You have no friends on WallSt

As the GME saga unfolds, I think there is an ever-lasting lesson to repeat here. Yesterday, while I was q-ing under the rain to do grocery shopping, I listen to the latest episode of The Compound Show with Josh Brown: the story he tells fitted quite well with the mood and the scenario. WallSt will do everything that it can to preserve itself. It is a fact and is better you deal with it.

I was quite enraged when on Thursday Robinhood and other platforms prevented traders to trade. Lots of theories floated around until the sad truth emerged. As Matt Levine (the ‘Bible’ again ;)) pointed out several times, in WallSt you have firms that try to compete for micro-mini-nanosecond differences, spend millions in fiber / radio / infrared technologies to beat the competition…but the reality is that it still takes TWO days for a stock trade to settle. When you buy a stock with your broker, you see instantly the stock added to your portfolio and the money you paid debited to your account. That transaction in reality happens two days later.

This is the ‘behind the curtain’ part, what 99% of retail investor (and a big majority of professional one) ignore but is crucial for the survival of the system. You can buy/sell only with a regulated broker, and that broker to operate needs a license: first you have to be accepted in the club. In a less prosaic way, this is well explained in the last season of Billions, when Axe try to buy a bank. He knows that it does not matter how much money you have, the game changer is if you are in the club or not. The system fights him and shows how there is no ‘rule for everyone’, everything is f**king pretty discretional. Why some European football clubs wants to create an European League of their own? Who wants UEFA rules when you can create and govern your own (and instantly increase the value of the club by 10x).

Once you are regulated, as Robinhood and the others are, then you have to follow the rules. When you buy a stock, your broker has to clear the trade, exchange your money for the stock certificate, in a ‘central’ clearing house: it is like a virtual place where all the club guest meet and do their trading for you. By the way, this has nothing to do with the fact that Robinhood routes all its trades to Citadel; Citadel has its own broker, which follows the same rules as RH. The issue is that the trade happens today but it settles two working days later. Even if you have the funds on your account when you buy a stock and you are not using any leverage, so your should not represent any counterparty risk, your broker has to deposit some money on the clearing house to ‘show’ the other participant of the club that if something goes wrong, your broker has still the means to settle that trade that happened two days ago.

The amount of funds each broker has to deposit on the clearing house depends on several factors, one of which is the volatility of the stocks your broker deals. Those funds represent a pure cost for the broker, because it is money that stay parked on an account doing nothing, it represents an insurance for the other participant that you are solvent. All of this is really boring but it is also important for the system to work, to prevent another crisis like 2008/09, when no one trusted anyone will be there tomorrow and Central Banks had to effectively put huge amount of money into every bank to have the system re-build confidence into itself.

So here it comes Thursday the 28th of January 2021. What is happening to GME might be funny but is also obviously crazy, so the central clearing house demands brokers to put more money as collateral if they want to deal in certain stocks that experienced big volatility. Now, you can have all the possible conspiracy theories in your mind, but the easier (and most probably true) explanation is that the systemic risk, as expressed by volatility, was increasing and the central clearing house wanted to protect the system. This happens all the time and it is like the lockdown I am experiencing now in London, no one knows how the situation would be without it, but that’s what risk management rules do, they prevent a risk so you do not experience the catastrophe. There is no way to have a peek into the alternative universe where the rule was not enforced to see if the catastrophe actually happens (obviously what we are experiencing here in London is to prevent a BIGGER catastrophe).

The central clearing house regulation is really annoying, and I tell you because I have to deal with it even if I do not work for a bank. I spent lot of hours working on it, hours that I could have spent doing something productive. This regulation was put in place because of the outrage after the 2008 crisis: the only thing you CANNOT do, is to be angry at the tax-payer funds funnelled to save banks in 2009 AND to what happened now.

RH did not have the additional capital and had to prevent the trading. The explanation given by its CEO is still quite silly.

What is the lesson here?

I worked for a bank and I deal with bankers everyday; I want to debunk a myth: these working relationships are nothing different than the ones you have working in other sectors. No vendor is selling you a product at the cost they paid; lots of vendors try to sell you things that you do not need, are not the best for you, have defects.

I started to use Interactive Brokers here with a margin account. They can close the borrowed part of my portfolio whenever they want; they will probably do at what it seems as the worst possible time for me. I will not be able to speak with a real customer service. They might go bankrupt one day and it will take me months, if I am lucky, to have my money back.

I have an Italian broker and they charge me fees that the Italian Government finds ‘fit’ whenever they like. One day I might be taxed just because I saved money and did not spend it. The CEO of the broker might for years gives favours (i.e. bribes) here and there and one day I will pay for it. If I participate in an IPO, I will get shares based on the relationship I have with my broker and the relationship my broker has with the issuer.

Here is Robinhood Customer Agreement. It is 33 pages long, do you fancy to read it? Did you read your broker Customer Agreement? Did you get your money back for that music concert that was cancelled in 2020? Did you get your money back for that holiday? Looks like it is hard to have ANY friend these days 😉

Just do everything with your eyes wide open. Do not put all your eggs in one basket. YOLO trading seems to be so rewarding because it is freaking risky. Sometimes you sign for those risks, sometimes the casino changes the rules. Card counting at the bridge table was not ‘illegal’ until someone profitably exploited it. Go on Netflix and watch White Tiger and Bling Empire: they are the two sides of the same coin. Like it or not, it is life: get over it.

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