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.
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.