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But if any of this stuff makes it into law, it will be the “little guy” who gets screwed, and this time for real. The end of low-commission and free trading could be in the cards, and that will make stock investing less equitable for everyone.
As this column has pointed out, journalists, commentators and some day traders created a phony populist meme that a short squeeze in penny stocks, massive gains and then losses for small and some large investors pitted Wall Street against Main Street. Throw in the Robinhood trading app slowing down trading in these stocks and you get a sinister story about big Wall Street looking to save failing hedge funds.
When the class-war frenzy starts, it’s hard to turn off. Politicians inevitably get involved. They will be considering dumb stuff, I am told — even if everything I described above was easily and logically explained away by facts far less sinister, and less appetizing, to the class warriors among us.
Recall: Robinhood is in the business of trading. It makes more money the more people trade, which means it was against its economic interest to halt some of the trading in GameStop as well as Blackberry, AMC and few others.
It restricted trading because it couldn’t meet capital requirements for settlement purposes. That’s why it ended up raising billions of dollars in capital and, at least for now, shelving plans to go public. End of story.
The losses by hedge funds that sold these stocks short (profiting when stocks go down and losing money when they rise) were real and staggering. But they had no impact on what Robinhood did.
Yes, some small investors lost money as GameStop shares began to decline (as I told you they would, with shares now down below $70 from a high of around $500). But that only happened after many fell for the message-board hype that a video-game mall retailer was the next big thing — when in fact there was some evidence it was heading in the opposite direction.
But even fake populism sells and now both conservatives and lefties are looking at legislation to protect the “little guy” from rapacious market forces.
One boneheaded idea bouncing around is ending a practice known as “payment for order flow.” The esoteric practice allows companies like Charles Schwab and Robinhood to charge low or no commissions to investors using their platforms.
To do that, these companies don’t match their own buyers and sellers of stock themselves. They sell their order flow to big Wall Street firms that match the orders. The more trades they sell, the more money they make. By selling the order flow, they can charge small investors less.
Sounds like a win-win. But a big reason this got on the populist radar involves a financial giant named Citadel Securities, which buys order flow from Robinhood.
Citadel is a brokerage and part of a bigger investment empire run by Ken Griffin, who also controls the Citadel hedge fund. That fund then invested in hedge fund Melvin Capital, which was losing gobs of money in the GameStop short squeeze because it also rolled the dice on an ill-timed trade.
You see where this is going: critics assumed Robinhood needed to curry favor with Citadel by short-circuiting the short squeeze to protect its investment in Melvin.
It all sounds very sinister until you apply some logic. Citadel needs Robinhood as much as Robinhood needs Citadel because Robinhood can sell its flow anywhere. Traders make a lot of money matching these buyers and sellers.
But Washington, of course, is a place where logic rarely applies. That’s why the buzz on Capitol Hill is that payment for order flow should be regulated or discontinued altogether. When Lydia Moynihan of Fox Business broke the news of talk about curbing payment for order flow, shares of Schwab sank.
Complicating matters are powerful players who believe payment for order flow is a form of market manipulation because the buyer knows where unsophisticated retail investors are trading and can trade against them. They believe all shares should be traded through major exchanges without the payment system, thus creating greater transparency.
Put aside that the transparency at the big exchanges is overhyped given the current market structure. And yes, traders who buy order flow also have an insight into retail trading patterns, but that’s part of life when trading against professionals.
The trade-off is that small investors get a seat at the table through discount and no-fee brokers like Robinhood.
The broad democratization of Wall Street began in the early 1990s with small investors buying mutual funds and index funds. It has evolved to buying individual stocks thanks to low-cost online trading and now no-fee trading.
It was always going to be messy because trading against professionals is never easy.
But if the GameStop frenzy showed anything, it’s that a band of market “deplorables” armed with no-cost trading can expose the weakness in the trading position of big hedge funds like Melvin Capital, and that is the way markets are supposed to work.
So before ending the practice of payment for order flow, consider the consequences — the end of no-cost trading, and the return of big Wall Street dominating markets.