The movie Burn After Reading ends with this scene:
CIA Superior : What did we learn, Palmer?
Palmer: I don't know, sir.
CIA Superior : I don't fuckin' know either. I guess we learned not to do it again.
Palmer: Yes, sir.
CIA Superior : I'm fucked if I know what we did.
Palmer: Yes, sir, it's, uh, hard to say
CIA Superior: Jesus Fucking Christ.
That’s a bit how I’m feeling about this week’s battle between the Reddit users who successfully short squeezed multi-billion dollar hedge funds by driving up the price of Gamestop—a soon to be Blockbustered video game retailer.
And now Robinhood has banned its users from buying these Reddit targets. The great democratizer of Wall Street suddenly turned its back on its users, without a decent explanation:
“We continuously monitor the markets and make changes where necessary. In light of recent volatility, we are restricting transactions for certain securities to position closing only.”
Why? Who are they protecting?
“We’re committed to helping our customers navigate this uncertainty.”
If anything, there’s very little uncertainty in this situation—everyone knows what’s going on. Two opposing groups are locked in a high-stakes battle of will that could blow up at any moment.
Oh, wait… it just did... and then it came back… and then it blew up again…
Stonks!
And now, renowned equity analyst Ja Rule has weighed in:
What’s amazing is that Robinhood’s actions have even got Ted Cruz agreeing with AOC:
I mean… What is going on?!?
Well, let’s take a step back and ask the following questions—questions it seems that platforms like Reddit, Robinhood, WeBull, Twitter, and Discord never seemed to consider:
a) Is this good for society and for the financial markets?
b) Does anyone have the potential to get hurt that can’t afford to?
c) How can we even monitor and create compliance or policy to make a good experience for everyone going forward?
The Public Good Question
Should short-selling even be allowed? Should mass coordination by retail investors be halted?
Should we have asked whether securitization should be allowed before 2008?
These things can all play positive roles.
Short selling makes markets more efficient by pressuring over-valued companies and identifying flaws in companies’ financial outlooks. Short selling can also lead to better research since there is value in analysts suggesting that a company may be a “strong sell.” Finally, short selling is critical for investors to be able to hedge their bets when trading a company’s stock.
No matter what kind of transaction or platform you have, there will always be some way to game, abuse, or just get out of hand with something.
I think these are the wrong questions.
Better questions would be how do we ensure that sophisticated financial instruments are used in a way that is transparent and doesn’t allow a very limited number of people to have undue influence on a market.
That’s what happened with the CDOs and the securitization market in 2008—where big pools of mortgage debt were being amassed and sold so many times over that the overall size of the exposure threatened the whole financial system, and no one knew it until it was too late.
This is something different. A bunch of short-sellers went short, knew the risks of their positions, and just assumed that no one else was going to give them any trouble. It certainly didn’t make any sense that someone would lean hard into Gamestop, a company that might not even exist in a couple of years.
But as we learned from The Dark Knight:
And if you can make a few million while you’re at it…
It didn’t help that the short sellers were massively overleveraged, disproportionately magnifying their market impact.
The positive here is that the next come someone wants to pile into a short position in that way, perhaps they will think twice about it. Reddit may have effectively ended the use of the big short by these funds as we know it.
I guess that’s was easier than voting for Elizabeth Warren and waiting on legislation—but jeez, guys, we could have had both!
Is the derailment of shorts bad? I don’t think it’s bad or good—it’s just now a factor that everyone will have to take into consideration.
The Bigger Issue
If a bunch of little guys want to use tech to coordinate and go head to head against some big hedge funds, even for kicks—hey, have at it.
The problem is that you don’t really know if it is, in fact, a bunch of little guys. What if one of the “little guys” is actually Steve Cohen and his hedge fund using an anonymous Reddit account and he’s long on the stock? What if someone bought off one of the little guys and offered him a million dollars and a bunch of the upside to start plugging a particular stock.
That’s when there’s a problem.
As we saw in the 2016 election, what may appear to be just a fellow American patriot who cares about freedom might just well turn out to be a bot farm with Russian backing trying to destabilize things on this side of the world.
That’s how people get hurt—when they don’t really know who they’re following or what their motivation is. The dark side of democratization is the lack of traditional forms of authority and quality measurement. We could reinvent those—and we should—but until we do, it’s hard to know who to trust.
On the flip side, what happens when, everyday, Elon Musk announces to his 43 million twitter followers which stock he just bought. Even if they know he’s going to dump it, the knowledge that other people are going to try to get in while the gettin’s good is enough to drive the stock up.
He could literally do that every single day. He’s not bound by any kind of fiduciary duty nor would he be violating any Twitter policy.
There are just no rules for that apply to Elon Roulette and the Army of Robinhood accounts.
Keeping an Eye Out
What’s very clear is that Robinhood, Reddit, and Twitter did not plan for this—and really, this was only a matter of time. They’re not even close to being in a position to track stock market manipulation across their sites, regardless of whether or not they want to do anything about it.
To quote Geri Kirilova from Laconia Capital, “you mean ‘this will be a great problem to have’ isn't enough of a strategy?”
I mean, if anything, the whole public ethos of Robinhood—including the on the nose name—was all about giving the “little guy” the power of the big guys. Which is why it was absolutely stunning that the company blocked purchases of Gamestop and AMC.
Users were using the platform as intended. They weren’t hacking or doing anything illegal. Now there’s a class-action lawsuit against them, and they’ve lost a bunch of consumer cred.
Name a worse move made by a company so close to the peak of their popularity.
Does New Coke even come close?
The damage done to their brand might be irreparable. Now they’re going to get pulled in front of a congressional subcommittee and it’s 100% going to come out that they were unduly influenced by the people who pay the bills—the institutions that pay to front-run the trades.
You can bet on that without even being on Reddit.
What’s also clear to me is that for sites like Twitter, Reddit, etc, this is a version of the problem they had during the elections. By providing a platform for people’s speech to get freely magnified they become a target for community-based manipulation. One day, it’s about 100,000 votes in a swing state.
Another day it’s about some thinly traded Australian swimwear brand.
It’s the same problem.
Deciding to be hands-off about what is being said on your platform, who is saying it, and how those voices get magnified has huge second-order effects. These issues, when platforms get to the kind of scale they are today, demand thoughtful policy and compliance work.
Is it too much to ask the people whose post gets magnified whether or not they own a position in a stock? I mean, we ask Instagram influencers to say whether or not they get paid by clothing companies.
This seems far more dangerous to be laissez-faire about.
What’s very clear is that new regulations meant to “protect the small investor” are going to ring a bit hollow when small investors couldn’t trade today and big hedge funds were free to do whatever they wanted.