Explain the GameStop short squeeze?

I don’t understand why a broker would restrict purchases of GameStop. If one had $30k of cleared funds on deposit, why would they care if I wanted to spend $300 per share for 100 shares.

This is probably getting into the weeds, Robinhood (and similar broker-dealers) received calls for more capital from the the Depository Trust and Clearing Corporation, known almost universally as “DTCC.” DTCC is responsible for making sure that when a broker buys stock for a customer, the shares arrive in the customer’s account a few days later and if a customer setls stock, that the cash arrives on schedule. Because of the volatility in GameStop, DTCC was concerned that Robinhood’s customers, and hence Robinhood, wouldn’t be able to pay for all of the shares that they bought, particularly if the shares plummeted in value. DTCC chose to to reduce the risk of default by Robinhood by demanding more capital from Robinhood. At some point, it was apparently easier for Robinhood to tell investors that they couldn’t buy GameStop anymore rather than try to raise the extra capital Robinhood needed to satisfy DTCC.

This article does a pretty good job explaining what DTCC is and how if affected Robinhood.

https://www.bloomberg.com/news/articles/2021-01-29/what-s-the-dtcc-and-how-did-it-stop-gamestop-mania-quicktake

Cuban gets dumber and dumber every time he’s on television. He’s obviously a great marketing guy and salesman, and he’s clearly capable of some degree of entrepreneurship, but he’s a billionaire with a capital B because Yahoo was dumb enough to overpay for one of his ventures (there’s a reason Yahoo eventually went down the toilet a few years later, mainly because of repeatedly over-spending on acquisitions and completing fucking up the brands of the really good acquisitions it made). But back to Cuban, this guy took his billions and laughed his ass off to the bank and has been trolling the world ever since. But he, like Elon Musk, is trying hard at building a cult-of-personality business persona. His business advice is quite often shit.

The part that still doesn’t make sense to me is why DTCC thought Robinhood could or would default. Robinhood secured the capital from the investors. Those funds are in RH’s bank account. They’re good for it because they already have it. Now, if RH wanted to set margin requirements to 100% and restrict naked options and limit instant deposit purchases, OK fine. That’s what TD did. But how could RH default if they’d already collected the money from cutstomers?

I can’t speak to Robinhood specifically because I don’t have access to their trade blotter or their balance sheet but I can understand how DTCC might have become worried. Assume that Robinhood has a new client that borrowed $1000 on his credit card. He deposits that into his new RobinHood margin account and uses it to get $1500 in buying power. He buys 100 shares of GameStop at $15 per share. Gamestop doubles to $30 per share, and Robinhood’s client now has $2500 in equity in his account ($3,000 in GameStop shares minus $500 in margin loan). So he leverages up his account to the maximum again. He borrows $750 more dollars and buys 25 more shares. Now he has 125 shares, a margin loan of $1250, and shares worth $3750. Assume every time GameStop doubles, this client does the same thing. By the time Game Stop hits $480 per share, our hypothetical client (making a bunch of simplifying assumptions, like his buying fractional shares) has a share balance of 305 shares with a gross value $146,400 and margin loan of $48,828. Now assume everyone wakes up from their fever dream and GameStop stock drops overnight to $15 per share again. Our theoretical customer has shares worth $4575 and a margin loan of over $48,000. And he has a credit card bill of $1000 due. When Robinhood makes a margin call on his account, he will not be able to come up with the $48,000 to pay for the shares he has already purchased. Robinhood can liquidate his account but that still leaves them short by over $43,000. Repeat this type of experience for thousands of customer accounts and we can understand how DTCC thought that perhaps Robinhood should contributing more capital upfront just in case its customers default. To my knowledge, DTCC does not know whether the people buying more GameStop stock are new investors putting in new cash or whether they are customers like our hypothetical trader who are just leveraging gains on existing positions. DTCC has a blunt tool to restrict its risk though, which is just demanding more money from Robinhood to limit its exposure.

We know that in the end, Robinhood really wanted its customers to reduce their exposure to GameStop stock. In theory, Robinhood could have called in outstanding margin loans from its customers, but that would have also caused an uproar. Our hypothetical trader with GameStop at $480 per share would have faced a margin call of over $48,000. And he ain’t borrowing another $48,000 on his credit cards to meet it, so Robinhood would have to sell 1/3 of his shares. That type of selling pressure, repeated across thousands of accounts, would have pushed the share price down too. It seems that Robinhood instead made the decision to reduce their total exposure to the stock by just keeping customers from buying new shares. It was a decision made in the fog of war. We’ll only be able to guess with imperfect information even in hindsight whether it was the best one.

Many of Robinhood’s traders were trading options but that just magnifies the degree of potential leverage and the risk of client default by potential orders of magnitude. The risk of default by Robinhood on options accounts would be born by the Options Clearing Corporation, which is basically the DTCC for options trades. But they too were likely worried about the risk of customer default and I don’t know if they too were demanding more capital from Robinhood. It wouldn’t surprise me if they did, although I haven’t read that they did.

But if you turn the margin rate up to 100%, none of this is possible. The guy deposits $1000 and can buy 100 shares at $10, not $15. Then they go up or down, and it doesn’t matter because you have his $1000 and gave it to DTCC. All those people who already bought on margin whom you’d have to margin call aren’t in any new situation, as they weren’t liquidated. They still had their shares, they just couldn’t buy more.

I’ve noticed I’m seeing a lot more online ads for investing. I’m wondering if it’s due to my participation in threads like this which is marking me as a potential target for investing services. Or am I just seeing a general wave of new advertising based on increased public awareness of investing?

Yeah, turning the margin rate up to 100% should’ve solved it as far as I can tell.

I think the issue might have been related to fund transfer delays in some fashion.

The problem was that DTCC was demanding more capital for any GameStop trades executed by Robinhood, whether cash or margin. Turning off margin but continuing to allow trades in the stock would mean that DTCC would still be demanding more capital that Robinhood didn’t have.

But why didn’t Robinhood have it? The client gave it to RH, so RH should have it. No margin, no problem.

According to the Planet Money episode I listened to, the money is not removed from the client’s account until the trade settles two days later. So no, the client did not give it to RH and RH didn’t have it.

What do you mean by “RH should have it”? Are you thinking that if a stock broker accepts a buy order for X shares it means they have those shares “in stock”, ie. on their own books or “inventory”?

That’s not how it works, though. Stock brokers don’t work like Amazon. It’s inherent in the concept of a broker. Literally, a broker is someone who buys and sells on behalf of another. Their entire reason for existing is so you can buy and sell stock without having to personally connect with another trader every single time you want to trade. When you buy X shares you are telling your broker to go find that number of shares on your behalf and when the broker accepts they are agreeing to deliver those shares at the specified price, and that process is not immediate. So that means the dynamics of the transaction are different from buying and selling goods at retail.

Besides, even if you did want a broker to only accept trades against some specific inventory they personally hold, they would still have to stop accepting trades when they “run out”. And then the exact same misinformed outrage would have occurred as people accuse them of “running out” on purpose or lying about it. The bottom line is that no matter the model you want a broker to operate on, if there is such severe demand for a stock that the broker can no longer fulfill orders for it you would have the exact same result. Doing anything else and continuing to accept buy orders would be the same “stock counterfeiting” theory posted upthread except actually true.