By Jonny Lupsha, Wondrium Staff Writer
A brokerage app is under fire for restricting GameStop stock trading. Robinhood and its CEO prevented retail investors from buying shares of the video game seller’s stock during its January rollercoaster. A professor for The Great Courses explains.
In January, the video game retailer GameStop saw its stock skyrocket by over 2,000%, costing hedge funds and short sellers billions. Wondrium Daily spoke with Duke University’s Connel Fullenkamp, PhD—who has also taught several lecture series for The Great Courses—to understand how Reddit users turned the tables on Wall Street.
Another aspect of the story coming to light involves a stock trading app called Robinhood, which suddenly restricted trading of hot stocks like GameStop during the trading frenzy, earning the ire of its users and others.
In the second part of Wondrium Daily’s report on GameStop’s stock surge, Dr. Fullenkamp discussed the Robinhood app—and the users affected by it.
Gamifying the System
One of the key factors of GameStop’s Wall Street rollercoaster was shareholders’ ability to watch the stock rise and fall moment to moment throughout the trading day. Dr. Fullenkamp, who is a Professor of the Practice and Director of Undergraduate Studies in the Department of Economics at Duke University, said that aspect of the trading has specifically come up in his classes.
“My students are all over this story, too; I’m teaching corporate finance and financial risk management,” he said. “So I said to them, ‘If you’ve got nothing to do all day, and you’ve got the change to invest in it, it’s great fun to get in there, as long as you can stick with it all day and watch it and make sure you get out before you lose your shirt.'”
He said that the pandemic played a role in new investors’ abilities to keep a close eye on their stocks as the share price spiked and plummeted from one minute to the next. Whether they’d been laid off from their jobs or were just working from home, a large portion of the working class has been able to metaphorically or literally keep a finger hovered over the sell button on apps like Robinhood.
He also suggested that there was an added entertainment value to it—an element of sport or of gamification, in which stock trading becomes fun instead of a boring, old-fashioned thing to do.
“[It’s] not just that people were working from home, but they were devoid of other entertainment opportunities,” Dr. Fullenkamp said. “Robinhood actually gamifies trading, and then you’ve got Reddit or other social media which gives you the crowd angle. It’s almost like going to the bar, getting wings, and cheering your team on with your friends.”
Robinhood temporarily halted its users’ trading on hot stocks like GameStop in the middle of the fervor as share prices were rising. On the floor of the stock exchange, trading is often halted. However, Dr. Fullenkamp said that in those instances, halting trading serves as a circuit breaker for a stock, a practice which was implemented after the stock market crash of 1987.
“In the crash of ’87, trading got so fast and furious it overwhelmed the ability of the system to keep up,” he said. “In that crash, the futures market—which kept the market honest through arbitrage—got separated and that just caused all kinds of havoc and losses, people basically trading in the dark. So what a lot of exchanges have done is, they’ve implemented so-called ‘circuit breakers.’
“This means that, if prices move too fast too soon, they say, ‘Okay, stop trading in this share or across the entire exchange; everybody catch their breath, figure out what the Hell’s going on, and then we’ll start again.'”
On the other hand, Robinhood caused a major clog in the United States’s financial plumbing system, the clearing and settlement system, which mediates financial transactions between a trading app like Robinhood and the actual stock exchange.
Clearing and Settlements
“In clearing, they verify the instructions and make sure you have enough money or you actually have what you’re supposed to pay and you’re going to get what you’re going to get,” Dr. Fullenkamp explained. “Settlement is the actual exchange of stuff: money for shares, shares for shares, money for money, things like that.”
Clearing and settlement systems are run through central third parties, and the clearing part of the system makes sure that its clients like Robinhood have a collateral account to protect the financial network. As Robinhood’s volume jumped, so many Robinhood users were only buying shares that the clearing house requested more collateral from the app, so that the app wouldn’t come up short or go bankrupt.
The amount of collateral would have been hundreds of millions of dollars; so Robinhood halted trading on several shorted stocks until they could raise more collateral.
Many in the public viewed this as unfairly protecting the hedge funds and short sellers who had bet against companies by shorting them. For restricting trading, the app is now being targeted in more than 30 class-action lawsuits, but do plaintiffs have a case?
“I think they’ve got a tough case,” Dr. Fullenkamp said. “Robinhood had a pretty tough choice to make based on this whole collateral thing; if you get into the details, you could probably complain that Robinhood should’ve known this was coming, given the increase in volume, and that they should’ve been better at raising this collateral. If anything, I would guess that that’s probably something that you could complain about.
“Whether a judge will say, ‘You’ve behaved in a way that damages your clients in a way that you couldn’t have foreseen,’ or not, I don’t know.”
This article is the second of two in an investigative series by Wondrium Daily about the GameStop stock squeeze. Read the first part by clicking here.
Dr. Connel Fullenkamp contributed to this article. Dr. Fullenkamp is Professor of the Practice and Director of Undergraduate Studies in the Department of Economics at Duke University. He earned his master’s and doctorate degrees in Economics from Harvard University.