system has to be fundamentally turned over.
Renting a car or house is very different from renting money.
When you rent out a car, there are many logistics involved, and there needs to be work done to upkeep the car or house (maintenance, repairs, etc.). The asset itself is consumed. There is risk involved, and the "lender" (the asset owner) is not guaranteed profit (the house might burn down or the car might get totaled). Being a landlord is not easy.
Compare that to money, which Islam sees as a means to an end, not as an ultimate goal in and of itself (that doesn't mean that Islam is against gaining wealth, on the contrary, as long as the wealth is gathered and spent in good, there is a lot of reward for it).
Money when lent out is never consumed. It's an abstract thing that the lender is contractually owed it plus the lending fee (interest). For literally doing basically nothing, he's able to generate income while taking minimal risk, and exploiting the borrower at the same time. If the borrower defaults, the lender is able to go after him for not just the principal, but the interest as well. He'll go after his assets and sell them to make his basically guaranteed profit.
Furthermore, it's possible to chain debt in a way that becomes a series of dominos, where if the first one topples, everything goes. We've seen this in 2008, it's inherently built into the system. You can't really do this with rent. While you can technically sub lease, there is a limit in practice, and because of fees, it isn't really feasible to go more than one or two steps. Not so with lending. You have borrowing on top of borrowing for instance, people take out loans against their partially paid for mortgages, to take out more mortgages, to buy property. Then the whole thing collapses at a moment's notice when the markets become finicky. Banks pool debts and sell them in packages, we've seen the end result of that.
>However, because of interest, those same wealthy people have an even bigger advantage. They take out mortgages, and after a while they can take out loans on said mortgages to acquire even more assets. It's genius really (in a very evil way).
A mortgage is a liability, not an asset. You can't take out a loan against a liability. Nothing you're writing here really makes any sense to me, despite the benefit of the doubt.
You can take out a loan on an existing mortgaged asset after you built some equity into it, especially if the asset increased in price during that period. You don't have to have paid it off. It goes to show how evil the entire setup is. It's basically laying domino blocks, the moment something happens, the entire thing collapses.
> You can take out a loan on an existing mortgaged asset after you built some equity into it, especially if the asset increased in price during that period.
Is not a mortgage very similar to owning X% of a thing? Like, if I had a mortgage for $100,000 and I've paid $10,000 towards it, it's almost akin to owning 1/10 of the house (which would play out in the event of liquidation, all other things equal). That real estate tends to rise in value as an asset class is tangential to the topic of usary. It seems plain to me that there is a concept of the current value of something versus the future value of something, with the difference being expressed as interest (to some degree)?
You sound like you're defining "development" when you talk about the difference between the future and present values of something. But I guess if the people actually doing the development pay interest to the people they got money from to do the development then it is... interest to some degree? Of course that results in less net development (due to the interest paid) but am I at least describing it in a way you recognize as accurate?
I have some bad news for you if you think profit sharing is going to replace free cash flow as a metric for company expansion. What happens if there's no profit? Have you been watching that Khadim Hussain Rizvi video where he tells the Pakistan Army to just repay the IMF loans' principal?
The fact that there are other examples of exploitation and fraud is tangential. The argument is that interest is one form of exploitation, it's not the only form.
> If that's true, then it's fundamentally broken (assuming interest bearing loans of course). You will never have a sustainable economic system that is based on interest bearing loans
Yes we should all switch the current economic system which has been the root cause of societal development. And we should switch to a fairy-tail system which you describe but miraculously does not and has not ever existed. One where people will lend out money for free! Why don't you start us off? I'd like a free loan please.
> Not true. There are moral alternatives. If you want to start a business, pitch your idea to investors who are willing to put in money in exchange for a portion of the company.
This is hilarious because its just another form of lending which in fact does yield interest. How do you think the investors will track ownership of the company? Shares which appreciate aka big bad interest.
> There are alternatives that don't involve interest. You see it all the time in the auto industry where they have 0% loans.
There are strings attached to those loans and the average auto loan absolutely has a non-zero interest rate. We are currently experiencing a massive auto loan bubble. Handing out low interest loans indiscriminately is irresponsible and the cause of massive economic damage throughout history.
I think you are confused. The government is "taking out the loan" by issuing bonds and paying an interest rate to the bond buyers. So which side is unethical? The lender or the borrower?
> Great empires were built without interest.
Like which?
At the end of the day, nobody is going to lend money without financial incentive. Why accept the risk? If you disagree then ask yourself why aren't you loaning out YOUR money for free? I will happily accept a free loan.
I think part of the problem is that the GP is conflating debt leverage and interest. My understanding is that there have been societies essentially without debt leverage, and no societies without loan yield.
As far as interest, all non-altruistic loans have strictly positive yield. You can use contracts to shift payments around and nominally get rid of interest, but you can always calculate an equivalent interest rate from the loan's yield. In the middle ages, they discovered that an investment, an insurance contract, and a contract-for-difference (sale of profit) together (contractum trinius) could perfectly replicate the cash flows of an interest-bearing-loan.[0] Presumably the contractum trinius is what eventually lead to the Catholic Church allowing interest-bearing loans.
My understanding is that the joint ventures set up for Islamic finance end up having cash flows equivalent to interest-bearing loans, though perhaps with important differences regarding collateral and leverage.
The yield on these loans is always strictly positive, and an interest rate equivalent to that yield is easily calculated. You can shift payments around and structure things so that there's nominally no interest, but there's still yield on the loan.
Now, I think there is some healthy debate to be had over the role of leverage and collateral in the economy, and also non-dischargeable debt like student loans.
> that the GP is conflating debt leverage and interest
I'm not :)
> The yield on these loans is always strictly positive, and an interest rate equivalent to that yield is easily calculated. You can shift payments around and structure things so that there's nominally no interest, but there's still yield on the loan.
In Islam, any loan that contractually requires benefit to the lender is prohibited, and that benefit does not have to be cash either, it could be a service or something intangible. Any attempt to dance around the issue (e.g. by stitching together intermediate contracts) does not change the fact that it is still interest under the covers, nominally or not. Islam cares about the actual substance, not what people call it on paper. This is already established in the texts which anyone can look at. As such, contractum trinius is prohibited in Islam.
Proper Islamic finance shares risk between the investor and investee, loans are strictly an act of charity since they cannot take interest. By looking at history, we know that it is possible to have societies that do not rely on interest, but on proper risk sharing. They don't teach that in the popular economic books though.
Believe it or not, real estate owners back in the day were willing to sell their house in installments without upping the price. So neither of your suggestions apply.
Even with interest and predatory loans, people today are not buying properties until later anyway, so that's not really an argument.
Secondly, in Islam the government has duties to perform, including providing good quality of life to its citizens, something we don't see done by so many governments today. Housing goes under this.
What do you mean by debt leverage? I don't really see how you can have interest without allowing for borrowers to profit from that debt. Businesses use debt to finance their operations. I can get a mortgage and profit off the appreciation of my property.
I had never heard of that contractum trinius thing! But it really doesn't seem any different. The borrow has to pay insurance premiums to the lender instead of interest premiums. Its only different in name. Additionally, the borrow has to pay for a separate contract that will allow them to profit off the debt! That's debt leverage for you!
You're correct, they're just thinking they found loopholes around the issue. Islamic texts explicitly call out this behavior and prohibits it. You can't stitch together individual legal contracts to reach the goal of lending money with interest. You can't "kid" God.
> switch the current economic system which has been the root cause of societal development
Strawman argument, and red herring. Just because we rely on something immoral that brought some value does not mean that there isn't a superior solution.
> switch to a fairy-tail system which you describe but miraculously does not and has not ever existed
Proper Islamic finance exists and has existed and has built empires.
> One where people will lend out money for free!
That's only in a capitalistic society where the only way to raise capital is lending. No they won't lend money for free (except if they want to be charitable). The solution is that money would be invested and risk shared equally among both parties, investor and investee, not lender and borrower, it's very different.
> This is hilarious because its just another form of lending which in fact does yield interes
It's very different. With an interest bearing loan, if the company doesn't work out, the lender will come after the borrower with the full support of the law, taking not only his principal, but the interest on top, destroying the latter. With an investment, if it doesn't work out, then the investor has lost his money and is not owed anything. It's risk sharing.
> and the average auto loan absolutely has a non-zero interest rate
I'm aware, but I wasn't talking about the average auto loan. You see it all the time when auto manufacturers offer 0% loans on certain models because they want to sell.
> Handing out low interest loans indiscriminately is irresponsible and the cause of massive economic damage throughout history.
Poison is still poison, regardless of the amount. The solution is not to give out more poison.
> The government is "taking out the loan" by issuing bonds and paying an interest rate to the bond buyers. So which side is unethical? The lender or the borrower?
Both are unethical. The Islamic perspective is that both the lender and borrower are equal in terms of sin (assuming the borrower is not doing it out of literally a life or death situation, which let's be frank, the vast majority of people are not in such a situation).
> Like which?
Islam prohibits interest, look up the Islamic empires all the way until the Ottoman empire.
> nobody is going to lend money without financial incentive. Why accept the risk?
That's the whole point. Without financial incentive, loans in Islam are purely an act of charity. If you want to invest your money, you invest it in ethical means that involve proper risk sharing. Interest bearing loans aren't that, there are countless other ways to make money. There were and are many rich Muslims that did not make their wealth using interest, but through investments.
> What empires has it built since the Catholic church started allowing interest on loans?
What does this discussion have to do with the Church? Islam is a separate religion and system, and up until relatively recently (post WWII mainly) the Muslim world was not involved in interest. Even post WWII, there existed nations that did not deal with it (e.g. Kosovo). Furthermore, just because someone decides to abandon their religion or morals does not mean that we have to do the same. We take pride that Islam is the only religion left in the world that is the way it was when it was revealed, without corruption.
> How does that work for someone buying a house?
Firstly, the government is responsible for providing a good quality of life for its citizens. Secondly, people can save money and buy, or buy in installments like they did back in the day and still do today in some parts of the world. Finally, owning a house is not an end goal, that's very materialistic thinking. I understand that it one has to secure his future, but home ownership as per the Western or American view wasn't the norm historically as far as I know. Today there exists governments that provide housing for their citizens (e.g. the UAE).
I disagree with you on every point. Capitalism has lifted far more people out of poverty than charity. Its not even close.
Society should not remain poor and underdeveloped just to adhere to your religious beliefs. I just want to point out one last thing:
> It's very different. With an interest bearing loan, if the company doesn't work out, the lender will come after the borrower with the full support of the law, taking not only his principal, but the interest on top, destroying the latter. With an investment, if it doesn't work out, then the investor has lost his money and is not owed anything. It's risk sharing.
It's absolutely not different. A loan which receives interest in the form of equity is still interest. The lender provides capital in exchange for ownership over the company. Instead of being paid in cash, the lender is paid in equity that ideally becomes more valuable than the original loan amount. That is in no way a charitable act. Also you are not necessarily personally responsible for a loan to your business.
I bet you have never used a credit card, opened a savings account, worked for an employer that has debt, rented a home, rented a vehicle, bought a mortgage, taken a loan for education, made an investment, or ever have any relationship with a financial institution. /s
I'm still waiting for the name of a society that operated without debt or interest.
> Capitalism has lifted far more people out of poverty than charity. Its not even close.
This is not the argument. Islam does not prohibit all capitalistic practices, as a matter of fact, it's generally pro free market. All it does is it places some boundaries on unethical, immoral, and parasitic practices. Interest is one of those prohibited things. Everything else that is not prohibited goes. Furthermore, Islam pushes people to work and to be self sufficient and not rely on charity. https://sunnah.com/riyadussalihin:296
> Society should not remain poor and underdeveloped just to adhere to your religious beliefs
Strawman argument. The Islamic world during the Islamic Golden Age was prosperous and ahead of everyone in all facets of life, while the rest of the world was in the so called Dark Ages.
> Instead of being paid in cash, the lender is paid in equity that ideally becomes more valuable than the original loan amount.
The difference is in the contract. In an interest bearing loan, the lender is contractually owed a profit. This is not the case in a proper risk sharing model, where the investor is willing to accept a loss. Risk is shared proportionally among both parties. A borrower who defaults will have the lender come after him not just for the principal, but also for the accrued interest, with the full support of the law.
Incidentally, the Quran addresses your very claim that interest is the same as trade: https://quran.com/2/275.
It is very clear that interest is *not* the same as trading and ethical investments.
Renting a house or car is not an interest bearing transaction as I explain in another post here. One main difference is that a rented asset is consumed (e.g. subject to wear and tear), whereas "rented" money isn't. And since you're asking, yes I didn't take on a mortgage, nor opened a savings account (to be fair, the bank opened one for me, and I had to contact them repeatedly to close it).
Furthermore, we have narrations that there will come a time where even people who do not consume interest will be affected by it. We live in those times today, even dealing with fiat currency causes individuals to be affected by interest because it's money printed at will to cover the government's debts:
> I'm still waiting for the name of a society that operated without debt or interest.
All throughout Islamic history until the fall of the Ottoman empire and the subsequent colonization by the West, which pushed its financial institutions in Arabia.
> A borrower who defaults will have the lender come after him not just for the principal, but also for the accrued interest, with the full support of the law.
You have a very narrow understanding of loans. In fact, creditors lose money on loans all the time. Borrowers routinely escape paying out the entirety of their loans.
> Incidentally, the Quran addresses your very claim that interest is the same as trade: https://quran.com/2/275.
> It is very clear that interest is not the same as trading and ethical investments.
You logic is that because allah declares it so, then it must be true. It really is as simple as charging a fee for borrowing an asset. In the case of a cash loan, the asset is cash. You can perform all the mental gymnastics you want, but renting out a car or a property or capital is really all the same principle. You have drawn a silly distinction for equity based on your religion.
All the Islamic financial institutions still charge interest. They just use different names.
> In fact, creditors lose money on loans all the time. Borrowers routinely escape paying out the entirety of their loans.
Just because some lenders lose money, does not make the contract any less predatory or immoral. That's like saying that there are some people who don't wear seatbelts and make it out of accidents without issues. The very fact that the US has trillions of dollars of student and auto and mortgage debt is more than enough to illustrate how much of a disaster usurious money lending is.
> In the case of a cash loan, the asset is cash.
I already explained how it's not the same. A tangible asset is consumed, experiences wear and tear, needs maintenance, etc. Money doesn't need any of that, you get back your asset in pristine condition, plus more.
> All the Islamic financial institutions still charge interest
If they do, then they're not Islamic, regardless if they claim they are. It's quite simple, and many scholars have called them out. Calling something prohibited by a different name to make it palatable is already mentioned in our books, and is outright prohibited. Dancing around the issue by stitching together a series of permissible contracts to result in something that mimics interest is prohibited. We have narrations about this.
The so called "Islamic banks" are a recent problem as I mention in another post. It's one of the many effects of post WWII colonization, where the West forced its values on the lands it occupied.
Dude how do you even survive without participating in ANY interest? If you don’t have a mortgage, you must rent. That property was bought with a loan. You have any bank account or investments? Those institutions provide loans. Did you get an education? How did you pay for it? You gotta be filthy rich to afford all those things in cash.
I’m just amazed that people actually believe what you’re saying. I would never want to live in a society where I am forced to accept charitable scraps from the wealthy elite.
Tangibility is a dumb argument. The car and the property or whatever are being rented out for a profit INCLUDING maintenance costs. Money depreciates and the lender absorbs risk. There’s opportunity cost with money.
Loans can absolutely be predatory! There should be absolutely be proper regulation. But your suggestion that ALL interest is evil just tells me you have no idea how the world works.
You use products and services from companies which use interest. Your government uses interest. It’s all around you.
Not necessarily. But I do my part of not participating in the system, that's the least I can do. Similar to how boycotts happen, if enough people partake, change will come, until then, we stick to our values.
> You have any bank account or investments?
Yes, but I don't have a savings account.
> Did you get an education? How did you pay for it?
Fortunately, I didn't go to college in the US where the student loan industry is out in full force. There are other countries where college is affordable, and for people who can't afford it, provide true student aid. Not "student aid" as in federal loans, student aid where the college works with the individual person depending on his or her family's situation to work out a solution, including discounts.
Also, let's take a step back. Just why are colleges so unaffordable in the US? Easy loans play a big role. The universities see that there is easy money to be had, so they up their prices under false premises. It's basically supply and demand, where the supply is poor folks being pushed to take on crushing debt. It's a very parasitic cycle.
> I would never want to live in a society where I am forced to accept charitable scraps from the wealthy elite.
That's not what I said, it's a strawman fallacy. I said that in the Islamic position, loans are only done as an act of charity. However, Islam heavily encourages people to work and self sustain: https://sunnah.com/riyadussalihin:296. Where does it say to sit back and rely on charity?
The government has a responsibility to provide stable conditions and tackle issues like unemployment. This has nothing to do with interest.
> Money depreciates
Because of interest that the government takes on, forcing it to print more money to devalue the currency, see how this all works out?
Renting and loaning money are fundamentally different. Show me any car rental agreement that goes on for 30 years like a mortgage. That's just one difference.
> But your suggestion that ALL interest is evil just tells me you have no idea how the world works.
I do, and I can't help but be amazed and saddened that people keep crying at the many economic issues and crises that keep happening, not realizing that interest is at the center of the entire mess.
> You use products and services from companies which use interest. Your government uses interest. It’s all around you.
I do not deny it. All I can do is make people aware of the dangers, and that because interest is so prevalent, many of the problems we see today are going to stay until that changes: https://sunnah.com/mishkat:2818. Today, we are all affected by the dust of usury even if we don't partake in it.
So this is like Facebook releasing a statement saying "It's time we were all nicer to each other" right? That genocide we were helping? You guys should figure that out. Hey guys, you know how you run a successful business clearing trades, and we just had to dilute our share in our company 50% because we fucked up our collateral calcuations?
Well, we've got an idea. You redesign your entire business so that we don't need collateral, and that way, we no longer have our problem.
Also, does anyone find this stupid "we have the best financial system in the world" bullshit a little insulting? It's just jingoistic PR chest beating. Pro-tip: Whenever you're in trouble, talk about how great America is.
I'm waiting for Elizabeth Holmes to release a statement about how the CDC should instruct all humans to encode the disease they have into their blood, because then Theranos would be a home run.
I guess what I'm saying is: If you're running a business, do your job.
They ended up in a situation where they had to prevent trading, draw down their entire credit lines and then do another funding round to shore up $3.4Bn - it's pretty clear they fucked up their collateral.
Do you consider them having their collateral requirements changed on them at 3am to be them messing up? If your bank tells you your mortgage payment is going to be 10x this month, and you have to scramble to cover that, did you mess up your personal finances?
Collateral requirements are quite a bit more fluid than a mortgage and Robinhood was not asked, AFAIK, to give 10x collateral so the comparison doesn't fit.
Even still: Yes-- good budgeting with savings should allow you to face an obstacle like a 10x mortgage payment. I'm not particularly frugal but I could, at a pinch, gather that much money. Assuming you're putting aside the recommended 6 months living expenses for an emergency, the non-mortgage part of that savings should cover the other 4 months.
RH is in a business that requires the deepest pockets of literally any industry on the planet. If they don't have that capital, they don't get to play, and that's their fault.
The bread and butter of any financial company is risk management. That includes foreseeing a pandemic as well as modelling the possibility of sudden stock volatility at 3am.
If you don't envision such a clearly possible scenario as a bank , or a broker (your mortgage payment suddenly going to be x10 is not such a clearly possible scenario) you severely fucked up in your chosen field of business, period.
If you own a car, you should know that you could be in a catastrophic accident at any time based on the behavior of others. If you are driving lawfully and someone t-bones you out of nowhere and you die, did you make a mistake in your driving?
A better analogy is that you should know that driving is dangerous and therefore keep insurance.
But again, dealing with changing margin requirements is a core part of the job when you run a brokerage, especially for margin accounts. They didn’t do their jobs right, and they want to blame someone else.
It sounds like you think that what happened is related to margin accounts. I don't think that is accurate (see the blog post this thread is on).
Robinhood does keep the equivalent of auto insurance, by the way of the deposits they make with the DTC (and probably other measures). So the analogy is that you keep insurance, and you suffer some catastrophic accident due to some crazy driver coming out of nowhere. Are you at fault?
But I do agree that they didn't do their job, with respect to PR / communications. And I agree that this blog post seems designed to mitigate the effects of that.
I'm not sure why you're acting like this is just something that came out of the blue and hit RH without any possible warning. They purposefully courted new, low information traders and gamified trading. Even before GME you could find complaints and warnings about how Robinhood was gamifying trading. And now they're surprised that this results in new trader behavior? Come on.
To complete the analogy, this is like deciding to go out and do unnecessary driving after midnight on new years eve. Maybe they're not legally at fault if they get hit by a drunk driver, but they sure as hell put themselves at a higher risk of this happening.
Because that is basically what happened. There is a reason why WSB and GME have been in the news. It's because what happened is surprising. Sure, in hindsight, you can identify causes for the phenomenon. But if you rewind back to January 1, I don't think most of us would have predicted this at any level of certainty beyond a theoretical possibility.
I agree with you that Robinhood did put itself at higher risk of this happening, but I don't think that means they did something wrong. Just like I don't think most people would blame the innocent driver in your hypothetical. Who, if we were to make the analogy more applicable, might be an Uber driver trying to make some extra cash.
For the record, back when I worked in finance I heard plenty of conversations about margin requirements going up, often forcing desks to liquidate positions that they otherwise wanted to keep. The idea that margin requirements might change is something finance has had to deal with for a very long time, and RH should have been prepared for the possibility. Better still, they should have had the controls in place to cool down the GME trade once it started to spiral, such as reducing the amount of leverage they let their customers have.
I don't know that it would be accurate to assume that Robinhood was not prepared for the possibility of their deposit requirements changing. I think it's more likely that they were unprepared for the magnitude of changes in a lot of their underlying assumptions. There were 600k downloads of their app on Friday alone, which is roughly 4x the previous daily high water mark, which itself was an anomaly. On top of that, most of those people are signing up to purchase shares in just a very small number of companies. I think there are very, very few businesses that are prepared for a black swan event of a magnitude that Robinhood experienced.
I am just responding to blaming them for not having enough cash on hand to meet the DTC's new deposit requirement, which did come out of the blue. You can say that Robinhood could have anticipated that at some point it may need to back up 100% of the activity of their customers with deposits, given that it is a possibility that is laid out in the DTC rules. But I don't think any brokerage is well-capitalized enough to handle that for every scenario.
But I understand that Robinhood has had other problems (reliability, customer support, etc.), and has also gamified stock trading in a way that is probably harmful. I am sympathetic to those criticisms.
> I am just responding to blaming them for not having enough cash on hand to meet the DTC's new deposit requirement, which did come out of the blue ... given that it is a possibility that is laid out in the DTC rules
These two clauses contradict each other. If it's in the rules, it can't be "out of the blue".
If anything, the clearing house raising margin requirements in this situation is both expected and desirable behavior. It's the clearing house's job to both prevent RH from getting over-leveraged and to step in and cover in the case RH goes insolvent. And frankly it looks like RH was way over-extended, and that the clearing house was totally right in stepping in to stop them. Who knows how much worse this might have gotten without their interference.
> But I don't think any brokerage is well-capitalized enough to handle that for every scenario.
Which is why you don't let yourself get into this situation. You'll note that other brokerages did things like raise margin requirements on GME, block margin trading on GME entirely, or stop trading on GME options. These are tools that brokerages have available to them to both cool off the market shift the burden of margin requirements onto their customers. Other brokerages did this specifically to avoid ending up in RH's position, which is why RH had to raise more money and they did not. And they did this even though the bulk of GME trades weren't even on their systems. RH either did not have these controls in place, or they waited far too long to use them
> These two clauses contradict each other. If it's in the rules, it can't be "out of the blue".
I would strongly disagree with that statement. Just because something is specifically identified as possible doesn't mean that it isn't "out of the blue" when it happens. That depends on a variety of circumstances. In this particular case, I think you can look to the fact that IB, TD Ameritrade, Charles Schwab, etc. also had to restrict trading.
>Which is why you don't let yourself get into this situation. You'll note that other brokerages did things like raise margin requirements on GME, block margin trading on GME entirely, or stop trading on GME options. These are tools that brokerages have available to them to both cool off the market shift the burden of margin requirements onto their customers. Other brokerages did this specifically to avoid ending up in RH's position, which is why RH had to raise more money and they did not. RH either did not have these controls in place, or they waited far too long to use them
I am not sure why you think this is attributable to margin trading, other than the fact that Robinhood offers margin trading. The deposit requirements that are at issue here are independent of whether the shares are purchased with margin or not. If it was in fact margin trading that was causing the problem, why would Robinhood limit buys in general, as opposed to just limiting use of margin? I think the likely explanation for why other brokerages did not have to raise additional funds is because they have a much smaller percentage of customers purchasing meme stocks.
> Just because something is specifically identified as possible doesn't mean that it isn't "out of the blue" when it happens.
Again, the clearinghouse did exactly what they were supposed to do; step in and prevent RH from ending up in a position where it could default on its obligations. That's not the clearinghouse doing something "out of the blue" that is literally them doing their jobs. I find it absolutely baffling that people are upset at the clearinghouse for doing their job, especially since I'm certain that had the crash been bigger everyone would be furious at them for not having done something.
> In this particular case, I think you can look to the fact that IB, TD Ameritrade, Charles Schwab, etc. also had to restrict trading.
They did exactly what I think RH should have done; tighten or restrict margin trading on GME and put option trading on GME into liquidation only. When volatility starts to grow out of control, it's the brokerage's responsibility to start restricting customer leverage in these instruments, if nothing else for the broker's own protection.
> I am not sure why you think this is attributable to margin trading, other than the fact that Robinhood offers margin trading.
Because margin trading is literally designed to allow traders to take larger positions than they could otherwise afford. This both increases the total net position that RH customers have and it reduces the total cash that RH has on hand compared to the number of trades, since part of the money is literally loaned to the trader by RH. This isn't a big deal when the positions net out close to zero, but it can be disastrously bad when all your customers start trading in one direction.
Example. Without margin if I were to buy $2,000 worth of GME, I have to actually hand $2,000 over to RH. The worst case deposit requirement that the clearinghouse can ask from my position is $2,000, and thankfully I've given that amount of money over to RH. But RH would also let me buy $4,000 of GME on margin. Not only has their worst case deposit requirement gone up to $4,000, but I have only given them enough cash to cover half of it. Part of the responsibility of a broker is to keep an eye on what trades are done on margin to avoid too large of a net position from building up for this exact reason, and to do things like adjust margin requirements to prevent this kind of thing from happening to them.
> If it was in fact margin trading that was causing the problem, why would Robinhood limit buys in general, as opposed to just limiting use of margin?
They limited buys because they literally couldn't afford the deposit with their clearinghouse. Sells don't require a deposit, naturally. I believe if they'd taken steps earlier in the cycle to limit margin trading RH would have had more cash on hand to meet their deposits and allow customers to keep buying GME, but not on margin.
You'll note that other brokerages did limit margin trades of GME specifically, as well as putting GME options (another way to increase leverage) into liquidation only mode. This clearly signals that the other brokerages thought that decreasing leverage in GME was a good idea. Maybe RH should've done the same earlier?
> I think the likely explanation for why other brokerages did not have to raise additional funds is because they have a much smaller percentage of customers purchasing meme stocks.
That is certainly part of it, sure. This goes back to "Gamifying stock market trading is a bad idea". But you also can't ignore that the other brokerages seem to have universally taken steps specifically to unwind the amount of leverage their customers had in GME, all steps that RH didn't seem to do until their clearinghouse forced them. If TD Ameritrade and similar were moving in to stop the GME bubble when they didn't even have the majority of the meme traders, doesn't that imply that RH should have done something far earlier?
> Again, the clearinghouse did exactly what they were supposed to do; step in and prevent RH from ending up in a position where it could default on its obligations. That's not the clearinghouse doing something "out of the blue" that is literally them doing their jobs. I find it absolutely baffling that people are upset at the clearinghouse for doing their job, especially since I'm certain that had the crash been bigger everyone would be furious at them for not having done something.
I'm not sure who else you're referring to, but I'm certainly not upset at the clearinghouse. I just don't think it's fair to blame Robinhood for not having the cash on hand to meet the unforeseen increase in deposits required.
> > In this particular case, I think you can look to the fact that IB, TD Ameritrade, Charles Schwab, etc. also had to restrict trading.
> They did exactly what I think RH should have done; tighten or restrict margin trading on GME and put option trading on GME into liquidation only. When volatility starts to grow out of control, it's the brokerage's responsibility to start restricting customer leverage in these instruments, if nothing else for the broker's own protection.
I don't disagree with you on that. It's not obvious to me that Robinhood over-leveraged itself though. If you are seeing some reporting on this that says otherwise, I would love to see it.
> > I am not sure why you think this is attributable to margin trading, other than the fact that Robinhood offers margin trading.
> Because margin trading is literally designed to allow traders to take larger positions than they could otherwise afford. This both increases the total net position that RH customers have and it reduces the total cash that RH has on hand compared to the number of trades, since part of the money is literally loaned to the trader by RH. This isn't a big deal when the positions net out close to zero, but it can be disastrously bad when all your customers start trading in one direction.
Example. Without margin if I were to buy $2,000 worth of GME, I have to actually hand $2,000 over to RH. The worst case deposit requirement that the clearinghouse can ask from my position is $2,000, and thankfully I've given that amount of money over to RH. But RH would also let me buy $4,000 of GME on margin. Not only has their worst case deposit requirement gone up to $4,000, but I have only given them enough cash to cover half of it. Part of the responsibility of a broker is to keep an eye on what trades are done on margin to avoid too large of a net position from building up for this exact reason, and to do things like adjust margin requirements to prevent this kind of thing from happening to them.
Right, I know what margin trading is, but that is a good summary. I'm just not sure how you can be so confident that the proportion of margin trading to non-margin trading was high enough that we can attribute most of the problem to the margin trading.
> > If it was in fact margin trading that was causing the problem, why would Robinhood limit buys in general, as opposed to just limiting use of margin?
> They limited buys because they literally couldn't afford the deposit with their clearinghouse. Sells don't require a deposit, naturally. I believe if they'd taken steps earlier in the cycle to limit margin trading RH would have had more cash on hand to meet their deposits and allow customers to keep buying GME, but not on margin.
You'll note that other brokerages did limit margin trades of GME specifically, as well as putting GME options (another way to increase leverage) into liquidation only mode. This clearly signals that the other brokerages thought that decreasing leverage in GME was a good idea. Maybe RH should've done the same earlier?
That's exactly my point. If the margin trading was the primary source of problems, it seems like RH would have just limited margin trading instead of limiting all buys (whether on margin or not). Doesn't the fact that they didn't make this distinction suggest that the margin trading wasn't a disproportionate factor?
> > I think the likely explanation for why other brokerages did not have to raise additional funds is because they have a much smaller percentage of customers purchasing meme stocks.
> That is certainly part of it, sure. This goes back to "Gamifying stock market trading is a bad idea". But you also can't ignore that the other brokerages seem to have universally taken steps specifically to unwind the amount of leverage their customers had in GME, all steps that RH didn't seem to do until their clearinghouse forced them. If TD Ameritrade and similar were moving in to stop the GME bubble when they didn't even have the majority of the meme traders, doesn't that imply that RH should have done something far earlier?
I've admittedly read up far less on the other brokerages than I have on Robinhood with respect to the Gamestop stuff. Has it been reported that the other brokerages did not restrict trading due to the same increased DTC deposit requirements? I had just assumed it was due to that, but it sounds like you are pretty sure it wasn't.
> I just don't think it's fair to blame Robinhood for not having the cash on hand to meet the unforeseen increase in deposits required.
I'm asserting that given how volatility and RH's overall situation was going, it wasn't unforseen. RH let itself become a counterparty risk, and therefore the clearinghouse stepping in was far from unforseen.
And since they had to negotiate down their deposit by half, raise money, liquidate client positions, and still halt buying, it's pretty clear that they were in way, way, way too deep.
> It's not obvious to me that Robinhood over-leveraged itself though. If you are seeing some reporting on this that says otherwise, I would love to see it.
They had to negotiate down their deposit from $3B to $1.4B and still had to liquidate client positions to meet that deposit and avoid going into receivership. That's a classic consequence of being over-leveraged.
Since these were deposits, this means that RH literally didn’t have the cash on hand to settle all their customer’s trades in GME alone, and (I presume) counting on sells to happen within the settlement window. That’s the definition of over-leveraged.
> I'm just not sure how you can be so confident that the proportion of margin trading to non-margin trading was high enough that we can attribute most of the problem to the margin trading.
Great point. I'm assuming that it's much higher for RH because of both who they attracted, and because they make it very easy to get a margin account. I'd love to see real numbers though.
> That's exactly my point. If the margin trading was the primary source of problems, it seems like RH would have just limited margin trading instead of limiting all buys (whether on margin or not). Doesn't the fact that they didn't make this distinction suggest that the margin trading wasn't a disproportionate factor?
Once your clearinghouse is demanding a deposit greater than your liquid reserves, limiting margin trading is not enough anymore. Eliminating margin before that would have reduced the outlay in general (as I mentioned previously), and might have also done a lot to reduce market volatility and calm DTC. But they waited long enough that it did not matter.
So new entrant joins industry, ruins pricing by giving product away for free, nearly goes under because it over extended itself, and then blames the rules. Yeah I'm sure everyone else wants to do what RH says.
"nearly goes under because it over extended itself" is not really accurate. They took the steps necessary to prevent that from happening, by blocking the behavior that would have led to that. Unfortunately, those steps, in combination with poor communication on Robinhood's part, and emotion, ignorance, and paranoia on the part of the general public, has led to a PR crisis for them.
They didn't block behaviour that would lead to that. They disabled their core product and raised $3.4 billion in a week to cover their fuck up. Most likely, the founders of RH found themselve significantly diluted by this event and if they hadn't been able to raise more capital they likely would've gone bankrupt even if they disabled everything. That's pretty much the definition of over-extending yourself.
It's as accurate as it is inaccurate. Had Robinhood not been able to find hundreds of millions of dollars of cash that day, they would have been declared insolvent.
I don't think that's true. They raised the additional capital so that their customers could continue buying shares of those 8-50 companies. Had they not raised that capital, they would have just had to keep blocking those buys, but they would have been fine otherwise.
That sounds plausible, but even then, if Robinhood couldn't meet the new deposit requirements, I think the existing trades just wouldn't settle (and obviously they wouldn't be accepting new ones)? I'm not seeing how Robinhood would have gone bankrupt in such a situation.
> if Robinhood couldn't meet the new deposit requirements, I think the existing trades just wouldn't settle (and obviously they wouldn't be accepting new ones)?
Defaulting on clearing obligations is the old school way for a brokerage to go under. The moment that happens, customers’ funds and assets are segregated and what is left goes into receivership. The parent company would then file for bankruptcy protection to avoid being stripped for the broker-dealer.
The point of a clearinghouse is that trades always settle. Certainty in that is paramount. Individual members’ survival is secondary. Which makes sense since it aligns interests.
I don't think this is the same as what you're referring to. Under the DTC rules, this would likely have been an "Additional Participants Fund Deposit". The rules seem intentionally vague about what happens if you don't make this payment. As far as I can tell, the rules allow the DTC to unilaterally demand an uncapped deposit from a participant at any time.
Fidelity has $3.3 trillion AUM. Imagine if all its customers decided to take some actions that led the DTC to demand an "Additional Participants Fund Deposit" equivalent to 100% of what's at risk, like in Robinhood's case. Would Fidelity's inability to pay that be viewed as due to a failing on Fidelity's part?
Not being able to cover your obligations with current cash flow (the situation where they would be defaulting on their obligations for existing trades they submitted) is pretty much the definition of bankruptcy, isn’t it?
You could call it that, but these are obligations that appear to have been unilaterally decided by the DTC without prior notice. As far as I can tell, any brokerage using the DTC could potentially suffer the same fate if the stars aligned.
Robinhood agreed to those terms as part of being a broker and using DTCC - it’s part of the common broker insurance pool agreement required to use the clearing house, and required when trading on highly volatile stock to reduce the risk to counterparties if the stock falls mid-transaction/clearing. It is for exactly the situation where a counterparty (like RH) goes bankrupt and can’t pay, which they nearly did.
Knowing this in advance and preparing for it is exactly the business RH is in, and they should have been much better prepared for it.
If they were unable to meet this requirement it is a clear default on their obligations as a broker, and they would be bankrupt at this point.
It would be like if I was trading on margin, but had no idea what my margin collateral requirements were - one day prices drop on the stock I’ve been trading and my broker does a margin call, and I’m going ‘uh what do you mean?!?’ when they liquidate my holdings because I never paid attention to any of that paperwork they sent over. Is it my brokers fault then?
> new entrant joins industry, ruins pricing by giving product away for free, nearly goes under because it over extended itself, and then blames the rules
Credit where it's due: ripping off the commission band-aid was overdue, and Robinhood single handedly caused it. And abridging T+2 is probably a good idea. (Though real-time settlement and clearing is probably not.)
What's missing in their communications is the mea culpa. We got into this to make big changes. We made them. One thing we overlooked was this weird bit of the financial system. Here is why we missed it, here is why it is obscure, and here are our tabula rasa suggestions on how it could be improved.
Getting rid of commission was actually probably a bad idea. It creates an expectation that a very complicated service should be free, and puts a lot of pressure on now free brokerages to find a new revenue source. There's a reason why RH is accused of helping Citadel front run their own customers.
This seems to me a lot like when VC backed startups artificially suppress prices below break even to push out competitors, with the intent to raise prices even more later. It's good for the consumer while they can get VC subsidized goods and services, then very bad for the consumer once the VC funds dry up.
> There's a reason why RH is accused of helping Citadel front run their own customers.
Are there serious accusations of front-running (a serious financial crime) and collusion to facilitate that crime? Or are you referring to people with a poor understanding of the interactions here making complaints that really boil down to privacy concerns, not actual front-running?
I haven't seen anyone post any evidence of actual front-running.
For why Citadel would pay for retail flow, if they're not committing financial crimes, market making is essentially profiting from separating pricing signal ("alpha") from pricing noise. If the prices are jumping around randomly, you make money by holding prices steady against that noise. If the prices are moving in one direction because new information ("alpha") has become available, you lose money if you try and hold prices steady against those moves. Empirically, in aggregate, retail flow has a lower signal-to-noise ratio (lower alpha) than the market as a whole, so market making on just that flow is more profitable, even though Reg NMS[0] requires Citadel to give RH customers' round-lot orders prices at least one cent per share better than available in the open market (price improvement over NBBO, combined with no sub-penny pricing).
By paying to exclusively trade against a low-alpha channel and damp out some of that noise before it affects the market as a whole, Citadel makes more money, at the expense of other market makers who would normally have exposure to that noise.
Also, there's a bias in execution called adverse selection: bad trades tend to get filled faster than good trades. For their non-market-making strategies, crossing against low-alpha flow has less adverse selection than trading those strategies on the public markets. Here too, RH customers trading round lots get prices at least 1 cent better per share than NBBO, unless the orders are passed through and placed on a regular public venue.
Disclosure: I work in financial services, but have never worked for Citadel.
He's not wrong that instant (or same day) settlement would be better than T+2, but there were plenty of other brokers that did not restrict trading. This was a liquidity issue for robinhood. This is a risk you run being a "cool startup that moves fast and breaks things" in the arena of securities trading. Additionally, Some of the bugs they've experienced are absurd in the context of a broker that potentially houses people's entire liquid net worth, including a bug that reversed the direction of trades - "oh you meant to sell those shares? whoops!"[0].
Why choose robinhood when the alternatives include some of the most well capitalized institutions in the world, eg JP Morgan or Bank of America Merrill Lynch - they have literal trillions in assets each and neither has these issues. I appreciate that robinhood pioneered zero commission trades, but that has been largely adopted by the industry at this point. From my standpoint I only see risks versus their peers and precisely zero benefits.
I implore everyone here to stay far away from robinhood.
I think this is jumping the gun. Robinhood takes some fault yes, but why are people ignoring the DTCC/clearinghouses role in this?
It seems they raised deposit requirements potentially more than was standard. This needs to be investigated.
WeBull's CEO claimed their clearinghouse told them to stop selling these securities (no mention of deposit requirements). If they really weren't even given an option to deposit more, that seems to me to be an abuse of power by the clearinghouse.
Finally, was the DTCC not having the long side cover the risk on the short side? It seems to me, the vast majority of the risk was on the shorts. The short side seemed to be made up of mostly large hedge funds, so if one went down, it would have been extremely difficult for the DTCC to front the cash on all of their trades, and of course shorting has infinite risk. The long side was finite, was distributed among multiple brokers and then even more distributed among retail investors. It seems like the risk was low there.
People ignore the clearing house because they don't see it, they don't interact with it, and they don't have a customer contract with it. For all their practical purposes, the clearing house doesn't exist.
It's obvious from RHs statement that they are stuck between the DTCC and customers. They are not willing to call out the DTCC because they are fully at the mercy of it. So they are trying their best to be positive and forward looking, trying to offer help to rally around something totally outside their control (real time settlements).
> they raised deposit requirements potentially more than was standard
What is your source for this?
DTCC collateral requirements are calculated using, more or less, a fixed, predictable formula. And the DTCC isn't the ultimate creditor in these arrangements. They are drawing on lines of credit from banks, who are ultimately taking the credit risk of the collateral being insufficient for settlement.
Vlad said live on air (in Clubhouse) in conversation with Elon Musk on Sunday that the clearinghouse increased their requirements from (IIRC) 30% to 100%, and that the formula for calculating that was "not transparent" and had a component that was "a multiplier based on their opinion".
RH negotiated with them all Thursday last week and reduced the required payment from $3B to ~$0.7B. So it sure seems like the DTCC made an arbitrary decision to jack up systemic safety cushion that resulted in the RH clients turning very sour.
DTCC has higher requirements for concentrated positions than for other uncleared CNS positions. Couple this with Robinhood laying out its own capital to fund margin trades and Robinhood Instant trades, and you've got some pretty aggressive capital commitments.
(PROCEDURE XV)
288
II. if the absolute value of the largest non-index position in the portfolio
represents more than 30 percent of the value of the entire portfolio (the
“concentration threshold”), an amount determined by multiplying the gross
market value of such position by a percentage designated by the
Corporation, which percentage shall be not less than 10 percent. Such
percentage shall be determined by selecting the largest of the 1st and
99th percentiles of three-day returns of a composite set of equities, using
a look-back period of not less than 10 years that includes a one-year
stress period,2 and then rounding the result up to the nearest whole
percentage.
The concentration threshold would be no more than 30 percent, and would
be determined by the Corporation from time to time and calibrated based
on the portfolio’s backtesting results during a time period of not less than
the previous 12 months.
Also, the fact that the man running Robinhood gave out material nonpublic information on a a private podcast with a billionaire says a lot about his judgment, in my opinion.
> had a component that was "a multiplier based on their opinion"
I'll chalk this up to colloquialism. The DTCC has very little discretion in what they do. That's why they're trusted to do it.
The "opinion" component could be a reference to their line of credit banks, who adjust the rates they charge the DTCC based on their varied risk models. There is a valid argument that there isn't as much transparency in that layer as there could be. But that isn't relevant to this case.
Any off-the-shelf collateral cost estimation tool should have told you, given GME's realized volatility in the week prior to the fiasco, that it was a high clearing risk. If the CEO is getting blindsided by the DTCC at 3AM, it's a oversight of internal controls.
> RH negotiated with them all Thursday last week and reduced the required payment from $3B to ~$0.7B
Negotiating collateral requirements involves netting out trades and delaying settlement on some trades and accelerating settlement on others. It does not involve recomputing collateral rules. (The DTCC can't recompute collateral rules for one member over another.)
In his chat with Elon Musk, the RH CEO said that Robinhood was given the $3B bill at 3am in the morning, and got it down to $0.7B after saying they would only allow closing out of positions for "meme stocks".
By his own words, RH took the first step to "change the game", which I am not really seeing discussion of anywhere. The DTCC certainly did not change any rules for them, but this still feels unprecedented.
It seems that they used this right by the fact that Robinhood was able to negotiate their deposit [0]. The DTCC demanded $3 billion. Robinhood negotiated down to $1.4 billion. If done by the formula, how is this possible?
We may not find out this news cycle, but my guess would be they wanted collateral for pending trades, and they eventually agreed on future trades only. The amount RH eventually raised, $3.4 billion, is in line with that.
... and now you will presumably give us an example of a case similar to GME where collateral requirements were not raised so we can see that the treatment was not standard?
All of them are at fault. The broker, DTCC and the hedge funds. The market is not functioning as a free market or "it is rigged" for various reasons.
The CEO of the biggest brokerage company says he has halted the "buy" side because it wanted to protect his clients(hedge funds) and his money and it will resume the trading when the prices reaches $17. If you dig deeper you may find that the DTCC/clearinghouses may have a vested interest in a specific position as their investors may be invested in that position (i.e. short).
Of course there might have been just a risk management issue and no collusion but in practice and in essence as well this was just a way to save the hedge funds(the client)'s money and ripoff the retailers(the product).
If companies like Robinhood don't come along, how do you think disruption in the financial market will happen? If we always go back to the existing players, rate of innovation will be so slow (especially in the financial market). And it's obvious that startups will not have the same amount of assets that century old companies have. But JPMorgan or BofA did not earn their trillions overnight. In fact, we can even say they have screwed over more people than Robinhood has.
I am not trying to say what Robinhood did was correct or that they have not done any mistakes. I am just saying that I am glad that companies like Robinhood exist because otherwise the entrenched players would have never taken any steps to innovate.
Is an obsession with "disruption" over "improvement" wise for a system that moves hundreds of billions of dollars every day?
We were on T+3 a few years ago. Now we're on T+2. That wasn't the result of some whiny blog post, it was the result of gradual and careful operational improvements. There's a lot of work that goes on in the back and middle offices of those century-old companies.
I don't think that the OP is arguing for "always" sticking to entrenched players, but rather for people to face the reality that the agility of startups come with drawbacks in their service (even though it's often not apparent).
It all comes down to making informed decisions. If you're just using RH for "playing around" with some surplus money, this lack of liquidity shouldn't be as important for you (as compared to, e.g., the ease of use, or low fees...). However, if you're using RH in a "serious" capacity, this (reliability) should definitely be something to seriously consider, since you may not have the guarantees that you can take for granted with traditional players.
The true problem with the RH situation is the lack of transparency throughout. It really does no good (and comes off as very "slimy") if third parties have to expose their business model or why they're having issues. A little transparency would have gone a long way for people to be sympathetic to the startup. But then again, I guess that harms the "magic" factor of a startup.
I agree with your sentiment, but for people who have used RH for a while, this is basically par for the course as far as RH support/PR goes. I'm surprised people haven't dumped them in the past for their reliability issues, and they shouldn't get a pass for this event either. For instance, Amazon wasn't the first e-commerce or compute resource provider either. Their competency and dedication to customers have put them ten steps ahead.
Completely agree; Robinhood seems to give us a new reason to distrust them each week.
The guy who allowed his service to store passwords as plaintext[1] says “There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time.” -- pardon my fucking skepticism of the deep technical knowledge he must possess to make such a bold assertion
“That same week, Robinhood released software that erroneously reversed the direction of customer trades, which meant that a bet on a stock going up was turned into a bet that it would go down. Mr. Tenev oversaw technology.
Technological issues continued piling up. In 2019, customers discovered that Robinhood’s software accidentally allowed them to borrow almost infinite amounts of money to multiply their stock bets. Last March, as the pandemic hit the United States and the stock market gyrated wildly, Robinhood’s app seized up for almost two days, leading some customers to lose more than $1 million.”
I like disruptive businesses. But sometimes I think SV fetishizes the “move fast and break things” mantra without understanding that it may sound cool without appropriately acknowledging the risk it brings.
I’m sometimes labeled as a codger but it makes me cringe when people espouse that attitude on projects that can ruin someone’s livelihood let alone on safety critical code that can end someone’s life
Merrill Edge is ugly but quite functional and featured on iOS. Same with Schwab. I don't need the "millennial" UI experience when moving thousands of dollars. And that's not to say it doesn't have value - I love it for many things. I'm a happy customer of Warby Parker, Brooklinen, Joybird, and Lemonade to note a few, all of which offer slick UI's and a bit of markup for a "just works, simply" experience. I much prefer ugly/clunky yet working correctly and not fucking me over randomly with bugs when it comes to major financial stakes.
You don't need a good UI experience the same way my dad doesn't need a "fancy website thing" because he can easily call his stock broker to make the trade. But if these companies don't evolve they are going to keep losing younger millennials and beyond to Robinhood as time goes on.
As I made clear, I clearly do value UI/UX and I'm not some old person making trades over the phone (I'm 24, directly in the Robinhood demo). What I'm saying is that in this specific use case, it's not nearly as important as correctness/reliability, which Robinhood has a terrible history with. An improved UI could be a factor that would draw me away, but there are simply more important things when it comes to where to bank my savings.
Again, the point here is that there's not a huge gap that people seem to try to say there is. They have a fully working website, apps, etc. They're regularly updated and all, see UI refreshes, the usual. Trading may take 4 clicks instead of two, but it's just so much more minor than people claim.
> if these companies don't evolve they are going to keep losing younger millennials and beyond to Robinhood as time goes on
Maybe to other companies, but I think Robinhood may never recover from this. Whoever does draw these away will have to offer bank-level correctness standards in addition to the nice UX. I'd be willing to bet Robinhood had a steady stream of bigger players leaving the platform as they got older because the product is optimized for new investors, not long term financial management. Maybe that niche of new investors is all they need, but their UX won't keep those who age/grow out of that type of user IMO.
i have a vanguard account with most of my investments, with like 10% in robinhood for gambling.
the way i think about it is vanguard works fine (theres some bugs but not end of the world). but it is not optimized for timed trades. it works well enough for me to put in a big chunk of money on a recurring basis or liquidate funds for use elsewhere.
robinhood allows me to easily trade off of market emotion or do options trading.
they serve two very different markets. if i tried to trade options using vanguard i'd probably want to throw my phone against the wall.
Maybe—just maybe—we shouldn’t be encouraging the general public to trade options? Triply so with margin accounts?
This is isn’t “democratizing finance”. It’s literally just a wealth transfer from the poor to the rich. It’s putting fish at a poker table full of professional sharks backed by billions of dollars and teams of analysts, and encouraging the fish to put their life’s savings on table.
Index funds are boring as fuck, but have done more to put market returns in the hands of the average member of the public than anything in the history of finance.
I’m not saying people who want to shouldn’t be allowed to trade options. But putting the ability in the hands of anyone who has zero financial experience but can download an app isn’t helping things.
i partially agree with you. robinhood is ran by rich guys who make money when people use the app - regardless if the traders make money or not. and i agree that index funds are a great way to get exposure to the long term growth of the economy.
however, giving people the ability to trade on margin and options just like the big shops is an equalizer. robinhood wasn't lying there. the problem really is:
1) education
there's a significant inequality in knowledge. the average person isn't taught market fundamentals, theory, or the technical details of how stuff works (how does a call work? what does T+2 mean?)
2) capitalism
the market is tipped in the favor of the big guys, because currently the financial market is incentivized to keep these guys not just afloat but jacked up. big gains = everyone is happier. as such, very smart people, like physicists, are attracted to the financial sector where they are paid the big bucks to make insanely rich people even wealthier, instead of working in academia or an industry where they can contribute their abilities to bettering the entire world. i.e. working on green energy or reducing environmental impact or improving productivity
Actually the biggest reason is RH was the first to offer zero commission trading and a very simple UI. That led to a big customer base of new traders. Lots of free marketing by those newcomers on social media and the inertia of switching brokerages kept the flywheel going. This incident was bad enough to make people get over the inertia of switching, others now offer zero commission trading, so RH is going to bleed customers as a result.
The other apps may not be quite as easy to use for someone who has never traded before, but the basics of trading and options have been democratized enough that it is probably no longer enough of a moat.
It may be 'excellent' relative to competitors in "shitty old financial company app" space, but it is in no way excellent compared to a high quality phone app.
Robinhood is successful because their software is actually good. My bullish case for them would be them leveraging this capability as a way in to becoming a Fidelity sized financial competitor.
Their CEO's inability to honestly communicate with the public is hurting them though. He should have lead with their liquidity clearing house issues and directly addressed the apparent conflict of interest. He appears to either be unwilling or incapable of doing this.
They've now after the fact explained some of the clearing house issues, but they still act as if they don't understand the conflict of interest question. Just address it directly.
When Elon asked him about it he should have said something like, "I can see why people would think we'd be under pressure from the funds that buy our order flow, but we live and die by our retail reputation and would not risk that to illegally coordinate with these funds. We'd go direct to our retail customers first. That said, we were not asked to do what we did or pressured by them, we had to make choices on the fly to stay liquid and in that craziness I failed to communicate what we were doing in real time to our users - that was my failure".
Instead he mostly dodged the substantive question and came across as full of shit (only addressing the narrow aspects not really in dispute). I think this could be the truth, but when paired with him lying on TV about their liquidity issues it leads me to distrust him, and by extension the company.
I suspect the reality is something in the middle, considering what RH's customers (the funds) would want, fear of mentioning their liquidity issue causing a run, and the clearing house concern. He handled this poorly.
Well that's a long reply, and I agree with you by and large. RH has a bright future if they communicate better with their users.
Re: Fidelity, by excellent I mean: it does what I want it to do, and the UI is clear enough. To be fair, I'm an infrequent trader who mainly uses Fidelity for banking, so I don't spend much time on the app. I'm also willing to sacrifice UI flashiness for a functional service that doesn't block me from trading when I do.
[ETA: I believe there's a lot to be said, and has been said, for ugly functional UIs that outlast fancier competition. The archetype is craigslist]
It sounds like we probably agree on most things and use fidelity in roughly the same way.
I’d argue Craigslist’s design is ugly, but quite good - it’s dense/high bandwidth, does exactly what people want without fluff. It’s fast. They also benefit a lot from network effects, but even ignoring that I think the website does a pretty good job doing what it's supposed to and is easy to use.
Fidelity is ugly and bad. Hundreds of hidden menus. Many things can’t be done via the app. Some actions require a phone call. Options trading sucks.
For an example, I wanted to wire my rent. The place to do this is via transfers.
Specifically: Transfer -> to bank account -> that I do not own.
That’s the flow to wire money to an external person. It’s not obvious and buried and it can only be done on a desktop.
Automated deposits are similarly cumbersome.
The app is also quite slow and the login flow is painful.
My first thought logging into their mobile app and desktop was "Jesus Christ this is terrible". Maybe it is functional, but RH knocks UI out of the park.
Zero commission trade is actually bullshit anyway. You end up losing more from inferior execution time than you would if you just paid the $5 per trade. Robin Hood also lied to users about this and ended up paying a $65 million fine[0].
"Not charging $5 per trade" implies that other brokerages such as Schwab, Fidelity, and TD Ameritrade — which haven't been penalized by the SEC — suddenly offered poorer order execution when they dropped their commissions, which by all accounts they did not. They all experienced declines in revenue.
What Robinhood did was to lie about their execution. They claimed their trade prices were as low as other brokerages, while in fact being much worse. SEC penalized them for (1) intentionally misleading customers and, in the words of the press release, (2) "failing to satisfy its duty to seek the best reasonably available terms to execute customer orders".
Unlike Robinhood, Schwab, Fidelity, and TDA all have popular real-time trading platforms where order execution quality is crucial.
Lol. You cannot judge your order execution quality as a retail customer. It takes the SEC years of investigation to do that. Its certainly not something retail brokers compete on.
Robinhood lied and should be punished but they were penalized for doing so before other brokers had gone to $0. It remains to be seen what happens at the other brokers now that they are free.
> Lol. You cannot judge your order execution quality as a retail customer.
If you've traded the same listed securities frequently on various platforms, you certainly can. In terms of speed, PFOF systems can hang on to limit orders that are marketable (ie they cross NBBO), technically not printing them outside the confines but taking their sweet time to make a decision about whether to cross the order or post it to an exchange. And once it goes to an exchange, you can also get a feel for how much of the displayed bid or offer you get on one platform versus another.
There's no money in proving that different brokers have varying execution quality, and it's not a regulatory requirement to execute instantaneously. I'm not sure how Nanex figures into it; there's nothing nefarious involved.
If I am in New York and I send a limit buy order to Schwab that is two cents through the offer, Schwab may route my order to a market-maker in Chicago who uses a decision model to either take the other side of my order on the offer, or post my limit order to the exchange with the best offer. Let's say the market-maker doesn't want to sell me the security and routes it to an exchange in Miami. By the time he posts the bid, the offer may have moved and my limit order may no longer be marketable. That doesn't mean Schwab broke the law. Routing orders between computer systems and making risk decisions takes nonzero time, and factors like latency and exchange fees can affect where the order goes and when it arrives.
Let’s be clear are you sending routed orders in this case?
Are you suggesting that limit orders are filling but at a different price than expected or not filling at all?
The reason Nanex is important is that they’ve made bank on proving that risk systems and broker latency don’t matter when enforcing reg nms.
Neither does order volume. If you can accurately track execution to the point where you can see slippage (not on the broker report cards) you can make money on that info.
None of that is to say different brokers don’t have different slippage just that in aggregate if you can accurately calculate it you a) have no business trading through a retail broker (and you know it) and b) there is money to be made in compliance that doesn’t take on trade risk.
I use two brokerages and I almost exclusively trade US listed equity options. That's why it's easy to know if I'm getting good liquidity or not; the price doesn't move as much and the spreads are far wider than cash. If I use the one with PFOF, on rare occasions it takes a minute or more for my order to show up on the screens. The other one is very fast with SOR but it doesn't always get a high percentage of the displayed size. When I worked at a shop I got most of the displayed size pretty much all the time because the SOR was way better.
Analogous to the PFOF situation...if a hedge fund sends a limit order to a bank the NBBO may have moved unfavorably by the time it gets sent down to a floor broker. That may be horrible execution but it's not illegal for a floor broker to suck at picking up the phone promptly.
I guess my point is that it doesn't take long to figure out which brokers can improve your committed price, which floors participate aggressively, which electronic crosses break you up, etc, and that knowledge can affect customer fills. But I get what you're saying and you're right that people could monetize it if they had hard quantitative slippage data. That wasn't really what I was describing.
>The reason Nanex is important is that they’ve made bank on proving that risk systems and broker latency don’t matter when enforcing reg nms
I don't understand what you mean by broker latency and Reg NMS...latency between different legs of SOR can affect execution even without a trade-through violation by causing the offer on Exchange B to fade if an order routed to Exchange A crosses the betters there well before the bid destined for Exchange B arrives. I think I'm missing a piece of the puzzle here.
The SEC judgement was on Dec 17, 2020. Schwab announced commission-free trading on Oct 7, 2020. IBKR dropped their fees (for IBKR Lite) in September that year.
Whether you would be better off with the $5 trade or not is dependent on how many shares you trade at a time.
It wouldn’t have been an issue if Robinhood had been upfront about their pricing. They still would have been a good deal for many retail investors, but they instead chose to lie.
This is terrible advice. if your slippage risk is such that you aren’t protected by NBBO you have absolutely no business on a retail broker of any sort. Meanwhile limit orders minimizes the most likely risk a retail trader has to overcome. Either you don’t understand the advice you were given, you were duped or you are trying to be duplicitous.
In any case, terrible advice to be repeating in the context of retail trades.
I don’t give any advice. I was probing to see the reaction .
It is amusing to look at postings glorifying the pundits advice. They are not your friend.
Have you actually placed a limit orders? Do you practice this advice with your own $’s?
Do you know how much taxes you pay for a trade considered day trading? If the limit order is executed same day it is considered day trading. What is the point then?
Why retail investors are penalted for that but hedge funds are not? Are you retail trader or on the other side of the table? If so why you are giving advice to retail investors? The motivations?
When I used to follow the pundits “advice” they were always wrong - limited orders were immediately executed. These “fluctuations “ causing execution of limit orders are never reported in the historical data . I used to purchase historical data for thousand $’s and never found these fluctuations in the official dat I saw on the screen. Meaning you can never rely on historical data for analysis. If you had the same experience you would know. Learning from practice I’ve different way of making $’s.
I spent years writing HFT trading systems. I’ve built back testing systems that actually worked. I’ve been out of the industry for more than five years and every order I’ve sent since I left (all through retail brokers including RH) have been limit orders.
I’m going to guess that I’ve spent more time in front of a real market feed than you trying to divine how the orders are impacting the book but who knows.
All that said I’d love to subscribe to your newsletter and learn the secrets to why limit orders have a different tax treatment than market orders.
Also for the record market orders tell the market you have no price sensitivity. If your newsletter could tell me how that’s better for retail investors I’d appreciate it.
Got it , just an observer working for the establishment.
Why you didn’t invest your own $’s if your algo is so good? Other peoples’ money I know.
Is that a real job? HFT is a scam. What about naked short selling (hft by other name )? Making money out of thin air? Selling something you don’t own? You did the hft for that too? What about GME now? 1.8 million missing shares . What your algos will do to the market? Crashing it?
Now the hedge funds are a joke, no? They aren't buying 50 million shares at 30c, nor $100, nor $300, and that's their problem. You can do hft all in nanoseconds - nothing is helping them. PRICE DOESN'T MATTER
How hft algo is helping the hedge funds now? The market will be never be the same , no hft , no newsletters , no apps will save it .
Just try with your own $ and you will learn from practice. Good luck following recommendations. Practice is the best teacher. Now - do you have thousands $’s to learn from your mistakes?
Say the national best bid and offer (NBBO) is:
Bid: $10.45
Ask: $10.55
You place a limit buy order at $10.55 for 100 shares.
$0 commission broker that sells order flow:
Your order is routed to the market maker buying your broker's order flow. They sell you the 100 shares for $10.55 since it's within your limit and within the NBBO spread.
$5 commission broker:
Your broker attempts to price improve by searching multiple liquidity sources and gets a hit at the NBBO midpoint: $10.50.
This is not at all how NBBO works. Effectively all retail brokers sell order flow and if they dont they still dont have any obligation to improve your price beyond NBBO.
All NBBO improvement requires is that if you send an order through the book you’ll get the best price on NBBO. Even when Robinhood got fined it wasn’t for that, it was for promising better than their competitors and then putting it in writing that they were happy being worse than their competitors.
They are diverting the attention from their core problem: lack of transparency.
I had a RH account for years and I didn't know it was a margin account (be sure: I did not signup for their "margin" service). All RH account are margin accounts even if they feel like cash accounts (but with T+0 settlement).
This is what triggered their cash problems and what drives people crazy now: a user feels they gave them 100$ to buy 100$ of stocks, while what happens is that you get a loan and they buy some form of stock in their name while committing to you for the value of one stock.
Robinhood is the facebook of finance. I moved my money out of them.
This has nothing to do with being a margin account, it's DTCC requirements related to wanting to buy the same stock everyone else at the same broker also wants to buy.
My understanding is that it does. One example (there's more like the instant deposit): when you buy a stock with money from another sale not yet settled, you are basically using margin (a loan) and thus RH have cash requirements which are a % of the cost of the trade to be settled.
If you don't allow that, and only let people trade on a cash basis after the trades have been settled, you effectively have 100% of the money you need to settle the trades you closed.
Robinhood isn't allowed to use your money as collateral with DTCC, they must use their own. That's why it doesn't matter what kind of account you have.
Presumably their lack of trade fees hurts them here.
That does not seem right unless there is something more hidden going on:
1) I issue on order and close a trade (using a broker as intermediary)
2) i have already provided the liquidity to settle that trade which is already in the broker's control
3) why would the broker need to provide more liquidity to guarantee this trade?
I have the feeling what you say is true but only because there is some finance magic going on that nobody needs but the finance system.
I have tried to look for more information about this DTCC requeriment but couldn't find much.
Thats true but do any brokers do that in their apps? Neither my Vanguard nor my Fidelity UI make it obvious when i’m using settled vs non-settled funds.
Yes, I never used any of those but it looks like they followed suit on the RH success and implemented something similar.
I had an Interactive Brokers account for years and there the distinction is very clear. A cash account just can't use money before they are settled (not different from many bank accounts show you two balance, one available the other one including pending transactions). To upgrade to a margin account you need to go through a rather long process of documents and signatures.
I agree that this is robinhoods fault, and that they have been deceptive in their PR about this, and that their UX workflows are misleading about what’s actually happening...
But, plenty of other brokers had the same issue. Including Merrill for instance. I would say that the more concerning issue that this has highlighted is how this part of the system gives large institutions greater access to markets than retail investors get. Addressing a systemic flaw like this seems like the best possible thing that could come out of this controversy.
The only reason robinhood has liquidity issues is because of T+2 settlement.
I mean why should a broker app need to have liquidity at all. Why restrict the ability to make this type of business to companies with a lot of capital.
They also have insane fees and require partnerships with banks to do so. Visa and Mastercard make this possible for Coinbase. Its kind of funny these crypto exchanges are supposed to decentralize our finances but end up relying on the same centralized financial institutions that brokers also use.
I can also perform trades and instantly have access to the money on my TDA account.
I'm going to simplify a bit, but there is a big difference in clearing crypto vs cash.
Clearing crypto doesn't require debt because your broker directly sends the TX on chain.
Doing the same with cash would require sending trucks of cash to their various clients banks throughout the day and would be prohibitely expensive.
That's why clearing was invented. I.e. having the bigger banks lending to the smaller and allowing to delay the actual exchange. (And hopefully never having to actually move cash since balance fluctuations between banks tends to be cyclical)
Clearing crypto doesn't require debt because the broker is doing an internal transaction. If done on-chain, it will be an atomic transaction. Neither require clearing with another firm.
Banks don't actually shuttle physical dollars back and forth as most transfer via SWIFT. The physical money banks need is only for teller withdrawals, ATMs or whatnot.
Swift is only a communication protocol it doesn't solve the clearing problem.
The clearing problem is really at its core about avoiding to move cash and how to transfer debt between two entities that don't know (and trust) each other, as far fetched as it sounds.
When you transfer $1 to a friend of yours that is at another bank, your bank owes you one less dollar and your friend's bank owe him one more. But aginst what? The promise by your bank to pay it with a physical dollar (or some other better debt) in the future. But if you are with a small bank, your friend's bank might not trust it. So the they use a bigger bank that both trust that act as an intermediary and that lends for a very small rate as it is a 100% collateralized debt. This is the definition of clearing.
Swift is a communication protocol to move digital cash. Once the wire goes through, the next bank has the cash and the last bank doesn't. That solves the clearing problem (for currencies). Yes, the process is sticky as every bank likes to hold the money as long as possible, but ownership is clear and fast.
The clearing problem for OP is with stocks and deal with purchasing and selling from different owners using a regulatory intermediary (DTCC). Getting all those parts coordinated is more challenging.
Everything is inverted from the bank perspective. When they receive "cash" they actually receive an obligation to pay one of their client against some other debt, which might not be an enviable position.
There is no such thing as digital cash actually. You have cash, the real and physical and all the rest is balance sheet expansion, i.e. debt.
If you are interested in banking I would encourage you to watch this course from the Columbia university: https://www.coursera.org/learn/money-banking which is the reference and is fascinating.
Real-time settlement means that if you sell your bitcoin on coinbase, then the currency you bought (say Dollars) is yours to invest fully or withdraw into another account (say your checking account).
If you sell Bitcoin on Gemini for dollars, you can instantly wire dollars to your checking account at your bank. (Haven’t tried Coinbase, so can’t say).
Robinhood could start by arranging that when you withdraw funds from Robinhood, you get them in real time. Minutes. Naw. They settle cash on T+1.[1] Still, that beats PayPal.
Is Robinhood an "industry leader"? T+0 settlement would be an enormous change. Is there any reason every other participant in the market would care what Robinhood thinks about settlement? They were just shown to be too small to participate fully even with their small slice of retail investors.
Real time securities wouldn't need brokerages to front collateral while the trades settle by the virtue of no settling period. They would only have to deal with customer capital used to buy the stock.
Wasn't a big part of this issue fueled by RH fronting the money for trades when the customer was transferring money into their account from a bank over ACH? Making ACH instant (which I believe is in the works) would solve that, not T+0 for settlement.
(I don't have a good feel for what was the bigger driver of RH's issues though: overextension because of slow ACH or slow trade settlement.)
No, brokers must front collateral to clearing firms simply because there's no inherent reason to trust any of the firms will have their capital or equity obligations in T+2 days. ACH transfers and margin, although possible reasons why a firm wouldn't have funds, are not the direct reason, which is DTCC requirements.
No, that was negligible. Robinhood actually fronts the least money out of all major brokers (something like $1000). And if that was the case the easy solution would be to block trades if your account didn't have the sufficient settled balance.
> Robinhood actually fronts the least money out of all major brokers (something like $1000).
None of the brokers I have ever used have ever fronted me money. If the required equity isn't going to be in the account by the settlement date, they won't spot me so much as a fiver.
There's an argument to be made that Robinhood Instant is a violation of federal margin regulations because it allows margin risk to be taken in an account with no settled equity.
I can transfer $100K (or maybe more) from my bank into Vanguard right now and trade using it instantly while they wait 3-5 days for the deposit to clear. It is definitely a common practice among the larger brokers.
That may have been an issue in some cases, but even if RH had all the money in hand, they aren't (if I understand correctly) allowed to use their customer's money as collateral. So, RH has to put up their own money as collateral, and it's tied up for two days. They apparently didn't have enough funds to do that, given the trade volume they were experiencing. Also, under normal conditions the collateral requirements would have been a lot less.
So customer A is doing stuff where you need to put up a collateral with some counterparty.
You can't use customer B's money (this is a key assumption that might be missing - it's all about the use of other customers money) for that collateral because, well, that collateral might not get returned in certain cases - that's kind of the point of having a collateral. You'd lose that collateral if the counterparty goes belly up (insolvency, fraud, whatever), and, most importantly, you'd lose that collateral if you become insolvent. That's not OK - this is regulated so that you are required to ensure separation of "your money" from "customers money that you're holding on their behalf", so that the customer's money is untouched and unclaimed even you go bankrupt. It's not your money, it's the customer's money that you're investing on their behalf, so you can't put it up as repayment or collateral for your liabilities; and you can't put one customer's money as repayment or collateral for another customer's liabilities.
But why can't customer B's money be used as collateral for customer B's trades? I guess because the collateral is all comingled when it is supplied to the clearinghouse?
That's my question as well. I think it's because the customer capital has to be transferred to the counterparty that issued the sell. I imagine that it makes things complicated if the DTCC has to send over 1-10% of this amount and then the brokerage that executed the buy has to send over the rest so, if I had to guess, they did this for simplicity's sake. Btw the requirement to not use customer collateral is enforced by the DTCC and not at a brokerage level discretion.
>Btw the requirement to not use customer collateral is enforced by the DTCC and not at a brokerage level discretion.
No, it's an SEC rule.
Broker dealers can fail, sometimes due to malfeasance but sometimes simply due to bad management or even bad luck.
In a system with a central clearing counterparty (in this case, the NSCC/DTCC), that organization mutualizes those risks by acting as "the seller for every buyer and the buyer for every seller": the process of novation splits each trade between buyer and seller into two. i.e. the seller sells to the NSCC and the buyer buys from the NSCC. Effectively the NSCC is guaranteeing the trades.
The collateral is effectively a security deposit that varies in size depending on how much risk a particular broker dealer is bringing into the system as a whole.
Does it make sense yet why this can't be done with client money?
I think the problematic scenario is when the customer wants to buy a security using the proceeds of a recent sale, which hasn't settled yet. Since the proceeds haven't made it to the broker's bank account yet, the broker would use their own capital in the interim.
There are reasons to prefer settlement is not instantaneous - eg it makes fat finger trades easier to unwind. There are also probably some special cases like creation/destruction of ETF shares, ADRs, IPO greenshoe etc which take a bit longer to work through.
But I think the main reason for these changes being slow to occur is because noone wanted to break the system in the process - the settlement process for share trades in the US is/was viewed as quite fragile due to the way it had evolved over time.
Adding support for fast settlement doesn't necessarily mean removing support for slow settlement. The customer placing an order could simply mark trades as "fast" or "slow".
Slower settlement gives the exchange and clearinghouse time to process the trade, it gives firms time to borrow cash overnight in the repo market to pay for trades made by the front office, it gives short-sellers time to borrow and deliver shares, and so forth.
T+1 means overnight (options settle this way), so T+2 gives everyone in the world (sometimes you trade from one region for a legal entity in another) a little more than a full business day to tie everything out.
I see delayed settlement as part of the reason why we are able to trade instantaneously; execute first and address the details later.
EDIT: Also, the way equity trades presently clear is based on a net short and a net long, rather than breaking out individual trades as would be necessary for instantaneous execution.
These are terrible reasons. Time to process the trade should be zero if systems are designed properly. If you need to borrow cash to trade you should do it first, etc.
If some participants want to stay slow, bear more risk, require more capital, etc... let them. But the rest of the financial system shouldn't be held back because of them.
Time for instantaneous settlement, across the board.
This will never happen if we leave it to banks, exchanges, clearing houses and the rest (some of them even have a vested interest in it not happening). This is one of the clearest use cases for blockchains [1]. It answers the problem of how next gen financial infrastructure will get built, and frankly the savings and benefits to be had are astronimical.
[1] These will probably be public blockchains, but it's possible a "proof of authority" real time settlement chain or similar operated by a consortium could work, too, as an interim step/for some cases
In the UK we do the tech and the finance in the same city.
My observation is based on over a decade working on trading and settlement systems at multiple major international banks, exchanges.
The infra is creaking at the sides, it is too expensive to fix individually. We're talking hundreds of millions, even billions, at every institution, that they internally decide, repeatedly, that they cannot spend. Every so often a bunch of them try and work out how to build an industry utility for faster, better settlement but can never get past the politics. So it won't change in a big way, not from the current vantage point.
But the world is changing. More countries and industries getting into the financial system, changing retail demand, more complexity for small businesses working internationally, etc... so I don't think it ends with "it's too hard to properly fix this" so let's not.
I am pretty convinced at this point that the world will fix it, as I've described, but from very different starting points to major New York and London institutions, and they'll drag the rest of the industry kicking and screaming along with them at some point... once there's money to be there in size, the big banks and funds will follow.
Sure, but end of day settlement (like is practiced on TSX!) has all of the reasonable benefits of T+2 settlement, while still taking place in an understandable time frame.
There are ancillary bits as well like unwinding of mistakes.
The problem is this, moving money fast is hard. It can be done, but its far cheaper to settle up at the end of the day, when the total inflow/outflow is calculated.
But crucially there isn't enough liquid capital to service this level of actual transaction.
I'd say the first reason is staring us right into the face, it disincentivizes actors on the market from engaging in exactly the kind of nonsense that is divorced from fundamentals we've seen over the last few weeks playing out on Robinhood.
Was that not just the market correcting itself? The stock was extremely over shorted, and the price rose to shake out the shorts. I think short squeezes need to be allowed to happen properly. If we don't want that, we would need to limit short selling.
the market is probably very soon going to return Gamestop to its actually reasonable evaluation, so the market didn't change.
What changed was Citadel (who is actually Robinhood's customer, not the retail investors) and Silver Lake making a bunch of money off retail investors while a lot of people who bought in at the top are going to be fleeced.
No value was created in this process or valuable information exchanged. It's basically market-makers and other hedge funds benefiting from volatility caused by a stupid hedge fund and retail investors going crazy. And the reason Robinhood wants all that real-time trade so bad is because Citadel pays them for order flow, that is their actual business, not you trading on their app.
> Why do you think the stock was “over shorted” apart from the fact that short interest is generally not that high?
It was the highest shorted stock on the market. That is "generally not that high"?
I think the fact that retail investors were able to cause a short squeeze on it, that cost shorts many billions of dollars, is an indication that it was over shorted.
> Or — what do you think are the bad consequences of “over shorting?”
There needs to be balance to everything; one of the naturally occurring risks of shorting is a short squeeze. Messing with that would ruin the risk/reward balance of shorting. Shorting creates more longs, and therefore drives the share price down. The risk of a short squeeze is a good way to prevent people from opening an extremely high number of shorts, and artificially driving the price down this way.
Short squeezes are not good for the market, period, but they only happen in extraordinary circumstances. And actively encouraging people to cause short squeezes in order to reduce the potential for future short squeezes seems... counterproductive.
If you want to reduce the number of people shorting a stock, creating artificial short squeezes would work, yes, but then I again ask: why do we want to prevent people (or hedge funds) from shorting a stock so much? What does that accomplish in the bigger picture?
The logic is almost like: we want there to be fewer car crashes, and more cars = more crashes. If we ourselves cause crashes, drivers will be afraid to drive, so therefore we will have less crashes.
> Short squeezes are not good for the market, period
This is an opinion. To briefly articulate some arguments that take the other side:
Short squeezes are a disincentive for hedge funds to take undisclosed bearish positions in otherwise healthy companies, and for options dealers to sell cheap call options on those companies. They also increase equity value for shareholders. A squeeze can reduce the debt load for a company by incentivizing bondholders to convert debt into equity, and the profit potential thereof may help a distressed company issue convertible bonds to raise funds.
During a short squeeze, assets are "mispriced," and their prices have high volatility. Having a "correct" and "stable" price for assets is fundamentally important to any market as the market's intended purposes are to allow society to "efficiently" allocate capital and let participants hedge risk. "Wrong" and highly variable prices inhibit both goals.
Of course short squeezes (like any asset mispricing) can be good for individual market participants: but on net for all participants, they are not. That's why regulators step in when assets are mispriced, and they have attempted to/successfully prosecuted those who have intentionally created short squeezes.
If we are going to call exchange-traded equities "mispriced," then I think it's fair to say that the mispricing exists prior to a short squeeze, when the stock is compressed by the price impact of the short seller.
> their prices have high volatility.
Volatility is not necessarily bad for markets.
> Having a "correct" and "stable" price for assets is fundamentally important
Stable prices require sources of potential energy like highly levered shorts to be dispelled, which only happens when the short covers. Also, unless you can walk on water you're not in a position to tell the market that one price is "correct" and another is not. The price is the price.
> the market's intended purposes are to allow society to "efficiently" allocate capital and let participants hedge risk
The market's purpose is to connect buyers and sellers in a way that allows them to get the best price in the world for a particular security at a given time. It has nothing to do with allocating capital in society, nor is it a hedging vehicle.
> "Wrong" and highly variable prices inhibit both goals.
If the price is wrong, go sell it. Also, prices vary because market participants react to changes in information. If the information is hot -- such as the emergent fact that sizable investors have found themselves in a tenuous short position -- then the price action will likely be hot as well.
> Of course short squeezes (like any asset mispricing) can be good for individual market participants
You're shifting my diction. Squeezes are good for shareholders and good for the company. The only entity for whom they are categorically bad is the poor sap who is covering the stock.
> That's why regulators step in when assets are mispriced
Regulators don't decide what an equity's price should be. Market participants do. Regulators have manipulated asset prices in the past and generally it doesn't end well. As Grantham puts it [0]:
All bubbles end with near universal acceptance that the current one will not end yet…because. Because in 1929 the economy had clicked into “a permanently high plateau”; because Greenspan’s Fed in 2000 was predicting an enduring improvement in productivity and was pledging its loyalty (or moral hazard) to the stock market; because Bernanke believed in 2006 that “U.S. house prices merely reflect a strong U.S. economy” as he perpetuated the moral hazard: if you win you’re on your own, but if you lose you can count on our support. Yellen, and now Powell, maintained this approach. All three of Powell’s predecessors claimed that the asset prices they helped inflate in turn aided the economy through the wealth effect. Which effect we all admit is real. But all three avoided claiming credit for the ensuing market breaks that inevitably followed: the equity bust of 2000 and the housing bust of 2008, each replete with the accompanying anti-wealth effect that came when we least needed it, exaggerating the already guaranteed weakness in the economy. This game surely is the ultimate deal with the devil.
> prosecuted those who have intentionally created short squeezes.
Invariably, those who cause short squeezes are the people who get themselves into tenuous shorts that they cannot finance. I have heard of situations where the SEC went after "short and distort" schemes. I have never heard that investors got in trouble for buying stock because they reasonably believed it would go up and candidly shared their trade thesis with other market participants. The market wouldn't even have a way to discover short positions to target, because the regulators don't require them to be disclosed.
It blew my mind when they went from T+3 to T+2. I couldn't fathom why they would go about changing it, but not go to overnight settlement. Government, though.
If the members of the DTCC want to have it done faster, they'll request it. There's been talk, but it involves everyone agreeing to it and changing their internal workflows as well AFAICT.
If that's an accurate definition, then it's safe to say it would technically mean same day.
Simultaneously, if we want to be technically accurate to a pedantic level, "instant" would be impossible given speed limits of information transmission (speed of light), etc. So "T+0" couldn't mean "instant" in any case.
Maybe some settlements are, in fact, near-instant but I don't think that's implied by "T+0".
The whole episode has been a case study for how not to handle PR. Robinhood lost the public narrative every step of the way, and all their statements were late, lacking in detail and even contradictory. Remember the now-famous "we don't have a cash flow problem" statement from their CEO, right before they had to borrow a billion dollars to stay in business?
Robinhood knew A was the case when it did B. Given A, B can cause really bad things. Then it failed to properly communicate as the bad things started to happen. Now it's blaming A rather than its decision to do B or its failure to communicate.
If you allow yourself to take the blame, and don't point the finger at th real culprit when asked you can't be surprised when no one accepts it when later you do.
The simple issue that I saw with RH is that they restricted the ability to buy stocks like GME but not the ability to sell. It’s one thing to freeze the stock in place. It’s an entirely different thing to basically create a situation where your actions drive the price down while only letting investors sell. I will be honest I don’t entirely grasp the situation, but this seems to me like it was not just a bad PR situation but rather that they actually did something wrong.
They didn't do anything wrong, they are not allowed to restrict sales, and they were forced to restrict buys because you can't get $3 billion collateral overnight.
Then why are they in this business if they don’t have the collateral? If I have the money in my RH account to buy the stock, why can’t I buy it? I understand restricting buying on margin because obviously that’s affected by volatility, but if I am bringing cash to a transaction, why is it suddenly restricted?
I don’t really have a horse in this race, I am just trying to understand how it’s ok for them to put their thumb on the scale in this way and then say that they didn’t have enough collateral and someone that is retail investors’ problem.
> Then why are they in this business if they don’t have the collateral?
The grocery store doesn't deserve to go out of business if they run out of paper towels sometimes.
> but if I am bringing cash to a transaction, why is it suddenly restricted?
They can't use your cash as collateral due to preexisting rules (part of new regulations after 2008). They have to use their own, and in this case it wasn't infinite.
They aren’t a grocery store. If they were out of GME stock to buy nobody would hold it against them. That wasn’t the case.
I clearly don’t understand the regulations around this. It seems to me that when stock is volatile is exactly when I should be buying and selling and if my broker can’t make that happen it’s a problem, no? And it’s also a problem that their inability to trade that stock affects the price. So what is the correct solution here?
They effectively were "out of GME stock". They usually have to put up 10% (or something) per share collateral with DTCC to send out more buys, but the volatility meant that it went up to 100% collateral, so they couldn't afford to allow purchases. This happens based on a formula where one of the factors is GME being the #1 stock being purchased that day on RH.
> It seems to me that when stock is volatile is exactly when I should be buying and selling and if my broker can’t make that happen it’s a problem, no?
If a stock is volatile you should not be buying it, that's how you lose money. The people who profit are market makers like RH's Citadel, who get paid on every trade.
> And it’s also a problem that their inability to trade that stock affects the price. So what is the correct solution here?
Technological improvements like the one RH's CEO wrote this article about. Btw, for reasons I've forgotten RH's collateral issues got even worse as the price went down again - if it kept going up it'd actually be more possible for them to continue providing buys.
Ok so they essentially couldn’t trade outside their own system? Or are trades inside their own platform still subject to clearing through the clearing house?
I think they could have traded within their own platform (not 100% sure), but customer interest in buying was so high that they weren't able to fill trades that way. Other brokers had more sales and that's why they didn't have to restrict buys as hard, although they did still restrict them.
The reason that I agree with you is that Robinhood's actions spooked buyers, and long-holders who are Robinhood customers lost money as a result...not to mention allowing covering shorts to front-run the retail demand.
Which is why they shouldn’t have restricted it at all. Volatility is the name of the game. If they can only trade equities with predictable prices they are probably in the wrong business.
And where the price is now is arguably the direct result of their actions. The price would be higher if they didn’t restrict buys while allowing hedge funds to gobble up the panicked sells from retail investors.
Judging by the sentiment on WSB it seems that this is far from over. Hedge funds have overshorted several stocks and those guys have figured out that if they simply buy up a large portion of the available stock they can name their price when the hedge funds need to buy to cover the shorts. It is of course impossible to quantify but casually looking at the posts, nobody is talking about selling GME at all, and every dip in price just means more retail investors can afford to buy into this. It’s a bubble for sure but it seems a lot of the users there are mostly interested in using it as a weapon against hedge funds more so than making money off it.
They had no choice but to restrict buys. They're subject to clearing collateral requirements based in large part on stock volatility. People keep saying RH should have just left it all alone, but if they had, they'd have been insolvent.
Ok but the idea that you can’t buy stock at a time when it is most advantageous to buy it seems like a flaw in the system. So what is the solution then?
Using brokerages that are sufficiently capitalized to clear the trades you want to make. You might have to pay fees to do that. Having other people assume credit risks on your behalf usually costs some money.
The money you put up to buy a stock is your money. SEC rules require that it be kept segregated. It is at no point available for your brokerage to post as collateral for its own risks.
DTCC protects brokerages from each other. Brokerages post collateral to insure each other in case a brokerage fails, and the customers, at other brokerages, on the other sides of the trades from the failed broker, need to be made whole. The clearinghouse isn't insuring against you the customer not being there with the $15 to buy your GME share tomorrow. It's insuring against something horrible happening at Robinhood that zeroes out all its accounts, drives it out of business, traps all its staff in a deep sea diving bell, that kind of thing.
So would instant clearing help with this? If I am able to spend my $15 and the exchange of equity for cash is atomic then this becomes less of a problem?
If you eliminate the credit risk between brokers, you lower the capital requirements for brokerages. But you create other problems. I don't have any opinions about it; I would just form my opinions by reading whatever 'JumpCrisscross says, so I refer you there.
> When people invest, they’re placing their hopes and dreams for the future in our financial system. We can’t let them down.
This is probably generally true but that investment behavior is not what drove their clearinghouse failure. I wish they would quit it with the fluffy rhetoric. Why doesn’t Robinhood understand that we want straight answers from them.
But "When people invest" - This isn't investment behavior. This is speculation and most likely simple addiction to gambling behavior they drive and incent people to do.
Would it make sense for securities places to charge each other interest for unsettled trades? You’d make more profit then if you could settle your trades faster, making it more carrot than stick.
Something like the overnight rate banks charge each.
Nope. I'm curious about the clearinghouses (DTCC). Robinhood explains the general process in a post from 4 days ago [1].
It would be great to see more details for the DTCC's increase in the amount of required collateral. I tried Googling for some info but didn't find much (probably haven't tried hard enough yet) ex [2].
Naively, what we saw was a failure of the financial system to support trades. It may not be Robinhood, but it may not necessarily be T+2 either.
Is there a website I can use to query the current deposit requirements for GME? Is it public info? Are there details provided for factors affecting that amount that can be compared across different stocks?
I'm a total noob please forgive my noob curiosities :)
Certainly, writing that is simpler than writing out the reasons behind 3 separate events. But I think Occam’s razor is more about actual simplicity, and would cut against arguing that there was an elaborate conspiracy that involves multiple large companies acting against their own interests.
"Simpler" is subjective and sort of beside the point of Occam's razor. The razor is about choosing the competing hypothesis with the fewest assumptions baked in.
"When you hear hoofbeats, think of horses, not zebras." A massively orchestrated conspiracy requires a lot of assumptions and so probably violates the razor.
Social media companies often check for things that are against the TOS when a media storm is brewing, this is not new. They're trying to stay ahead of negative press.
Yes and no, by banning WSB social media created negative press too. There's an implication: "if they got banned then there must be something wrong with them; probably racist or nazis".
I think because both the discord server and the facebook pages were cesspools of sexist/racist content, that during the GME frenzy they got even worse, and the services knew that they would face increased media scrutiny with all of the increased attention. The hit pieces practically write themselves.
I also don't think it's the 100% truth. First, I don't understand why you couldn't buy just some stocks. If RH really had not enough money, you couldn't buy any stock. Second, when you buy stocks on RH or any other exchange, you have to have the money on there on the account. So the money is there. There is no risk on the long side at all. Third, RH was not the only one, suddenly several exchanges have the same problem at the same time .. no I don't think so.
When you're getting your face rearranged in one corner of the boxing ring, very often the body tries to naturally move to another corner.
Settlement cycles and market censorship are two separate things. It's on robinhood to make sure they can meet the same liquidity standards that banks have been "stress tested" for ever since 2008. Keep in mind that it wasn't 3 years ago where T+2 was just a dream.
Real time settlement is going to be driven by centrally governed organizations and their market counterparts (DTCC / SWIFT).
This post is equivalent to an Op Ed saying World Peace is what society needs. Vlad, we understand you are trying to salvage some of the PR mess that was made by placing the blame on others. This post is lacking substance on next steps and how Robin Hood would like to implement this. While it is not what your Company does, what is your suggestion?
The implicit call is that the SEC should push for it and financial institutions should accept the push. I'm not sure there's much to say beyond that; the basic technological principles behind getting real-time information from the NYSE to DTCC are simple and well-understood. The industry just has to invest the time and money required to make it happen.
I have seen on Twitter that Robinhood was unable to use customer funds to satisfy clearing deposit requirements, but I couldn’t find an actual authoritative source on this. Is this correct? It seems to me that, to secure a $300 purchase buy a customer, Robinhood ought to be able to use that customer’s $300.
Do you have a citation for this? I found an relatively old FINRA document that sort of seemed to say the opposite, but it wasn’t obviously in reference to stocks and I think it also predated Dodd-Frank.
> Brokers cannot use client money to satisfy their clearing fund obligation. So whether or not the accounts had a settled balance didn't matter - as you can see from the other brokers which halted buys and did not have "instant transfers".
One is the payment capability of the customer to pay RH when the purchase is settled (T+2).
The other is the relationship and payment capability of RH to the clearing house (DTCC) for its orders that it has placed with other brokers.
RH is required, as a broker, to provide its own collateral to the clearing house so that the clearing house can guarantee to other brokers that all their trades will be settled at T+2.
RH is not allowed by law to use their customers' money as collateral to DTCC. If RH goes broke, then DTCC does the following:
a) takes all their collateral and uses it to make the other brokers good on their trades (which makes the counterparties good on the trade)
b) takes the customers money and uses it to complete the trades (which makes the customers good on their trade).
> RH is not allowed by law to use their customers' money as collateral to DTCC. If RH goes broke, then DTCC does the following:
I still can’t find an authoritative citation for this, and it seems seems like poor design to me.
Suppose Robinhood has one customer. That customer opens a cash trading account, deposits $1bn into it, waits for the deposit to clear and waits an extra week for good measure, and then uses all $1bn to buy an absurdly volatile stock.
Now, between the execution of the trade and settlement, Robinhood is apparently holding $1bn (in a segregated account?), and Robinhood needs to post some largish fraction of $1bn with their clearer to offset the risk that Robinhood fails to pay the $1bn at settlement.
To me, this seems like un unreasonable requirement for Robinhood. If their actually go bust before settlement, they owe DTCC, etc $1bn, the customer has $1bn deposited (in the same segregated account), and the customer is owed some number of shares of the stock. All the money is there!
So why can’t Robinhood satisfy its clearing fund requirement by putting the appropriate fraction (or even all) of the customer’s $1bn into segregated account with its clearer? After all, the mere fact that Robinhood has a whale for a client does not mean they are any more likely to go bust, except for the fact that “bust” seems to include this odd case where Robinhood can’t independently secure its customer’s trade.
Robinhood Instant's model doesn't actually require a customer to have settled funds to make that $300 purchase, so Robinhood has to pay for the $300 until the customer's deposit clears.
Separately, when someone with Robinhood Gold buys shares on margin, that purchase is financed in part with Robinhood's funds. Look up "initial margin" and "maintenance margin" to understand why. This involves some risk for Robinhood, because assets can sometimes lose value faster than Robinhood can sell them to preserve its equity.
Finally, Robinhood is a clearing member and has to put up money as insurance to keep the clearinghouses capitalized in case some bad juju goes down in the markets and Robinhood hits the skids.
This particular issue you cite has little to do with customer funds. Look up delivery-versus-payment. In foreign exchange, for example, one can avoid this issue by settling via a provider like CLS [0]. I’m reasonably confident that stock transactions are immune to the problem you’re imagining.
In any case, I think it would be entirely ridiculous for one’s stock broker to front the entire purchase price for each and every stock purchase to secure customers against counterparties who might take the money and not deliver the stock. This would involve the broker coming up with 100% of the price, not merely an amount related to the anticipated worst-case P&L.
[0] https://www.cls-group.com/ In this particular instance, I do know what I’m talking about. The story of Herstatt Bank is fascinating.
They do have margin accounts, but as I understand it, that was not what caused these deposit requirements to shoot up. I.e. the margin accounts were not what caused the problem.
These clowns can’t even prevent their customers from using infinite leverage. (See WSB leverage hacks.) Their CEO doesn’t even understand clearinghouse rules. (He said so on TV the other day.) They should STFU and not share their “thoughts” on market structure.
I don’t even know what to say about this. It doesn’t sound like he learned his lessons at all. He’s calling for real-time settlement which is not practical for equities. On top of that he completely dismissed RH’s root problems: very loose margins and new account standards. I was defending RH on HN last week but I have to reconsider.
> He’s calling for real-time settlement which is not practical for equities.
Why not? In most cases share ownership is just a row or two in some database. If you can update those in real time (which you should; a legacy system that doesn't support this can be upgraded, even if at significant cost in implementation and testing), and do instant (or near-instant) funds transfers, you should be able to settle within minutes. Certainly same-day, at least.
Now, I would accept that maybe instant settlement is not desirable. Maybe it's good to be able to reverse fraudulent or illegal trades before money fully changes hands, for example. But that's a different thing.
dumb question, why is not practical? As for the root problems, those are not related to the issue from last week (not sure if you're aware, but margin had no factor in play with the DTCC requirements).
There are many reasons but most importantly, delayed settlement serves as fraud deterrent and error/exception handling. Should be T+1 same as options. Think of it as a database, do you want instantaneous non-reversible commits by default when transactions number in the billions with known error rate? Or perhaps have a reasonable buffer for safety?
For cash, pretty much every country has a functioning real time gross settlement system that manages to do essentially instantaneous non-reversible commits by default and carries all the large payments and the netting settlements for all kinds of smaller bundled payments. Yes, there are risks, errors and fraud - but if that's manageable for very, very large amounts of cash, why wouldn't it be for stock?
I would go even further. If I am building a next gen electronic wallet (which happens to be a side project of mine) I’d build in a full week of escrow-like mechanism by default.
I can maybe see T-0. But I am pretty sure Vlad is talking about near real-time. Even with T-0, most of the trading is done in the last ten minutes at 3:50 EST (due to vwap). I don’t see the benefit in settling T-0 outweighing the value of safety net provided by extra time overnight.
Robinhood got called up at 3am with an extortion demand for $3 billion due that morning, unless they shut off Buy orders of GME.
The collateral call had nothing to do with Robinhood’s ability to pay for the orders it was placing.
The problem was the GME short sellers were insolvent at the prices the stock was trading at, and contagion from the hedges failing would have left the clearinghouse looking at billions in loses.
Robinhood didn't get extorted, their clearinghouse told them they needed more capital to secure further $GME trades, because the volatility has been off the charts.
I think the point is, the effect of that sudden change was the screwing over of retail investors at the expense of funds and firms that weren't locked out. And that RH should have seen this coming if it were all "by the book". And how the hell can those fees go up so instantly?
If we're going to be all "free market" about how only the strong survive, RH should be eliminated.
It _was_ by the book and they _should_ have seen it coming.
"How do clearinghouses determine how much is required?
It’s pretty technical, but the process basically works as follows: clearinghouses look at a firm’s customer holdings as a portfolio. They use a volatility multiplier, looking at specific stocks, to quantify their risk. The clearinghouse may assign significant additional charges based on how much of one stock a firm’s customers hold. If a firm’s customers have more buy than sell orders, and the securities they’re buying are more volatile, the deposit requirement will be higher. Clearinghouses can also require additional deposits if certain thresholds are met."
This is the same fallacious argument that media cartels use to claim that copyright infringement "costs" them and incurs "losses". No, this is unrealized revenue, and that's generally not punishable by law; there have to be specific circumstances which would indicate fraudulent behavior.
RH is trying their best to stay afloat and carry out their fiduciary duty, and it seems that the incompetence is not with RH but with the many users who misunderstood how RH works.
(To be clear, we should dismember the entire system of short-selling shares of corporations, for the billions of dollars worth of damages and injuries which are done to the employees of those corporations and the social fabric. But that is not the same as revoking RH's charter.)
If RH is eventually found to have stopped trading on GME in purpose to manipulate the price then sure let the SEC draw and quarter them. But RH wouldn't be so severely punished for having downtime and this is basically that.
Which is why you push back and tell the clearinghouse to make a public statement to that effect.
The CH is faced with two options: One, make the statement and hurt a public reputation they don't care about in the first place. Or they could cut off all trading to RH, which puts RH on the same side of the fight as they have been trying to market themselves as being on from the beginning. Win win.
I don’t think it was the CH’s choice. I believe the collateral requirements are set in Dodd-Frank.
And financial firms don’t go j to extended bankruptcies when they run out of cash like other companies. They immediately go into receivership and/or liquidation. Trying to play chicken with the CH would have just ended RH as a company pretty much immediately.
If it was a regulatory requirement, then they should have been put in to receivership immediately. Being unable to meet colleterial requirements means they extended credit beyond their means.
It’s possible with blockchain.
Imagine if each stock had its own blockchain, made up of transactions of shares transferred from one to another, in exchange for a selected stablecoin. Every trade ever done is recorded and available to the public.
I'm really ignorant about all this securities trading stuff. Can somebody enlighten me to what this change actually means? Or maybe point to some "beginners guide", after which I'd understand what he is talking about?
T+0 means securities and funds change hands instantaneously (or maybe EOD) rather than on the present two-day lag. That two-day process is managed by a clearinghouse that requires members like Robinhood to put up large amounts of money, which Robinhood doesn't have in spades, for clearing and collateral. He's trying to blame that requirement for Robinhood's most recent miserable failure.
That far I could vaguely guess, but I don't see any connection between these fact.
First off, what do you mean by "Robinhood's most recent miserable failure"? The story as I know it: WSB pumped up GME, somebody (Melvin's Capital) majorly fucked up and lost money, somebody (Blackrock, Citadel, some lucky traders) gained something from the situation, basically, business as usual. Then Robinhood screwed over it's customers, by forbidding them to perform some operations, motives for which remain questionable and may result in a prosecution (because of affiliation with Citadel), but AFAIK that's very theoretical and right now Robinhood didn't really suffer any loss.
None of this really fits the description of "miserable failure" on Robinhood's part, as far as I can tell. So what do you mean? Am I missing some details?
Is he blaming T+2 for forcing him/Robinhood to prevent users to buy stock? How so?
Second, I still don't quite understand what T+2 means. All trades look instantaneous to every particular seller (including all Robinhood clients), right? Also, all trades are recorded by a centralized entity (NYSE), so there also cannot be any disagreement between brokers about how much who owes whom. Actual money/securities movement between brokers is T+2, but in the essence that is just some bureaucratic bullshit, and shouldn't affect broker's clients' (including all Robinhood users) ability to buy stock, right? Also, whatever the current regulations are, Robinhood somehow performed under them until now, so it somehow managed to meet whatever clearinghouse requires of them, right?
So, in the essence, I still don't understand what the fuss is about, and how Tenev could possibly blame T+2 for anything (which, btw, I don't see him explicitly do: he doesn't say that it was because of some clearinghouse requirements he was forced suddenly to shut down free trade of stock on his platform, does he?)
> what do you mean by "Robinhood's most recent miserable failure"?
I mean "failure" in the literal sense. It's not a particularly reliable brokerage.
"FINRA said in a statement that the brokerage failed to make sure clients were getting the most favorable prices possible from October 2016 to November 2017." (19 Dec 2019)
> Is he blaming T+2 for forcing him/Robinhood to prevent users to buy stock? How so?
In a sense, he's blaming T+2 for tying up his firm's money, which his firm uses to make margin loans and put up collateral.
> I still don't quite understand what T+2 means
It means that if I buy stock from you today, I pay you (and you give me the shares) in two days' time. The trade is instantaneous but its settlement (where we actually exchange the goods for the dough) is not. That transaction is carried out through a clearinghouse.
> all trades are recorded by a centralized entity (NYSE)
NYSE is one stock exchange. It doesn't record all the trades. Look up DTC and NSCC.
T+0 would enable the Robinhoods of the world. Are the big players and the regulators they've captured and the legislators they've paid for interested in enabling Robinhood et al. after the events of last week?
You think T+2 is a form of regulatory capture? Any type of regulation that makes it easier for retail to lose their money would be welcomed.
When things were delivered by horse, it was T+14, we are now down to T+2 for stocks and bonds (mostly anything related to private industry), T+1 for options and government stuff, and T+0 for futures. Everything is pointing at eventually everything being T+0.
I'll repeat, Robinhoods are welcome, especially if they do dumb things like this GME debacle. I expect the big players to lobby for relaxed margin requirements so that they can let retail lose their shirts like the 1930's while they profit by taking the smarter side of trades and insulate themselves by letting the Robinhoods fail in case of market failures.
I am not surprised they haven't made an API public yet. Looking at how razor-thin their operational margins have been on IT and financial fronts, any hypothetical added load from traders trying to algorithmically hammer some API is probably going to wind up in disaster.
I cannot speak for all of the engineering that goes down at Robinhood, but the way their web-based trading interface performed for me was regrettable at best. Never was able to load my history in that interface without my browser getting javascript timeout warnings. Always had to go back to my phone to see what dividends I got paid out. This sort of problem, which strongly-encouraged me to switch to a different broker, does not give me much confidence that other areas of engineering at Robinhood are handled much better.
Yeah, I think end of day would be sufficient at least for now.
Maybe someone with more knowledge of the situation will correct me though. I think there can be counterparty risk issues (eg during the 2008 crash) that are removed by immediate clearing/settlement.
Funny how the dinosaurs in this thread are arguing whether a < T+2 settlement is possible as fiat transactions are not atomic.
In forth semester of computer science, I toyed around with Bitcoin (2014?). A client had asked me to build a crypto exchange and so I faced the problem of when to credit a user Bitcoin that they sent to exchange-generated addresses.
Turns out the whitepaper specifically addressed this problem and by waiting 6 blocks, Bitcoin was designed to have such low probability of a chain reorganization that I was safely settled (finality in 60mins).
That's how I built it, and it's also the way that 99% of centralized exchanges operate today.
It's a good thing that DTCC aware of this issue and is looking into accelerating this to T+1 (followed by T+0) using blockchain and distributed ledgers.
If you only think about the American stock market from the perspective of a domestic retail day trader, sure, real-time clearing sounds easy enough. When you expand it to institutions, real-time settlement means having to warehouse all the funds they might need to trade with in a day with their prime brokers as cash. Not Treasuries. Cash. Because their broker has to be able to wire out that $1bn instantly. (That's what real-time settlement means. Real-time payments.) For market makers, this effectively requires removing their buyer of last resort obligations since they would be practically capped by their cash on hand. There are additional complexities when one considers foreign investors. Options exercises and expirations. ETFs. Futures.
Historically, the loudest advocates for shortening settlement times have been global money centre banks. A switch to real-time settlement and clearing would require every market participant either (a) have flawless payment rails to every other market participant or (b) put all their cash with a global bank who can provide that guarantee.
End-of-day or overnight clearing, on the other hand, isn't too much to ask for. It preserves the robustness and extensibility of delayed settlement. But it removes a few days of collateral requirements. Pushing for EOD clearing would be a smarter play for Robinhood, from a government relations perspective. (If this is solely PR then whatever.)