Malt Liquidity 28
Robin HODL
Robin Hood redistributes the margin
Since I started writing this post last night, Vlad Tenev has been openly bullied by Elon Musk in front of the entire world, Robinhood has raised 2.4 billion in equity dilution (on top of the 1.5 billion from the bank loan + the first set of emergency funding) and just now, I see that they are trying to raise another $1 billion in debt. If you’re keeping track, that’s double what the Melvin Capital bailout was.
This is what happens when you try and mess around with the rules in the most regulated industry in the world - and as I have documented, I am no fan of Robinhood and their consistent flouting of compliance and responsible margin lending.
A quick summary of why their cash position is so fucked:
1. When you sell a stock, there’s a delay between when you receive the money for it and when the trade is “settled” - the stock shares are officially transferred to someone else’s name. (This is why you have to be recorded as holding shares on an ex-dividend date to get paid a dividend.) Essentially, your broker fronts you this money for 2 days and deposits a nominal sum of money with the clearinghouse, which is usually a low single digit % of the trade notional value, as the credit risk is so low on the actual settlement.
2. This is an extremely normal, everyday occurrence. There are strict limits on how much retail clients can leverage their accounts, so the risk is not outsized. For example, we know AAPL is not going to crater to zero in one day, so there is no reason to treat that possibility as plausible to the point where Robinhood would need to put up serious cash to account for it.
3. However, about 70% of Robinhood clients had a position in GME, a stock that was registering absolutely insane vol, not to mention that a lot held derivatives (which settle at T+1, but are exponentially more volatile). And Robinhood is pretty bad with how they handle margin, as seen when I documented the case of a $4k account that ended up with a million dollars worth of AAPL or one of the many times WSB broke Robinhood’s margin calculations. I am sure that Robinhood did not account for the fact that there would be an unexpected source of volatility that would arise out of how its users were trading where they couldn’t control the trading of the product itself.
4. So when GME starts showing an outsized amount of volatility, the clearinghouse notices this and thinks, “Hey, if a bunch of these people lose money, you’re going to have to cover for the margin you let them trade with.” Thus, the collateral on GME specifically went from 2% for a normal trade to 100% of the notional value required. This is true for all brokers, not just Robinhood, but a) Robinhood had by far the most client exposure to GME and b) they had nowhere near the cash to suddenly cover for this, as you cannot use client deposits as collateral. The “low risk” credit that Robinhood offers just to settle trades instantly has a very high lending risk of being a massive amount of client loss that they can’t pay back to Robinhood. So each time “Diamond Hands” went trending on Twitter or was posted on reddit, it turned into an additional day where Robinhood had to pray that users liquidated their positions on the stock before it craters.
5. So all of a sudden, Robinhood has perpetual T+2 days of credit risk exposure tied to GME completely at the whims of the positions of their clientele. And the insane new signup flow that hit them went straight into GME - positions which they were now required to post 100% collateral. It’s sort of like being able to make your payroll, but not if your employees choose not to automatically withhold. You have enough, but you don’t at the same time, even though things will potentially work out in a couple days (when the next revenue comes in) as long as you can afford to get there. It is likely that Robinhood was insolvent Thursday when they shut down trading in GME out of pure desperation for their users to stop forcing them to post collateral that they didn’t have.
6. On top of this, they are being excoriated for selling order flow - their only source of real revenue and their entire business model which will likely be outlawed shortly - and enraged their entire client base who will likely leave after cashing out or blowing out on GME. These cash infusions are likely lead investors desperately trying to keep the company solvent so they can hopefully get something back when someone acquires it for 10 cents on the dollar, if that. Retail blew up the brokerage that tried catering to them and pushing the worst style of trading on them by trading a literal “game stock” - the irony can’t be understated.
On that note…
I will resume commenting on stories other than Robinhood, reddit and GameStop by Tuesday, as things finally seem to be settling down
Autogenerated content is going too far, and trying to reboot Standard Oil
Yes, Parler was the problem. Nothing to see here, move along.