Big Technology Podcast - Emergency Podcast: The Story Behind Gamestop, A Conversation With Ranjan Roy of Margins

Episode Date: January 29, 2021

Ranjan Roy has documented the fundamental issues driving today's market volatility, from Zero Interest Rate Policy to the rise of Robinhood. He joins Big Technology Podcast for an emergency episode on the Gamestop madness, explaining the forces behind the surge.  You can read Margins here on Substack: https://themargins.substack.com/ And two specific articles we discuss: https://themargins.substack.com/p/robinhood-and-how-to-lose-money https://themargins.substack.com/p/game-stop https://themargins.substack.com/p/zirp-explains-the-world

Hello and welcome to the big technology podcast, a show for cool-headed, nuanced conversation of the tech world and beyond. And today we're doing an emergency podcast, no intro music. We've got to get this up on the internet as soon as possible. And the reason is because I think it's time to dissect everything going on with the GameStop situation and what it means for the stock market. Now, I think it's important on this show to focus on the systems that underlie what we see in the headlines, not the headlines itself. You can read all the stories. we want to tell you what's actually going on in the economy and the political system that makes what we see in the headlines. So, and do it in a way that's without spin and just gets right

to the heart of the issues. And so I think that's important to do it with the GameStop story in particular because there have been a lot of frothy headlines and a lot of inaccurate, in my opinion, takes about what's going on. And it's all been moving so fast and it's been hard to keep up with anyway. And I'd really like to get to the heart of the matter. And joining us today is someone who I've been reading fairly religiously. I assigned myself all of his work over the winter break and feel decently caught up. And I think that there's nobody in better position to weigh in on what's happening than our guest today, Ron John Roy, who is the co-author of The Margins, a terrific newsletter on Substack. Welcome, Ron John. Great to be here. Great to have you. So,

To begin with, you know, you have an interesting background for someone who writes so prolifically about finance. You actually started trading foreign currencies. Is that where, is that correct? Yep. I worked on the emerging market currency derivative desk, long sounding title from a Bank of America from 2002 to 2009. And then you eventually got disillusion with what was going on. Yeah, I realized about halfway through that it was definitely not what I wanted to do for the, rest of my life. But I mean, it was exciting. I love economics. I love geopolitics. So it was definitely an interesting place to be. But the financial crisis was kind of the nail in the coffin, just seeing how everything played out, seeing how power structures were distributed, seeing where

money was made and how it was made, especially during kind of a chaotic and trying time like that. Yeah. And having a chance to see it firsthand, I think adds a level of a authority and and just general knowledge to your writing that's made it really particularly great to read. I started out my career selling advertising technology and buying ads. So to write about the ad systems that Facebook is doing, I always felt that that was an advantage. And like, it's very cool to be able to see your writing from a financial standpoint. And I don't know, I feel like sometimes in society we're lucky to get writers that just get it. And I feel like you're one. So let's talk about, uh, I,

I feel like what we could do today is just go through some of your pieces that will get us to a point where we can explain not only what's going on with the GameStop situation, but what in society is making our market so totally bonkers. So I think a good place to start would be zero interest rate policy. You wrote a piece called ZERP explains the world. What is that? All right. So ZERP is zero interest rate policy. Basically after the financial crisis was the first time it started. started to really get implemented, but it's again the idea that interest rates go to zero,

interest rates go negative, just they're incredibly low. And the idea is now that money that would have been sitting in a savings account, getting one, two, three percent will find its way out into the world, productively investing itself into all new sorts of endeavors and basically just being put to use rather than sitting around. And so what does that lead to? If you can't make money in a savings account, you're going to start making more speculative investments. Is that the takeaway here? Yeah. I mean, so in that piece, I definitely kind of walk through the risk curve. The idea that venture capital as an asset class traditionally was focused on high risk endeavors, biotech technology, things that, you know, could very likely

not work out. But when they do work out, they pay off a lot. And that's why very specific money went into those kind of startups, those kind of endeavors. But then what happens is when interest rates are so low, then traditionally someone who would invest in, you know, treasuries has to move their way up the risk curve to achieve the same yield that they were previously. Someone who's investing in high grade corporate debt might start moving to high yield debt. Someone who was investing in high yield debt, start moving into something even riskier. And basically everyone starts taking on a little bit more risk, potentially a lot more risk. And then just across all types of industry, across everything, things start getting a little weird, getting a little distorted, and

you end up where we are today. Yeah. And so basically, so why keep the interest rate so low? Is it because we're having some economic problems and we need stimulus? Because if that's at the root of this, maybe we should raise it. And so we could have people make, you know, normal returns in a savings account versus have to run to more risky investments as a retail investor. Yeah, I mean, the Federal Reserve, the two things, again, are inflation and employment that they're supposed to be looking at. Theoretically, they do not look at the external markets. And inflation has been incredibly low, even with low interest rates. So that's kind of the core argument, there's a lot of speculation or talk whether inflation could take off this year. But

in general, over the past decade, it's been shockingly low. Meanwhile, until the pandemic, employment was relatively in a good place. Unemployment was low. So the Federal Reserve, because those two factors, which normally would require higher interest rates, were fine. They didn't. I mean, there's been no real impetus to raise. Back in like 2017, 2018, the Fed was getting back into a rate hiking cycle of where they were raising rates, market was freaking out. I mean, overall, things were not looking good in terms of the market reaction. So we moved right back to our ZERP world. And are we so addicted to ZERP right now, like the low interest rate or almost effectively zero interest rate that we can't move off of it? Yeah, I mean, for me,

this is the big thing, is even the hint of it, like the Federal Reserve has basically Jerome is basically, I mean, their comms or their communications department and the way they speak has become as important as their economics department. Because if they even hint at the idea of a potential rate hike down the road, and we're not even talking about today, now to give guidance out, you know, six months, a year from now, two years from now, if there's even a whiff of a rate hike in the future, if it's even mentioned, the market will freak out. And again, And, like, end of 2018 and or end of 2017 into 2018, there were market freakouts. Back in 2013, there was the taper tantrum, which was similar.

Once the Federal Reserve announced, they would basically be moving away from this way of operating market completely freaked out as well. So I would say everyone has come to a point where they just kind of assume this is the natural state of the world and this is how we will do all kinds of business. Right. And so this is responsible for, let's say, us entering a pandemic and the market are partially responsible for us entering this pandemic. The economy is terrible, but the market keeps going up. Because that's just where people put their money. Yeah. I mean, why the market has been going up in the last, I mean, during the pandemic is definitely there's like many layers to it. But I would still say at the core, it's, and you get this, I get this question from friends. It's just an intuitive thing, you know. if you come into any kind of money, and last year, I mean, as a very relevant point, like people saved a lot of money if you were fortunate to keep your job, if you worked in tech, if you worked in finance or any kind of industry like that. So are you going to leave

it in a checking account at 0% or are you going to try to do something with it? So it definitely that all this kind of collection of individual decisions, you, me, anyone sitting at their desk just thinking, do I want to leave cash in a checking account? When those get put together an aggregate, you end up getting into weird places in the market. And that's how we end up with Tesla, for instance, trading at $748 billion in a $1,200 price to equity ratio. Yes. I think Tesla, I mean, anything for me, and it's definitely, I am called out that it's an oversimplified view, but sometimes to me, especially in economics and financial markets, the simplest view is you can be somewhat illuminating.

And when things look weird like that, I think it's a pretty straight line to zero interest rates. Yeah. Okay. And so I want to put a pin in this before we start moving into the Robin Hood stuff. Isn't it crazy that the way that we've decided to run a healthy economy, which is that you can't make money really in low-risk investments. And many people feel forced to just shovel their money into the market, which is much more volatile. And, you know, there's got to be an end to it. Like, otherwise, it's a Ponzi scheme. So what do you think about that?

I mean, this question of what is the end is something that I've been asked myself. And, and again, full disclosure, I've been worried about this for much longer than I almost care to admit, but admittedly from like 2016, 2017. So I have definitely missed a lot of this upswing over the last couple of years. And that's the difficult part of trying to guess how it ends, because it can go on much, much longer and get much, much weirder than any of us could ever imagine. And again, Tesla was kind of weird. GameStop is a lot weirder. So does something come crashing down? Or is there something down the road that makes GameStop look like just another kind of day, normal day in the markets? And some people might argue, and some of my

friends tell me this, that actually it doesn't matter that the market is unhinged from the business fundamentals. It's all about what people believe, just like everything is about the story people tell them to. So what's the matter with that perspective? Or maybe they're right. Yeah, I mean, the market can be unhinged until it needs to be hinged back to economic reality. So what does that mean? GameStop is the perfect example. So I mean, to get into that piece, but just quickly related to this, so I had made the comment that GameStop CFO is this guy Jim Bell, naval officer, you know, he's going to be in charge

of deciding what to do with this insane stock price movement. Right. And just to say what happened before you continue on that. So I'm sure everybody's read the story, but just in case, GameStop went from like $6 to $400 because a Reddit group inflated the stock to try to stick it to the shorts and make some money in the process. Okay, go ahead. Yeah, to start getting to the GameStop story, GameStop stock sky rockets.

Theoretically, that should be good. And everyone at GameStop should be ecstatic. That's the best possible thing that can happen to you as a. company. But the thing is, knowing that their stock is a game, not to make a pun there, but is this joke right now and it's a meme, it's going to come down or it easily can come down as fast if not faster as it's gone up. And if you're a CFO coming up with a one-year business plan, you know, a three-month, even three months out, like how are you supposed to do your job? How are you supposed to, if GameStop is really in the midst of coming up

with this digital transformation plan to go from physical retailer to some kind of online force, how can you do that if you have no visibility as to where your kind of financing abilities will be even tomorrow, if not a week or a month or a year from now? So it just screws up the ability of a normal business to actually do business. So bring that back to the market. I mean, if, so basically you're saying something can be unhinged. until it's hinged. Do you think the market has a chance of, you know, falling very quickly back to like something close to resembling reality? I mean, I can genuinely say I do not know.

And because, again, this is one of those things. I would say two years ago, I would confidently tell you yes. But could Tesla go to 2,400 times earnings? Possibly. Yeah. I mean, at this, watching what's happened over the last six months to one year has just, it has been such a great reminder. And this is even having sat at a trading floor during the depths of the financial crisis, like working overnight the night Lehman went bankrupt, or the morning Lehman went bankrupt. This, it just gets weirder and crazier and new and novel all the time. Yeah. And as long as the zero interest rate policy continues, people probably just keep fueling it until they can't anymore.

So that's not right. There's no reason not to. I mean, if you're sitting here, as long as the market goes up and you basically all kind of infrastructure, the economy is telling you to put your money into slightly riskier and riskier assets, you will do that. It's how things are designed to be done and it's how they're actually happening. Okay. And now let's get to one of our main players.

in the GameStop story, Robin Hood. So I'd love to hear from your perspective a little bit about the Robin Hood product and how does it sort of sync with zero interest rate policy to help infuse more capital into the market. And then after that, I'd like to get into the way the Robin Hood business works. But first, let's talk about the ease of use and how the product sort of puts gasoline on this fire that zero interest rate policy lights. Yep. So when I traded, I traded currency derivatives. There are these things called non-deliverable forwards, one specific type of derivative product. But options are a separate derivative product. And I remember I never got involved. It always seemed kind of complicated. But then, you know, I started dabbling in learning. But I never did that professionally at a bank. But then I remember opening my own options account.

with Fidelity in around 2011. It took four days, I think, to get approved. I had to fax in three forms. It was a pain in the ass. And I remember thinking to myself, you know, I am a professional trader. I have some money saved up. How are they telling me that I need to like do all this work just to buy a simple call option?

Right. And just quickly, an option is you pay money for the option to buy a stock at a certain price. Yeah, and an option, and this is important as we get into kind of the Robin Hood business, an option is simply an agreement. It is, I am agreeing with my counterparty to have the right to buy at a certain price or to sell it a certain price for a simple caller put. But it is a agreement between two people that something, it will be allowed at some point. Right. So I buy an option for GameStop at $90. Then GameStop. goes up to $200, I can then trade those options and make $110 off of every single share that I've

agreed to option. So let's say GameStop is trading at $6. I could potentially buy the right to buy GameStop at $100 for like 10 cents. Because again, normally if GameStop is at $6, why the hell would I want to pay for the right to buy it at $100? So the market maker will say, all right, that's a stupid bet. That's going to cost you $0.10. But, But now, let's say GameStop, I actually have the screenups at 285, that option is now worth $185 that I paid 10 cents for, at minimum. I mean, it's like if the option expires today, it's now worth $185. So I'm up, what is that, like, 185,000 percent or whatever it is.

It's alluring. It's alluring. Yeah, it's, it's gambling with leverage. and it's which is always which is always an alluring thing right okay so you were saying it took you four days to set it up with fidelity how does robin hood change that yeah so so robin hood it's instant it's like part of the onboarding and and this was a big thing and and actually i will not i have never traded an option on robin hood i signed up for a robin hood account i think pretty early on i remember I was very interested in it as a product.

I put a little bit of money, even best in some stocks. But from everyone I've spoken to everything, I understand, you know, it was especially even before, it was incredibly seamless. There's no real legal onboarding. It's just kind of checking some box and you can get started trading options right away. And it's in a way, it's almost encouraged by the entire platform. And how is it?

So the platform kind of gamifies a little bit. So can you talk a little bit? bit about how it encourages this type of stuff? Yeah, the gamification side. And to me, that this is always an interesting thing. Like fidelity, no offense to them, I still use them. I'm a happy customer. Their mobile experience sucks. Robin Hood is fantastic. And, you know, it's like, they make it exciting. There's like confetti that can go off when you buy stock. there are even even things like little product decisions like originally you know leaderboard these are all the stocks that are trending right now so then it drives you to think about those kind of things making this idea that screenshoting your gains is something that never happened on desktop it's called like we call it like gain porn basically like yeah yeah everyone's sending around and this especially on like uh reddit wall street bets like you it's just so much easier on a mobile device and it's become so much much more common. I never saw anyone screenshoting games or sharing them out of anyone I knew,

even like plenty of people investing until the last few years. So that whole mobile gamified experience really made it just something completely different. Right. Okay. So let's put it all together. Zero interest rate policy. Basically, you want to put your money and risk your investments. Robin Hood makes it easy to trade options and and it gamifies the active trading makes you want to do it more. Game porn makes you feel like you'll always win. So how so what is that what what does it like when these forces combine? I mean game stop goes to 360 or 400 or whatever it is. It's it's it's I mean not even getting into the social media social platform aspects of this yet. Those factors alone combined clearly mean that kind of the story stocks, the trendy

stocks, everyone will pile into them. They'll not just pile into them. They'll lever themselves up with call options. And it will change it from them being kind of peripheral to the story, to them becoming the story itself behind the stock. Yeah. Okay. So let's get to GameStop. We'll get some more Robin Hood stuff on the back end here. What that, so, so the, the Reddit, they drove up. Actually, you know what? I try to get the, do the cliff notes, but why don't you give your perspective on what happened here with GameStop and how it ended up soaring to the heights that it did?

All right. Well, again, and you'll see a common, common thread here is I do not know what actually happened. And that was definitely in my piece. Like, I really want to stress this because what everyone is bought into this narrative. the little guys all came together to fight evil hedge funds in suits. What actually caused the jump? I do not know.

But again, a few days ago, the stock just starts roaring higher. I think what is it like? It went from, again, you said six to 40 to 100, 400. And the thing is, it fed on itself to a level that, again, like even the Bernie meme did not did not achieve. I mean, people who I never asked me questions about finance or financial markets are bringing up GameStop. You know, like, it's reached such a level in the national consciousness that clearly ends up feeding on itself that if you have a couple of bucks and, you know, you've always, you never wanted to dip your toes in, but it's just exciting and you want to

take part in this. I think, I mean, that's clearly had a big impact on the whole thing. Yeah. And my group chat with my brothers where we never talk about finance. I got a message, hey, boys, we stock it's just become this thing that everyone's talking about. And the original conceit of it was that there were some hedge funds that were short, GameStop, and there were people inside this subreddit Wall Street bets that were saying,

let's make these short sellers regret what they've done and, you know, not even send it high, send it to the moon. And they did. Well, actually, yeah, go ahead. There's the fundamental story that GameStop is this, you know, dying retailer, but clearly the fact that the founder of Chewy who understands e-commerce comes on board to GameStop was a positive signal, that, you know, maybe there's something here. And again, you know, they have a brand.

Gaming is not going anywhere. It's like growing. There's definitely a story there. but so that so that's one element and uh roaring kitty has been saying that game stuff you know should be a buy for a long time not just and roaring kitty is uh roaring kitty is a YouTuber slash prominent reddeter deep fucking value if i can say now we got to put the explicit no i'm kidding we've been going that way these days yeah yeah yeah i actually at a friend's wedding i had done a speech pulling marital advice from Reddit

and the big joke was saying the Reddit usernames. That was like the funny part. Right, right, right. It was a couple of years ago. And now it's just Bloomberg in the New York Times and everyone's debating how can I write this stuff. How do you cite this? Yeah. Yeah. Yeah. So he's, I mean, there have

been people pushing this for a long time. But the big question is what really shot it up. So because again, you have this idea that Melvin Capital and the hedge funds and I'm doing air quotes with my hands are so short and now we can squeeze them out. But what on whatever last Monday really made this move is still definitely an uncertain thing. I'm hearing in the way that you speak about this, that you're still leaving

the possibility that some institutional investors help push this thing to the height that it did or that some Wall Street entrenched interest did that versus the narrative now that it's the little guy. So you're open to that possibility. 100%. Again, so $20 billion of volume traded on, I think, on Monday, that is not coming from Wall Street. I don't, maybe it is. And maybe that means that Wall Street bets is actually institutional money or professional money. But whatever it is, that clearly there was something beyond the small retail traders. There's huge lots of like $130 million on one shot being bought and sold. Again, clearly there's professional institutional money. But the other thing to

remember, and I keep stressing this, of course there's going to be hedge fund managers on the long side. If they see this bubbling up, if they know, if Wall Street bets has the information that Melvin Capital is short and vulnerable, I can guarantee you there are. plenty of hedge funds who are sitting there, licking their chops, they are just as happy to go after Melvin Capital as anyone on Wall Street bets. And again, this idea that, and again, hedge funds in quotes, Wall Street in quotes, these are such kind of nebulous terms. Like every professional money manager is happy to go after each other. They're not in cahoots. They will, you know, crush the other person with glee if it means that it will make them more money.

And so, again, the idea that everyone is on the short side together, terrified of the little guys all banding together is just to me, I'm not sure what happened, but I can almost guarantee that there is some professional money on the long side as well. Yeah. And so I DMD you about this. And I was like, Ron John, who wins and who loses? And you're like, I'm not quite sure. I think Wall Street wins from this. That's the main lesson. So, yeah, no, I'd love to hear your thought on that.

Yeah, Wall Street, anytime there's lots of money being moved very quickly in both directions, Wall Street will win. And again, it's the house always wins. Yeah. And in part, that's because of the way that, well, actually, I'm going to get to that question in a second. I'm going to be about way Robin Hood makes money. But first, you had a story in your newsletter this week about how you had seen real volatility in the foreign exchange market and how that had been dangerous and how that was an analog to what might be happening here. So do you want to share that story? Yeah.

So John and I, my co-writer of the margins, we talk about the emerging marketification of the United States sometimes. from Turkey, my parents from India, I lived in Singapore, like we both have plenty of exposure to the rest of the world. And in the U.S., there's just been a lot of little things that have kind of been feeling more emerging market-y in the way things are structured. And so for me, again, I focused on markets, Malaysia, Indonesia, South Africa, Brazil, Chile. And one of the things, So actually, and I'd written my undergrad college thesis on how Malaysia responded to the Asian financial crisis. So the idea is called tourist money or tourist dollars. It's when Western funds would go into some new market, just pour tons of money into it because it's hot and trendy.

And then the second anything goes wrong, they all skip down and they all leave. And it's that acceleration of the capital flight that causes real massive. societal problems. And Malaysia, back in during this time, they implemented capital controls, which when we were all happily neoliberal in the world, you know, the IMF, everyone is saying capital controls are terrible. Capital should flow freely. But it was just this kind of perspective that when you look at it, that kind of national aggregate scale, capital flowing in and flowing out too quickly, it leaves people in really bad situations. It causes, you know, internal strife. It causes political problems. It really leaves things in a bad place. And to me,

any of these meme stocks, going back to how the CFO of GameStop will handle this, I think leaves all these companies in somewhat vulnerable positions, even though it might seem that it's wonderful. So I'll take the side of it. I'm just going to play this for the devil's advocate. I mean, I know you talk about how no one wants to catch a falling knife so it could just end up dropping. But GameStop was already shorted more than it was, than it was, uh, then it was, uh, held and it was a, you know, like a terrible stock to own. And so how could all this interest, like even if it drops, um, cause, cause problems for the company. Yeah. I mean, this is exactly the thing that it's the speed of the drop. It's, it's, because again, let's say

game stops, I don't know, is there a fair price? If it was at six, were they hoping it would go to 20 or 30 or 40? Let's say 40. Right. That, you know, like the CFO was dreaming of having a $40 stock that fund all their expansion dreams and digital transformation, they'd hire McKinsey and it would be wonderful. It's not, you know, the idea that the stock will quietly settle back to 40, I think, is just impossible. It's going to be volatile. Yeah, it's going to be insanely volatile. And then again, when you, could you actually go bankrupt in this and then have to lay off employees? Could it be, there's just, it simply kills your ability to actually plan and do proper business. And again, at the aggregate scale for countries, you know,

when capital fled a place, it completely changed the expectations. You could have had projects, infrastructure projects and stuff that you're planning to build. Just the entire country believes that a certain thing will move in a certain direction. And then that dream is gone very quickly. Yeah. And that might be the case for GameStop pretty soon. Yeah. Or they might stay at a ridiculous number like Tesla. Welcome to Zerpland. Yes. Okay. After the break, I want to talk to you a little bit about sort of the perspective of the actual Redditors that have engaged in this and the elements of the Robin Hood trade that

folks might not be focusing on. All right. We will be back on the big technology podcast right after this. Hey, everyone. Let me tell you about the Hustle Daily Show, a podcast filled with business, tech news, and original stories to keep you in the loop on what's trending. More than 2 million professionals read The Hustle's daily email for its irreverent and informative takes on business and tech news. Now, they have a daily podcast called The Hustle Daily Show, where their team of writers break down the biggest business headlines in 15 minutes or less and explain why you should care about them. So, search for The Hustle Daily Show and your favorite podcast app, like the one you're using right now. And we are back here for the second half of the

big technology podcast, an emergency episode, the Ron John Roy of the margins. Great to have you with us, Ron John. Good to be here. So second half got to kick off with the fact that we've been talking a little bit about how Wall Street's going to win. And is it possible that like people in Wall Street do well and the Redditors and the retail investors trading GameStop send their message? Because that's what I've heard a lot in my mentions this week. I've had folks coming in and saying you're you're not understanding this this is about the little guy sticking it to a hedge fund that was shorting a company that we you know that we believed in and uh the wall street the wall street ecosystem now knows about us and fears us and that's good and you know by and by the way a lot of us

made money in the process so what would you say to that is that is that like a normal uh is that an argument that carries weight yeah so so my mentions have definitely been uh flooded with that same kind of uh same comment that i'm missing the bigger point yeah good to know i'm not alone because i've been like you're not alone and it's the thing that's so frustrating for me is it for the last two years writing the margins i have been screaming about inequality i've been screaming about like infrastructure that is stacked against the little guy these are the topics especially with big tech and with it finance that you know really are important to me but But to me, I just don't understand what is the message here?

Because yes, you can disrupt a market. We have learned that. I do think whatever has happened, the little guy, quote-unquote, has disrupted this market. But again, what that means here is Melvin Capital could very well be fine. I mean, if separate from this, this is one part of their portfolio, they might be fine. And in reality, Melvin Capital, with using leverage and using these tools that we're all calling evil, took home plenty of money and were paid out plenty of money and bonuses over the last number of years. You know, it's not like anyone will really be hurting on that side, but I do think one thing you definitely learn, and this is, again, having traded my own money for the last decade now, taking profit is the hardest thing to do. in any kind of trading.

So to me, the idea that a bunch of younger, inexperienced traders who make really quick money and now can tell themselves that they actually are really smart and knowledgeable about the market are going to either one take profit, or to take profit and not put it right back into something else are so low. And then what will happen is eventually you will lose. And that's actually, that's the scariest part of this to me is I think there's a lot of people in that kind of that emotional journey. And this is something coming from the trading world and sitting there and making and losing money and then trading myself and making losing money. And I'm literally supposed to be professionally trained to do it. It's emotionally intense. It's like it's the ups and downs of it. So for someone who's inexperienced to sit there and think that they're worth X and then tomorrow they're not worth that. It is a dangerous, scary thing, a place to be. And I mean, that's, that's to me the biggest concern here.

Yeah, it sounds like a casino, first of all. It's like, oh, are you going to walk away from the table? You just made some money on blackjack. And you've pointed out in your newsletter that Robin Hood had to put up bulletproof glass because traders kept showing up to the office. What do you think that means? I mean, this is the part that's really uncomfortable to talk about. I don't know where if you are 24 years old and your screen was telling you yesterday that

you're worth 250 that you went from zero like you'd saved at two grand now you're worth 250 grand and then a couple of weeks from now you're now word zero or even worse you're in the red because the options you bought exactly like what how how will you react how will you respond these things I mean, these are real issues that need to be addressed. And clearly, this is stuff that when I had to wait four days as someone who was literally a professional trader with a reasonable bank account to trade a single option from Fidelity, they clearly had really strict measures in place to make sure anyone who's getting involved knows exactly what the hell they're doing. I mean, Robin Hood, it's very clear that one thing that they have absolutely no interest in, is that side of the equation, how their users will actually be able to handle all this stuff. A perfect segue into another piece that you wrote Robin Hood and How to Lose Money.

You identify very clearly that the people that are trading on Robin Hood are not the customers. It's somebody else. So can you go into that a little bit because it is no fee trading, but it's also they got to get paid somehow. And how does that, you know, skew the incentives to make them want you to trade options maybe quicker than a fidelity would, who you would pay? Yeah. So, so how Robin Hood makes money. And when I wrote this last July, it definitely was not as much in the conversation. I'm very happy that more and more people seem to have been talking about the concept of payment for order flow or PFO is like, was nowhere in July. The New York Times had just covered it. Now it seems to everyone. Yeah, with your newsletter. Everyone is talking about it now is that, is Robin Hood quotes you a price? There's a bid and there's an offer.

And then when you transact, you would buy at the offer, sell at the bid. They will pass that order off and actually have it executed with the Citadel securities or one of their other market makers. Within that spread, within that spread is where all the action happens for market making. And I was a market maker on the emerging market desk, so I'm very familiar with how the stuff works. It's like between that bit and the offer is the magic that you can make a lot of money or a little bit of money. So Citadel, so the typical thing with a fidelity or Schwab is they will usually get execution better than what was originally shown and they'll give most of it back to the customer. Citadel will.

Well, unpack that really quickly. So that means that like you buy a stock for a price, but it's a moving market. And so there's a market maker in the middle that will actually determine the transaction price. And so is that right? And then so a company like Fidelity, who has experience in this or does it on its own, will ensure that you're not going to lose a lot of money in between that bid and what you actually pay for it. Yeah. And Fidelity is charging you a commission, not anymore, but in the past, they would.

And they still are charging plenty on options. So they don't have incentive. They have, they don't have incentive to really. get you to over trade. They will make some money on the fee, but on the spread itself, they'll happily give back to you so you're a happy customer. And if you're an experienced trader, you are going to be really cognizant of where you're getting your fill within that spread. So the thing is with equities, especially highly liquid equities, no one's really noticing this is like fraction of a cent stuff. But with illiquid, any kind of asset, especially options,

the spread gets wider, so there's much, much more room to play within the middle there. And options definitely are a more profitable thing for a market maker to be involved in. Even for me, again, emerging markets, the spread was much wider, especially for a country, you know, it's like a country the more unstable or underdeveloped they are. The spread's always going to be wider. The market maker is always making much more money in that space. So Robin Hood is making money by working with Citadel, who is the market maker there and some passes a bit of that back along to Robin Hood when people trade on Robin Hood.

Is that right? Yeah. They're in Citadel Securities. And actually, after I'd written the piece, they reached out just to clarify, Citadel Securities is the market maker and then Citadel itself is the hedge fund. Yeah. So Citadel Securities, they'll, they. will give back some money to Robin Hood from how much they were able to improve, but they

can give Robin Hood less than they give. So they will pay Robin Hood even more for things like options. So the whole system essentially is incentivized to get you to trade a lot and then end up making money for Robin Hood and Citadel. Yeah, which clearly it is. You know, it's like Robin Hood is worth whatever $14 billion, and it's free. So, and I mean, coming from, you know, covering technology, this whole idea, it's almost become so cliche at this point that if you're, you know, if you're not paying the user is the product, but this is just an even more extreme example where clearly someone is getting paid somewhere.

So this is how Robin Hood gets paid in this case, and Citadel. And you talk about how the users are the gravy. Yes. Because again, if you're an inexperienced trader and you don't care where your order is actually being executed, if you're not even paying attention, that is where the real money is there to be made. Now, maybe there's something that's happened here where Robin Hood's users have woken up because Robin Hood had to pause trading on GameStop and they realized who side it was on. I mean, I know it's probably liquidity issues that Robin, like, they didn't have enough money to back all the options that they were, that their users were buying. But do you think people's eyes are going to be open to the fact? Because that was another feature of my mentions this week was just people saying, you know, we'll never trust Robin Hood again.

Do you think people's eyes will be open to that? I mean, I would be the happiest person and I should have been the happiest person watching this backlash because what I was writing last July is Robin Hood. whole promise of democratizing finance and we were as inspired during Occupy Wall Street, to me was kind of ridiculous. Again, you are a very good business that makes markets and encourages people to trade and passes those trades off to Citadel Securities, who pays you. And this is a wonderful profit, like potentially profitable business that is great and will turn their founders into billionaires. Democratizing finance? I don't know about that. But so the entire premise always was suspect to me.

So I should be happy that suddenly everyone is saying that it was bullshit. But for this specific thing, it's almost infuriating to me this idea that, you know, they were working. I do not believe that they were secretly in cahoots with the hedge fund who's short and they're trying to help them. I do think, and I agree that whatever the liquidity issues are, and they indicated that, you know, this is clearly they're saying it's preemptive, what exactly happened will come out at some point. And I hope it's not as bad as it could be. But I mean, they want an orderly kind of like move away from this, whether GameStop slowly gets sold down. Everyone wants an orderly unwind of whatever is happening right now from the regulatory side, from the platform side. People just

want things to, like, quiet down a little bit, move down. I don't think... Except for Reddit. What? Except for Reddit. Yes. Yeah. I get it, though, but this is a thing, like, if you're, if you think you have made, or actually, I don't get it, because honestly, if I was long and I think I've made a ton of money and I'm still being given the option to realize that profit, cash out. I would hope I'm not angry. I should be elated and I should be celebrating and eating my chicken tendies, but like, but, yeah, but, I mean, yeah, to, to be pissed off that I can't buy more is the part that kind of really captures the whole absurdity of this entire thing is like, it worked, I won, yet I'm so addicted to this way of doing business and

thinking that I can get even richer that I want to do it more and I'm mad that you're not going to let me. Right. I'm going to be optimistic that this is something that has exposed. Like, when do we spend a week talking about finance? I mean, it might be just because Trump's out of office and we have attention for other things. But when do we spend a week talking about finance and the financial system and how, you know, who's in bed with who in the systems and how to fix that?

It doesn't happen very often. And maybe there is more attention that's drawn to the disparities between what retail investors get and what, what the institutional investors get and how the retail tends to get ripped off. Yeah, I mean, again, this has been the most frustrating part of all this for me is this is the stuff that piece in July called it the gravy, that retail traders are considered the gravy while institutional people are getting better terms and more favorable treatment. Yet, the conversation now has just gotten so weird. again, with AOC and Ted Cruz agreeing with each other, that people should have more access

to buy equities, you know, like, it's just, it's gotten to such a weird point for me, versus if the conversation really coalesced around, how do we build a kind of sustainable, stable infrastructure where everyone is treated equitably? I know that sounds really boring, and that's, no one's ever going to talk about that and that won't go viral. We'll talk about it here. That's what the point is here. Yeah, yeah.

That would be exciting for me. That would be interesting. But, yeah, I mean, the conversation has gotten there, but it's, I don't know if it's gotten there in the right way or people are even talking about the right thing. Does it end with raising the interest rate to maybe put a lid on some of the volatility we've seen? To me, again, the danger of how that unwind takes place. is if there's runaway inflation, of course, the Fed will raise interest rates. I mean, especially right now, until unemployment goes down, without runaway inflation, interest rates will not be raised and they should not be raised.

So trying to kind of dissociate the two is very difficult. But again, like this stuff, so many different factors touch on it. Because again, with the stimulus, like should it be targeted or should everyone receive checks. Are those checks actually going into Robin Hood, or is that just kind of a meme that's going around? Like, there's, what is pushing it and how to reasonably and quietly unwind this is an incredibly difficult thing. And with any kind of financial mania, I'm sure throughout history, there's always been people sitting there being like, you know, how can we try to unwind this and relax this and quiet it down a little? But usually it does not end like that.

so you see chaos coming i mean i i i just hope it's not as chaotic as i imagine it could be yeah um the thing that well actually um i want to conclude uh asking about you know our history if and you know how we ever whenever we think about finance uh and how the good times will always last it's always proven to be wrong um but before that you know we mentioned solutions and it's not going to go viral. What's your solution, if you have any, in terms of how to handle this current moment? Friction. I mean, Robin Hood should never have been allowed to be built in this kind of way. No one should be allowed to trade on margin or even trade options within a few minutes. I mean, that's such a simple thing. And that's the way it actually was before. So there's no

reason we shouldn't be able to go back to that. And to me, that is not an anti-democratic thing. It's just a reasonable thing. It's like, and again, like there's so many behavioral things that as a society we try to put limits on or try to help people and educate them on that speculation in the financial market seems like a pretty easy one and good one to kind of take that approach. Yeah. And then, of course, you'll have the Reddit folks saying, look at you, trying to responding to our liberation moment, trying to. Yes, big Wall Street over here. Yeah, yeah. But, I mean, the issues that you point out are true. Every time we go into a recession, everyone says, how do we not see that coming? Should we see it coming? Right now? The thing that generally worries me is we're entering this in an already weird precarious. precarious state. You know, the economy is already in kind of a bad slash good

slash amazing slash terrible place. So in a typical mania, everything is good and then everything gets bad. This is unlike anything that I mean, I've seen or read about or learned about. And like most manias, how it plays out, you never, it's different every time. So what this looks like. But for me, the even weirder part of this is usually there's an underlying story that drives at the internet bubble, even the housing bubble, like house prices always go up. The internet's going to change the world. This one, so the energy of the last year with the Shopify and a Peloton and all of those

stocks at least had some level of like real, you know, digital transformation is coming. Everyone's work from home is going to become, you know, these are all whatever the degree of the rises, even Tesla, at least there's a bit more of a story. This is just kind of nihilistic. Like, this is like, this is literally, they call it Yolo. Yolo training. Yeah, yeah. I know. Like, it's such a different beast right now that how it plays out is just so unpredictable that, yeah, that part definitely worries me a bit. Yeah. Well, when this all went down, I went right to your newsletter and actually no I went first straight to your DMs then you mentioned you'd be writing about it I saw it come out read your piece immediately and then linked it in big technology because

I just thought it was so good so as this stuff goes on I will be following closely and I appreciate you covering it with such nuance which I think we need more of in this world so Ranjan appreciate you coming on can you tell folks where to find your work yep you can go to the margins and substack.com and sign up there. Okay, terrific. I'll be there. And then how about your Twitter handle? It's at Ranjan, R-A-N-J-A-N-X-R-O-Y, Ronjon-X-R-O-Y.

Great. Well, we'll get, I hope we'll have you back with John some time. It would be great to get the full margins team in the house. I know we've talked about that since before the podcast actually was founded and we'll have to do that soon. but I appreciate your time here on a Friday for this emergency show. And I feel like I understand what's going on a lot better. So thank you.

Thank you. All right, everybody, thanks for listening. We'll be back on Wednesday with a regularly scheduled programming. Have a nice weekend.