Investment professionals occasionally liken trading against small, uninformed investors to shooting fish in a barrel. Beginning in late 2020, however, the fish started shooting back. (That analogy was from a hedge fund manager. Another hedgie, the notoriously volatile Andrew Left, said, “Bring a five-year old to my office and I can beat him. Bring a thousand five-year olds to my office and I’m in trouble.”)
That is precisely what happened in early 2021 when thousands of day traders, whipped into a coherent, righteous anti-Wall Street frenzy on the WallStreetBets subreddit, shredded the fortunes of Left and another hedge fund manager, Gabriel Plotkin of Melvin Capital.
Both, it turned out, had the extraordinary bad luck of shorting Gamestop, a failing maker of obsolete gaming consoles, at just the wrong moment and fell victim to a “gamma squeeze” involving the coordinated purchase of inexpensive short expiration, out-of-the-money calls. (Gamma is a term in the Black-Scholes equation that measures the first derivative of delta, the dollar change in options price per dollar change in stock price. When call option sellers find themselves overexposed, they will protect themselves by purchasing the underlying stock, which in this case initiated a price spiral that took out Plotkin and Left’s short positions.)
Were the Gamestop short squeeze all that Spencer Jakob’s The Revolution that Wasn’t: Gamestop, Reddit, and the Fleecing of Small Investors was about, there would not be much reason to pick it up. But in the capable hands of Jakab, editor of The Wall Street Journal’s Heard on the Street column, the Gamestop episode becomes a platform that explores three important issues in modern economics: first and foremost, the so-called “democratization” of finance by increasingly cheap, and eventually “free,” trading platforms typified by Robinhood; how so many on both the political right and left misrepresented the episode; and finally, the critical role played by short sellers in smoothly functioning capital markets.
Jakab starts with “Mayday,” the May 1, 1975 deregulation of the fixed brokerage fees that had ruled Wall Street since the late eighteenth century. It then segues forward to the attendant rise of the discount brokerage industry, spearheaded by Charles Schwab, then on to Jack Bogle’s first inexpensive index mutual fund and the rise of the ETF.
In the process, investment costs underwent a seemingly inevitable entropic decay into finance’s version of heat death – Robinhood’s free security trades, which much of the rest of Wall Street was forced to imitate. Of course, trades on its platform weren’t really free; Robinhood made a pretty penny from payment for order flow – fees paid by the “wholesalers” who actually executed their customers’ trades, who in turn grazed off the bid/ask spreads.
The “power of free” can be an awesome thing to behold, especially in Robinhood’s case, whose customer base had shot past 22 million accounts by late 2021.Like the 19 cent bananas at Trader Joe’s, a Robinhood account can be an incredible deal for prudent investors who use it to build globally diversified portfolios of low-cost stock and bond ETFs for next to nothing.
Alas, that’s not how it acquired most of its customer base, which was instead attracted by the exploits of one Keith Gill, AKA Roaring Kitty (his YouTube persona) who began to accumulate cheap deep-out-of-the-money calls on Gamestop stock in 2019, which mushroomed in value with the gamma squeeze on Plotkin and Left in late 2020 and endowed him with eight-figure net worth by the next year.
Gill, who possessed a CFA charter, was a sophisticated operator. The first tranche of gamma squeeze foot soldiers in back of him also did well, but those in the subsequent waves did not. The unfortunate Salvador Vergara supplied the book’s most heart-rending story – that of a security guard whose discipline and frugality yielded a $50,000 index-fund portfolio by age 25, but who, seduced by tales of Roaring Kitty’s exploits on WallStreetBets, blew it all on a margined bet on inflated Gamestock shares.
In the late 1990s, academics Brad Barber and Terry Odean studied “66,465 households at a large discount brokerage firm” (guess which one). The title of their classic 2000 paper in The Journal of Finance says it all: “Trading is Hazardous to Your Wealth.” Adjusted for risk, the portfolios that traded the most earned the lowest returns; the most frenetic quintile of traders lagged the market by several percent per year, while the least active quintile nearly matched it.
Barber and Odean have just looked at Robinhood customers in a similar way, using as a proxy for WallStreetBets-induced herding the growth in the number of Robinhood customers holding a given name over 24 hours. When that number of a stock’s owners on the platform increased by 10% overnight, the involved security lagged the market by 1.8% during the next month. This gap increased monotonically as their holding-increase threshold rose. At the most frenetic extreme, on 45 occasions the number of accounts holding a given name rose by more than 750% overnight; during the following month those stocks lagged the market by an astonishing 19%.
This reviewer stands in awe of the ability of Stanford University to impart to its graduates the ability to rationalize unethical behavior as being in the public interest, as so ably demonstrated by Elizabeth Holmes, the founder of Theranos. Vladimir Tenev, one of Robinhood’s Stanford-graduate founders, honed this sort of humbuggery into a fine edge; responding to criticism of the company’s business model from Berkshire Hathaway’s estimable Charlie Munger, Tenev came up with this gem:
It is clear that the elites benefited from a stock market that kept many families sidelined from participating while they amassed huge wealth from decades of investing – driving a deep wedge between the haves and the have-nots. Suddenly, Robinhood and other online trading platforms have opened the doors of financial markets to everyday people, deeply unsettling the old guard who will fight to keep things the same.
In truth, Robinhood had managed to siphon wealth from millions of its customers into the pockets of Citadel Securities, the biggest wholesaler of Robinhood’s trades and source of the lion’s share of its payment for order flow revenue. Far from sticking it to Wall Street, Robinhood’s righteous legions wound up having their pockets picked by it.
The most astonishing episode in the Robinhood saga came on January 28, 2021, when the brokerage suspended Gamestop purchases. Robinhood’s customers, as well as politicians ranging from Alexandra Ocasio Cortez on the left to Ted Cruz on the right, raged at the “conspiracy” that allowed hedge fund managers to trade Gamestock – at record high prices – when Robinhood customers could not. (One of the author’s very few oversights was in failing to mention the condemnation from Elizabeth Warren, the Senate’s most vociferous critic of the securities industry.)
There was, of course, no conspiracy. Rather, the halt resulted from a collateral shortfall in Robinhood’s clearing-house account, which in point of fact saved its clients from billions in losses from buying Gamestock shares at what turned out to be the stock’s peak price.
The WallStreetBets-engineered gamma squeeze may even have produced long-term damage to the financial system by putting the fear of God into short sellers, who going forward will be far more cautious in pursuing their craft.
And an essential craft it is, serving as a critical cog in the price discovery process that efficiently allocates capital to commercial endeavors. Those who need convincing of this need look no farther than the most bizarre meme stock of the entire Robinhood/WallStreetBets saga: the brief bubble in the shares of the hopelessly bankrupt Hertz car rental company, which tried to capitalize on the price pop with a billion-dollar stock flotation at its hallucinatory bubble price before the SEC put its foot down.
The Revolution that Wasn’t, indeed. Rather, it was much more of the same. The author fondly recites my favourite bon mot from humorist Fred Schwed, who best summed up the timeless nature of the financial services industry over 80years ago: “At the close of the day’s business, they take all the money and throw it up in the air. Everything that sticks to the ceiling belongs to the clients.”Jakab’s beautifully written volume is an entertaining read about how Robinhood continues that proud tradition.
William J. Bernstein is a neurologist, co-founder of Efficient Frontier Advisors, an investment management firm, and has written several titles on finance and economic history. He has contributed to the peer-reviewed finance literature and has written for several national publications, including Money Magazine and The Wall Street Journal. He has produced several finance titles, and four volumes of history, The Birth of Plenty, A Splendid Exchange, Masters of the Word, and The Delusions of Crowds about, respectively, the economic growth inflection of the early 19th century, the history of world trade, the effects of access to technology on human relations and politics, and financial and religious mass manias. He was also the 2017 winner of the James R. Vertin Award from CFA Institute.
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Investment professionals occasionally liken trading against small, uninformed investors to shooting fish in a barrel. Beginning in late 2020, however, the fish started shooting back. (That analogy was from a hedge fund manager. Another hedgie, the notoriously volatile Andrew Left, said, “Bring a five-year old to my office and I can beat him. Bring a thousand five-year olds to my office and I’m in trouble.”)
