Investors generally don’t have to think about clearing houses – when they do, it’s usually a bad sign.
This crucial piece of financial market plumbing was in focus after Robinhood and a host of other brokers outraged individual investors – and some lawmakers – on Thursday, by restricting the trade in GameStop Corp.’s very high flights. GME,
and shares of other companies strongly sold.
Although the stock triggered a series of conspiracy theories centered on the alleged collusion between hedge fund managers and brokers, brokers seemed to have little choice, as the clearinghouse, frightened by the volatility of GameStop and other stocks, increased the amount guarantee that brokers had to post to ensure that trades would be settled.
Although to an investor, making a transaction may seem like an instant transaction, there is more than that. In fact, it usually takes two days for the trade to be settled and the money and bonds actually change hands.
Clearing houses stand between buyers and sellers, ensuring that the negotiation is completed in the event that one side defaults. Clearing houses require that their members – banks and brokerages – be well capitalized, to deposit guarantees and pay for a default fund.
When trades become volatile, the risk of default increases, especially when investors are buying stocks on the margin or with money borrowed from their broker. It is understandable that clearing firms are nervous and may require brokers to increase the amount of guarantees they must pay to offset their trades.
That was at stake Thursday. WeBull Financial LLC Chief Executive Anthony Denier told The Wall Street Journal that the broker’s clearing firm was informed by Depository Trust & Clearing Corp., which serves as a central hub for clearing operations, that it would need to place more guarantees .
As a result, WeBull, like Robinhood and other online brokers, moved on Thursday to restrict trading on GameStop and other volatile stocks. The New York Times reported that Robinhood took advantage of credit lines to meet his collateral obligations, while raising about $ 1 billion from investors to allow him to facilitate negotiations on GameStop and other popular actions.
For a detailed analysis of what was at stake – and how the Dodd-Frank legislation implemented after the 2008 financial crisis to mitigate the danger of systemic failure played a role – dive into the following Twitter topic:
Brokers eased restrictions on GameStop purchases and other stocks on Friday. GameStop rose 32% in Friday afternoon’s stock, setting the stage for a weekly increase of nearly 300% as it changed hands close to $ 260 per share. It ended 2020 below $ 19 per share.
The broader US stock market was stumbling, however, with important benchmarks on the way to huge weekly losses. The Dow Jones Industrial Average DJIA,
was out of its low session, but remained at 540 points, or 1.7%, while the S&P 500 SPX,
lost 1.7%. Both the Dow and the S&P 500 were on their way to weekly drops of around 3%.
The rise in heavily shorted stocks, driven by an army of individuals through Reddit’s WallStreetBets forum and other online platforms, appeared to be causing pain for hedge funds. Analysts attributed the broader sale in part to the forced liquidation of profitable long positions by hedge funds and other investors who needed money to cover losses on the loss of short positions.
But a more crucial concern for investors is whether the speculative frenzy around GameStop could cause a wave of cascading losses that could threaten the financial system.
Chester Spatt, professor of finance at the Tepper School of Business at Carnegie Mellon University and former chief economist at the Securities and Exchange Commission, said he was optimistic that the issues surrounding the small squeeze were confined to a relatively narrow sector of the Marketplace.
“But it is important for intermediaries to take measures so that the losses suffered by retail investors do not permeate the system, which is why I think measures like those taken yesterday were important,” he said.
Meanwhile, macro strategist Jim Reid of Deutsche Bank noted the results of a quick survey of bank customers, which he said attracted 700 responses, but showed little consensus on how much the situation posed a threat to financial stability (see the graph below).
German bank
“The high number of responses in a short time to this survey indicates that the issue is affecting the financial markets and the wide spread of opinions suggests that the markets have not yet come to terms with the consequences (if any) of a week still epic, ”he said.