The Breakdown - 'I Am Not a Cat': The GameStop Hearing Shows How Desperately a New Financial System Is Needed

Episode Date: February 20, 2021

This week, instead of our normal Weekly Recap, NLW digs into Thursday’s congressional hearings around GameStop, Robinhood and WallStreetBets.  He explores:  Why there was a significant focus on T+2 settlement  Bipartisan agreement on retail investors getting screwed, but different diagnoses on how to address Why Keith Gill, aka Roaring Kitty, aka DeepFuckingValue is a new American folk hero Ultimately, NLW argues that any congressional action needs to make it easier for retail investors to be full participants in the market, rather than further limiting their options. -- Earn up to 12% APY on Bitcoin, Ethereum, USD, EUR, GBP, Stablecoins & more. Get started at nexo.io -- Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   The Breakdown is produced and distributed by CoinDesk.com

I'm happy to discuss with the committee my purchases of GameStop shares and my discussions of their fair value on social media. It is true that my investment in that company multiplied in value many times. For that, I feel enormously fortunate. I also believe the current price of the shares demonstrates that I've been right about the company. A few things I am not. I am not a cat. I am not an institutional investor, nor am I a hedge fund. I'm just an individual whose investment in GameStop and posts on social media were based upon my own research and analysis.

When I wrote and spoke about GameStop and social media with other individual investors, our conversations were no different from people in a bar or in a golf course or at home talking or arguing about a stock. Hedge funds and other Wall Street firms have teams of analysts working together to compile research and analyze shares of companies. individual investors do not have those resources. Social media platforms like Reddit, YouTube, and Twitter are leveling the playing field. The idea that I use social media to promote game stock to unwitting investors and influence the market is preposterous. When the stock price broke $20 in December, I knew my investment was a success. I was so happy to visit my family in Brockton for the holidays.

The money will go such a long way for us. We had an incredibly difficult 2020. Most difficult was the tragic and unexpected loss of my sister, Sarah, in June. I am grateful to be in a position to give back to and support my family. As for what happened in January, others will have to explain it. It's alarming how little we know about the inner workings of the market. And I am thankful that this committee is examining what happened. I also want to say that I support retail investors right to invest in what they want, when they want.

to support the right of individuals to send a message based on how they invest. As for me, I like the stock. I'm as bullish as I've ever been on a potential turnaround for GameStop, and that remain invested in the company. Thank you. Cheers, everyone. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world.

The breakdown is sponsored by nexo.io. and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, February 20th. And the clip that you just heard was an excerpt of the opening statements of Keith Gill at yesterday's congressional hearing about GameStop.

Now, before we dig too deeply into this story and what happened yesterday, I have to set the scene from the actual hearings. Among the speakers, you have one of the hedge fund industry's most dynamic young successes. you have the CEO of the hottest financial app of the last few years. You've got a guy worth $21 billion or something insane like that. And then you have a guy who goes by Roaring Kitty on Twitter and

YouTube and deep fucking value on Reddit. Guess which of them looked the most real, the most thoughtful, the most considered, the most confident, and the least full of actual hot garbage. Bingo. It wasn't the CEO. It wasn't the hedge fund guy. It wasn't the 21 billionaire. It was the guy with the hang in their kitty poster in the background who started his testimony saying, I am not a cat. If you've been listening to the breakdown for the last few weeks, you have a lot of the backstory of Wall Street Betts and GameStop, so I won't go too deep into it, but here is the fastest TLDR I can do for all the newbies out there. Wall Street Betts is a community of investor on Reddit. These are memesters and DGens, not hedge fund guys blowing off steam after work. They have

regular jobs, regular backgrounds, but they come together to discuss their thoughts on stocks. Over the last year, they've become a stronger and stronger force in the markets. They had a Bloomberg cover story in February 2020 talking about how they were taking on big institutions even before COVID. Once COVID happened, they were the earliest to bet on a market rebound, and their logic, which will resonate among Bitcoiners, was based on the fact that they simply believed that J-Pow and everyone else involved with the Fed and the government were going to do whatever it takes to make sure that stocks only go up. More recently, they've been short-squeezing firms taking on stocks that they think are undervalued. This came to a head in January when they nearly short-squeeze the hedge fund Melvin Capital out of business, based on their GameStop position. Indeed, were it not for a nearly $3 billion injection of capital from new backers,

Melvin could have been wiped off the face of the planet. When that happened, when you had a well-known hedge fund brought to its knees by a community who's about description says like 4chan found a Bloomberg terminal, you know that there was going to be some serious media attention, and boy, was there. Would this be the one time finally that the little guy actually beat the big guy, despite all odds being stacked against them? The battle lines were drawn. Mainstream media told the Redditors to take their gains and go home. Wall Street bets called for diamond hands and kept holding. But then something remarkable happened.

In the middle of it all, Robin Hood, the app used by many of these traders turned off the ability for people to buy GameStop. and a set of other related stocks. Now, without getting too technical, the whole point of the strategy of these retail guys was to keep bidding up the price of the stock by buying it and then not selling it. This would in turn make it so that the short funds would have to buy the stock at those higher prices to cover their short positions, which of course would further bid up the price. Ergo, if you don't allow people to buy the stock, it cuts off this strategy entirely. and what's more, they were still allowing Wall Street bets to sell.

Understandably, this community felt betrayed. This app Robin Hood that had allowed them to get into the game with commission-free trading was basically now doing the big guys bidding, cutting off their ability to buy and pushing them instead to sell. Conspiracy theories abounded specifically around Citadel. Citadel was one of the firms that helped inject money into Melvin Capital, but they're also the biggest source of Robin Hood's revenue. Because the fact that Robin Hood doesn't charge commissions on trades

doesn't mean that they don't make money. Instead, they sell data about order flow to companies like Citadel. After all of this went down, there were calls on both sides of the aisle for a big hearing to dig in, and the theoretical point of yesterday's discussion was to figure out what actually happened to see if and who needed to be blamed and to figure out what needed to be re-examined.

There were a lot of different interpretations. going in, and you can kind of see this in who was actually called. You had Vlad Tenaf, the CEO of Robin Hood, and the questions for Vlad came around kind of three separate lines. One, did you do something specifically wrong? Two, is there something wrong with the system in which you are operating? And three, do you encourage stock degeneracy? Steve Huffman, the CEO of Reddit, was definitely called on the do you encourage Digen side of the coin. Gabe Plotkin of Melvin was called in the context of should this sort of short selling be allowed. Ken Griffin from Citadel was called to find out whether there were back-channel conversations between them and Robin Hood to force them to stop the buying

feature for these meme stocks. And Keith Gill, aka Roaring Kitty, aka D.F.V. was there to ask if there was somehow stock manipulation on the part of these retail traders. Now, I want to explore one of the themes that came up most from Ken Griffin and Vlad Tenif, which was about the idea of T-plus two settlement time. They argued, and some on the congressional side also argued that we needed real-time settlement. Warren Davidson from Ohio even argued that a blockchain solution could be used for real-time settlement, which would help stop this issue. And because I'm going to spend a lot more time on narrative and cultural implications, I want to actually read an excerpt from a piece by Jill Carlson published here on CoinDesk that explains a little bit about what this T-plus-2 settlement time thing

really was. She wrote, Robin Hood did not halt trading of GameStop to punish the insurgent mass of retail traders, nor did it do so out of a paternalistic impulse to try to protect them. Robin Hood halted trading of GameStop because it had to, thanks to a set of standards put in place by market players upstream. Robin Hood's clearing firm, the company that facilitates the settlement of the broker dealer's trade, could not keep up with the risk it was being asked to take on. Clearing firms exist in part to mitigate the consequences should a broker-dealer fail to

meet its obligations. Clearing firms, therefore, need to keep a tight handle on risk. This means they need to put up more money to make good on trades as markets get wackier and wackier, that is, as volatility increases. The GameStop market was about as wacky as it gets. The clearing firm couldn't take on any more risk. Robin Hood couldn't fork over any more funds to the clearing firm. The the music had to stop. These are precisely the type of controls that became so clearly important in the wake of the 2008 financial crisis. Strict risk management, transparency, liquidity thresholds, and capital requirements. These standards were designed to prevent reckless behavior to mitigate the fallout should a financial firm become overexposed. When retail traders demanded these rules be implemented on big

institutions 10 years ago, they couldn't have imagined those rules would someday shut them out of the market. Why does it take two days? People love to say this is a technology issue and that innovations like blockchains can fix it. The reality is, as with so many things that people claim blockchains can fix, that this issue is almost entirely one of process and regulation. Perhaps new technology can be a catalyst to revisit these, but it is certainly not the limiting factor. So effectively, what Jill is saying and arguing is that the capital requirements that came with these T plus two settlement times that forced Robin Hood because it wasn't sufficiently capitalized to shut down this type of trading is an unexpected consequence of a consumer protection.

rule and really a system protection rule put into place 10 years ago in the wake of the great financial crisis. To solve that takes political will, not just new technology. Ultimately, getting specific about what types of rules are actually to the benefit of everyone in the system versus just an artifact of a previous time is something that I think is going to be really important. Looking for the best way to stay on top of your investment game? Nexo.io has you covered in three easy steps with their high-yield savings account for digital assets. Step one, create an account at nexo. I.O. Step two, transfer assets to your secure nexo wallet with no minimum or maximum limits on funds deposited. Step three, sit back, relax, and earn up to 12% compounding interest paid out daily on your

crypto and fiat. Your passive income made simple. Get started at nexo.io. Another big dividing line that we saw in yesterday's testimony was different interpretations of what to do when the game is rigged. There was a lot of, let's call it, bipartisan consensus that these retail traders weren't in the wrong, per se, but that the game was rigged against them. And so in that context, do you try to change what the big players can do,

or do you limit how the little players get to actually engage? Even before these hearings, you had some calling for more protections. I love that word, protections, where people are protected presumably against malicious external actors, but really they're protected against themselves and their agency to make their own decisions. By the very nature of this type of hearing, which is divided into five-minute segments where anyone on this committee can either ask questions or, as is more often the case, score their political points and figure out how to get their soundbite in. We didn't necessarily get a lot of

progress on this issue, but I wanted to flag that these are really the two lines. If the game is rigged, do you change what the big players who it is rigged in favor of can do, or do you limit how the little players get to engage. On social media, as you might imagine, the main frustration had to do with the hypocrisy of the whole thing. Nick Carter tweeted, Congress is busy grilling a day trader because he made a good trade while our physical infrastructure is literally in tatters and half of Texas is without power. They can do two things at once is just about priorities. Congress is obsessed with financial markets and PR. Meanwhile, our manufacturing base is gone. Inequality is at gilded age levels. And our physical infrastructure hasn't been updated

since the 1950s. The excellent documenting Bitcoin account on Twitter tweeted out, Congress brought in a Reddit user named U-slash deep-ficking value for testimony quicker than a bank executive in 2008 for buying foreclosures. Radigan Carter tweeted out, Fed President tells CNBC no bubble, Akman says hell is coming on CNBC, but then net's $2 billion short, but Congress questions roaring kitty. Easy to understand why dudes are angry, opting out to Bitcoin and think the system is totally broken. You keep giving them no reason to believe it is not. I think this is one thing that really needs to be teased out and discussed. There is absolutely an insurgent and populist aspect of this, right? The things that Radigan are saying

are true in terms of that feeling of injustice when Bill Ackman can go on CNBC, say hell is coming, make a huge short position that he reinforced and self-fulfilling prophesied with his appearance on CNBC, make a bunch of money and have that be fine, but somehow roaring kitty with his 500 followers on YouTube can't say what he thinks about a stock is just ludicrous. It is not post hoc rationalization to say that there is a political dimension to this, that there are people in this community who have been frustrated for some time. If you've been paying any attention to Wall Street bets over the last years, and other types of communities like it, this sort of take-it-back nihilism rooted in the total

lack of culpability around the great financial crisis has been present there for a very long time. At the same time, it's sort of dismissive to the individuals involved to assume that it's only nihilism or cynicism or political discontent that's driving their decisions. Let's go back to Roaring Kitty's testimony. The part that I didn't play for you was about why he was interested in GameStop in the first place. He started looking at it two years ago in 2019. His thesis was, basically, that people had much too strong a belief in its inevitable bankruptcy and much too little belief in its capacity to turn around. He based this on two things. First, investors he

believed didn't understand the nostalgia and brand love and loyalty among adult millennials who now had money. This is the only gaming-only retail chain, and brand nostalgia is a potentially extremely powerful force. What's more, these investors don't yet really understand just how big a cultural phenomenon, a time spend phenomenon, a media entertainment phenomenon gaming is. We are still at the early innings of understanding that e-sports are almost certainly going to be more popular than what we think of as sports now in the future, and that this $200 billion market is going to massively expand in the years to come. That was part one of his assessment. Part two, was he had much more faith than other investors in the ability for GameStop to take the foundation

of that brand and turn the company into something that was more technology first, using retail spaces in new ways to complement a technology-driven business. Put differently, this was a fundamentals analysis, a long play position that he took years in advance and shared along the way. Now, what happened in January was something different, as he said. I am on record saying that the fact that this community figured out how to use Wall Street strategies against it means that they should get the W, not get hauled in front of Congress. But that's not exactly the point that I want to make here. The point that I want to make is that we potentially do a big disservice to this class of investors when we acknowledge the rightness of their political frustration, while not legitimating them as

investors who have a financial point too. I have seen a temptation with some of this to say, yeah, they should be pissed. The system is fucked and it screws them. But then write off any financial decisions they then make as the actions of angry, hurt, depressed, lonely, basement-bound boys and people rather than the actions of thoughtful, savvy market participants. And I think it's wrong to do that. There are going to be a number of additional hearings. I think there are two more scheduled, so this is not the end of this story. But I want to leave on my main thought, which is this. We are rapidly leaving the era of information asymmetry in investing, where some hedge fund could get some alpha by knowing something different. With the possible exception of machine learning applied

to huge data sets, basically retail investors see what hedge fund investors see. Because of that, competition is now more than ever about one, the scale of capital that can be deployed, and two, how popular media narratives can be used to influence markets. The GameStop situation perfectly plays this out. Hedge funds have, one, huge reserves of capital and access to more when things get tough, and two, access to mainstream financial media TV appearances. Wall Street Betts for their part has, one, networks of people that can individually and voluntarily take directionally aligned actions, and two, memes. It's decentralized networks and memesters versus Scrooge McDuck's pool of gold and the direct line to CNBC.

That's what it comes down to right now. I think that rather than asking what protections these retail investors need, we should ask how we give them more power to compete legitimately. In an era where the information asymmetry has been destroyed, more market participants could mean a healthier market. So asking how we give them more power to compete legitimately means one, asking where there are unfair powers on the side of the institutional players. It means ending the hypocrisy of how we look at them, going back to the Bill Ackman thing. But it also means most notably that there is a fundamental disconnect between the complete opacity with which hedge funds and institutions like them are able to operate as compared

to the total transparency of these Wall Street bets retail discussions. Is there more transparency that's needed in this system to allow these retail investors to compete more legitimately? Worth discussing. The second thing that we need to do, however, to allow. retail investors to compete more legitimately is give them paths to do more. To take the easiest example, investor accreditation, how in the world are we still on a system where investor accreditation is based on something as arbitrary as income designations, as though someone who happens to have a

high-paying job in the medical field would know anything about stock investing? Or moreover, someone who happened to inherit a life insurance policy that clears them in terms of the asset requirements, how would they know anything more about investing than these guys who spend hours and hours a day learning about it? It's ludicrous. It's absurd. It's unfair. And it's easily solved. There are so many ways to create paths for people to demonstrate that they have the knowledge and sophistication to participate in our financial markets in a bigger way. It seems that there's some momentum in that direction. So I'm hopeful that we'll keep treading that way. But I think it's a must. And I think there are more examples like it. And of course, surrounding all of this, there's the larger macro

backdrop. We live in a world and are currently in an administration where it is very clear that the Federal Reserve intends to be even more aggressive about full employment. Even if we acknowledge the importance of that mission, the only tools they have are tools that tend to benefit corporates and assets first. In other words, more people might have jobs, but asset prices are likely going to rise even more, keeping the path not just to employment but to real wealth out of reach. Remember, about half of Americans don't participate in the stock market at all. The higher stocks go, the more difficult that participation becomes, and so the importance of giving people better paths in rather than more restrictions on what they can do seems vital. It is tempting, I think,

to be depressed looking at this whole situation, to rage against the hypocrisy, to lose oneself in frustration at the injustice of someone like Keith Gill who's just trying to provide for his family and was willing to take risks to do so, a quintessentially American thing being hauled in front of Congress when so many people who have done so much worse within the quote-unquote rules of the system aren't. It makes us want to reject the system. It makes us want to cast aside as not possible anything redemptive. And certainly listening to five hours of congressmen and women score their political points and their soundbites to take home to their constituents doesn't make one any more optimistic. At the same time, it's nearly impossible for me to watch what happened yesterday and not think

that retail investors have more of a chance for a more just, open, fair, transparent, participatory system than they had before the hearing started. There is a shift happening. GameStop is is part of it. Obviously, I think Bitcoin is part of it. And there is a growing sense or perhaps a remembrance that markets are meant to serve people and not the other way around. This is a moment to lean in to scream our values, our wishes, our demands from the hills. So I appreciate you listening as I do a little bit of that here. I hope this gives you more information for you to do it in your own ways wherever you are. I appreciate you listening and until tomorrow, guys, be safe and take care of each other. Peace.