The Real Reason Robinhood Froze GME Buying - and Why It Matters

Retail investors, Redditors, hedge funds, trading platforms, and financial media are "over" the epic GameStop Corp. (NASDAQ: GME) "Super Squeeze" that saw shares rise several thousand percent in days.

Now that GME is down 86% from last week's high, currently trading around $53 during pre-market hours, and sinking like a stone, it's all very "last week."

Congress and regulators, who always seem to be late to the party, are making more noise than ever, though, and that means it's not quite over. No one seems to know what really happened.

And that means we've still got some things to talk about, because Robinhood's move and what could be coming in the aftermath have big implications for retail investors.

Here's why...

The Spoiler Few Saw Coming

One of the biggest, most contentious questions at issue is why Robinhood and other mobile investing and trading apps basically stopped their users, particularly the Redditors from WallStreetBets, from buying GME; they allowed only sale orders to go through.

Just when the "Super Squeeze" was reaching a crescendo, right when the Redditors had Wall Street on the ropes, and at the point of maximum pain, with blood in the water - at the exact wrong time, the platforms threw cold water on the small day traders.

Every tweet, soundbite, and quote from everyone who wasn't a hedge fund trader conveyed anger with Robinhood, to put it mildly - saying things like "un-American," "unfair," "fake news," and a whole bunch of other words I shouldn't print here.

That's because, while retail buying was halted, big institutions could buy and sell whatever they wanted. People felt Robinhood had put their thumb on the scale and thrown the game for Wall Street. There were credible reports that Robinhood was automatically unwinding users' GME positions against their will.

Robinhood and some other platforms came out with vague statements about keeping its users' money safe, and "mitigating risk" to accounts - as if any of the retail investors had a gun to their head. "It's all for their own good" was the general drift of the messaging.

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But almost simultaneously, Bloomberg began reporting that Robinhood was starting to draw heavily on huge lines of credit, tapping into "at least several hundred million dollars."

Was it a conspiracy? Was the "fix" in?

The little-known, but extremely powerful and critically important entity was making its presence known, and it was not happy...

The Depository Trust & Clearing Corporation Was Nervous

The DTCC settles almost every trade for almost every brokerage in the country - $1.6 quadrillion worth of securities, bonds, and derivatives (it's true - the notional value of options and other derivatives reaches into quadrillions of dollars) in 2014 alone.

Not a lot of regular investors realize this - particularly when you can be in and out of trades and buy and sell stocks on your smartphone - but as fast and high-tech as the markets are these days, the DTCC is responsible for taking in the money from stock buyers and delivering that money to the sellers.

It's not a stretch to say the DTCC is at the heart of the financial system. And last week, it was on the verge of a heart attack.

Why? Well, the DTCC could see perfectly well that it was mostly under-capitalized, with gun-slinging desperado day traders moving shares of GameStop and other big short-squeeze plays like Bed Bath & Beyond Inc. (NASDAQ: BBBY) and AMC Entertainment Holdings Inc. (NYSE: AMC).

The DTCC worried, perhaps not unreasonably, that all the traders on Robinhood and other platforms would up and walk away, that they would simply not pay $250... $320... $400... $450 a share for GME.

In that event, the DTCC would be faced with unfathomable losses - sellers would be screwed, too, which in turn would cause systemic problems too numerous and too nightmarish to get into here.

And so, by close of day last Thursday, the DTCC demanded the discount brokerages pony up billions of dollars to cover the risks they might be facing.

The more shares discount brokerage users bought, the more cash the DTCC demanded. By that Thursday, the DTCC had brokerages cough up $7.5 billion - a 28.89% boost from the $26 billion they were already holding from brokerages.

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Robinhood drew down its credit lines and got a $1 billion cash injection from investors. But even that tidy sum was really only enough to cover what had transacted to that point. If Robinhood customers were going to keep buying GameStop at higher and higher prices, Robinhood would have to fork over billions more to, by that point, a completely freaked-out DTCC.

There were no more billions to be had, at least not easily, so Robinhood threw cold water on the party; they simply stopped customers from buying any more GameStop shares. There was no problem selling your shares, but you couldn't buy for love or money.

Ultimately, there was no sinister "one hand washes the other"-style conspiracy to save floundering hedge funds; there was no secret bargain to deny retail and day traders the chance to make a, frankly, well-deserved killing. After all, the Redditors, the day traders, the "little guys" were really only doing what hedge funds themselves do all day long.

It was the tail wagging the dog - a classic case - and as someone once said, "ain't nothin' wrong with that."

Here's What Happens Next

So it wasn't collusion but simple mechanics - the mechanics of trading and money - that kept a big payday from getting even bigger. Of course, that hasn't stopped politicians - most of whom don't have the foggiest how markets actually work - from furiously and self-righteously demanding "hearings" and "answers" "for the people." Something tells me we might even get those hearings. Congress loves a good, grandstanding hearing, with a nice photogenic parade of congressmen and congresswomen chewing out discount brokerage CEOs (as opposed to Silicon Valley CEOs).

I would be surprised if, from a regulatory perspective, anything concrete came of them - that would be like fixing the barn door long after the cows have escaped, been caught, and turned into wagyu beef dinners at Delmonico's.

What I expect is the brokerages will find a way to "accommodate their customers" (read: make money on their customers) while keeping the DTCC happy. My decades of experience tell me, when there's that much money on the line, with the real promise of hundreds of billions more, businesses will find a way to get along and do business.

After all, and as I said the other day, these kinds of coordinated actions, with, say, millions of retail investors and traders working in loose concert with one another, will become the "new normal." There's been a seismic shift - correction, there is a seismic shift - happening, and frankly, I'm excited for it.

There's a trading revolution underway - what else could you call it when hedge funds lose billions of dollars to retail investors in a matter of days? The "Super Squeeze" could be the market's hottest trade, and GameStop wasn't the only opportunity with that kind of potential. Go here and find out what my friend and Money Morning colleague, Andrew Keene, has to say about this kind of trade - it could have you laughing all the way to the bank.

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About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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