The Invulnerable Hero*
January 28, 2021·Money
The GameStop story everyone's telling isn't the real story. Beneath the retail-versus-Wall Street narrative sits a much older and more dangerous tale: one about leverage, cascading institutional failures, and how regulators respond by treating the symptom rather than the disease. The question isn't whether retail investors won. The question is what happens when enough people understand what actually broke.
• The coordinated broker shutdowns weren't about market chaos. They were a pattern repeating. When institutions face vulnerability from an unexpected direction, regulators and gatekeepers don't fix the structural weakness. They prevent the next thing from triggering it.
• Leverage isn't a flaw in the system. It's the system. Hedge funds operate with gross exposure levels that require constant rescue packages and emergency restrictions. That built-in fragility has become the baseline assumption everyone operates under.
• The real vulnerability is now visible to a much wider audience. The places where these institutions can be hurt, the mechanisms they depend on, the fact that they monitor and predict retail behavior to front-run it. That knowledge doesn't go away.
• What matters most is what happens next in the institutions themselves. Forces that were coordinated against an external threat will now turn cannibal. Funds will pounce on each other using the same strategies they watched emerge from Reddit, freed from the same regulatory concerns they face publicly.
• The rules are about to be rewritten, but not in the way people think. Regulators will choose between actually enforcing fair markets or protecting the leverage game that built the hedge fund industry. History suggests which direction they'll choose, but this time more people will be watching.
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Comments
Good note Rusty. Narratives inside of narratives inside of narratives on this one, hard to untangle but fascinating. It was fun that ET via Donnelly’s guest post last week was ahead of the crowd on this (not unusual for ET obviously), although I still feel his early take had a lot of gatekeeper narrative to it (kept seeing other’s take home was around ‘the new gen of reddit degenerates’ narrative which I think is total BS). Your note much more fair imo, seems pretty straightforward to me to assume that this has not remotely been all retail and WSB and that cannibalistic institutions happy to join in, yet the low hanging fruit “Boo reddit degenerates” narrative will certainly be opportunistically taken advantage of by Boomers to dismiss and by the rule makers to change the rules, as is already happening.
I largely agreed with Radigan Carter’s take (highly recommend to ET audience which I expect may not be so fond of it from demographic standpoint) that Boomers et al are vulnerable to naively assuming that anyone who says ‘it is different this time’ is a young fool, while in reality from my middle age ‘stuck in the middle’ perspective the rules of the game a la The Long Now and resulting change in incentives (it is now rational to speculate before music stops), esp for younger people, are a pretty major structural change. And the tools and access have clearly evolved significantly (ET has discussed this much in the past also, perhaps more around fiat news than investing). So I’m with the young people that big changes are afoot and I scoff at anyone who’s dismissive of that. On the other hand the young degenerates think they’ve won something when in reality the rule-makers are like the FED and they will never run out of ammo (ET: Stalking Horse), as you said hardly the revolution some hope for.
Last my mind is already reeling when I take a small step back…In the last MONTH the following common knowledge events have occurred: 1. US citizens, at least white ones, can violently invade the centers of power and walk away (next time cover your faces fools), 2. US oligarchs will decide who gets to freely use the ubiquitous communication platforms they’ve built and who does not, 3. Digital ‘occupy’ type movements can accomplish much more than physical ones per effort expended, and 4. Financial institutions will simply BITFD any vestigial perception of free markets before they consider addressing root causes. Obviously these types of conclusions will not surprise ET readers but I think there is still a surprising and fundamental lack of mainstream awareness of much of the deeper currents going on here.
Wow, great comments, Rech. I’ll take a look for Radigan’s piece on this.
Note that through the pandemic, complex systems without leverage (internet, package delivery, for example) worked fine despite heavy stress and massive volumes. The financial system is uniquely unstable due to leverage.
And uniquely unwilling to grapple with that, no matter how many times it raises its head.
I sure hope we find out who was behind the decision that several online trading platforms made today to stop trading in certain stocks all within minutes of each other , just like the major networks all deciding at the same time to switch away from the Presidents news conference the day after the election.
Just like all the Social Media company’s deciding that of all the thousands of news articles in existence that day - the New York Post article needed to banned. Again at the exact same time!
There is nothing free and fair about any of this.
Rusty - Thanks. Quite insightful, as always. I trust you’ll push any data that you find supporting your “suspicions” to us.
During a media appearance today, I got a spike in responses on social media for suggesting that brokers have the free market right to protect their balance sheet. 2:1 against. With a clear Retail Bros vs. Boomers flavor. So I’d love some detail on your closing thought.
Fairness + free markets + rule of law: Do you have quick thoughts on what a reasonable response to the recent frenzy would include?
Thomas Peterffy was interviewed on Bloomberg just prior to the close and threw out some interesting numbers. 3 million open option positions on GME, average contract value of $10,000. So, there are $30 billion worth of derivative bets on what was a sub $20 billion stock. This is how the short interest exceeds the float. And, one side has lost $30 billion (the shorts) and one side has made it. But, the shorts are being force liquidated as they no longer have account value. His concern (judge for ourselves his veracity) is that the clearinghouse integrity is in question and this can take down the brokerage firm when the client has no money to make good. His estimate is that IBKR has about 5% of the accounts with a position in GME and their system automatically liquidates as account values hit thresholds of no margin. He doubts all firms have their system. And, I just saw a headline that Robinhood is having to draw on credit lines. Once again, leverage is at play when things go this haywire.
BITFD
Good conversations starters and very good questions - let me suggest that we move the detail to the forums so that we can hear from more people than just me (ie - please start the thread!).
How about this for starters?
https://wallstreetonparade.com/2021/01/gamestop-shares-dark-pools-owned-by-goldman-sachs-jpmorgan-ubs-et-al-have-made-tens-of-thousands-of-trades/
Continue the discussion at the Epsilon Theory Forum...