PFOF and its discontents

During the meme-stonk craze of 2021, everyone had one question: Is a working-class revolution happening in the stock market? 

The answer was self evident: No. Some people made money in a speculative bubble, which was nice for them! Some more people lost money, which was less nice for them, but they memed a hedge fund into oblivion, which was pretty funny. And in the process they started to fancy themselves the new sans-culottes, which was very dumb.

Dumb Money, out today, takes that misperception and tries to reify it. You can read the mainFT review here, with interviews with the writer, producers, director and so on. But Alphaville is going to focus mostly on the movie’s fidelity to reality. And we can’t believe it’s come to this, but we’re going to defend Ken Griffin (shudder).

The movie basically gins up outrage about a bizarre conspiracy theory that Griffin was behind Robinhood’s ham-fisted decision to abruptly freeze its users’ ability to buy GameStop near the peak of the 2021 meme stonk craze. Because Citadel (the separate hedge fund) had taken an equity stake in Melvin Capital, or something.

While it is almost painful to engage with this line of thinking, I had to watch it get laid out for almost two hours, so now it’s your turn.

The alleged conspiracy appears to be that Robinhood prevented investors from buying shares of GameStop so hedge funds could cover their shorts? But there was an actual reason, which was that insane amounts of volatility in meme stocks prompted clearinghouses to demand more liquidity from brokers.

As mainFT reported at the time, brokers dramatically raised their margin requirements for their customers, and Robinhood faced a $3bn charge. Given that it couldn’t meet that it had to halt trading. in all the most volatile meme stocks. But Redditors could still trade merrily as much as they wanted on other brokerages, which mostly just raised margin requirements!

The movie also makes spooky noises about payment for order flow (PFOF), where market-makers like Citadel Securities pay brokers like Robinhood to execute bundles of their clients’ trades in dark pools. We haven’t read the source material in The Antisocial Network and can’t speak to any conspiracy theories in it, but the movie’s theory appears to be that because Citadel Securities was paying for order flow from Robinhood, it was able to lean on Robinhood to protect . . . Citadel the hedge fund’s stake in Melvin Capital?

This is bizarre for many reasons. First, it doesn’t make sense to say Citadel Securities would want people to stop trading GameStop shares.

Here’s a very obvious fact about financial markets: No one trades for free. Trades include spreads that go to the market-makers who act as intermediaries between the two sides. Citadel Securities is one of these market-makers! The more trading that happens — especially by individuals! — the better it is for Citadel Securities. That’s why the market-maker made a record $7bn of revenues in 2021.

Oh and when there’s a ton of trading in a stock that doesn’t have a huge amount of shares outstanding, like GameStop, that spread goes nuts. The SEC had a nice chart in its staff report on the GameStop saga:

If anything, Citadel Securities and other market-makers should have been encouraging more trading in GameStop, not discouraging it to rescue competitors to the Citadel LLC hedge fund. This will be painfully obvious to our financial-industry readers and has been covered well before, but we’re hoping against hope that some Reddit degens and regular folks see it as well.

Even Better Markets — hardly a friend of Wall Street in general and Citadel in particular — only termed it “unsubstantiated speculation” in its otherwise critical report on the saga.

The biggest problem with the movie is that other people involved in the GameStop mania were more deserving of anger.

All of Dumb Money’s Redditors are charming and relatable, and there’s no hint of the platoon of scammers who hosted Twitter spaces for months after the hedge funds’ short positions actually got squeezed, claiming that the Big Squeeze would still happen if more traders would only HODL. Unlike Gill, these internet personalities were manifestly not posting real-time spreadsheets with their investment positions.

In fact, I got in the habit of dialling into some of these characters’ Twitter spaces after the GME short squeeze happened. Here’s one of the exchanges that stood out at the time: One guy spoke up to offer free software to help day traders keep track of positions, for tax purposes. He was immediately met with hostility from the space’s hosts. This was because his software involved recording of purchases and sales, and that implied that these “diamond hands” investors would ever sell.

Things got really nutty, and not in an inspiring way.

The movie also fully ignores the corporate executives who conspicuously egged on a retail-trading mania before diluting the ever-loving shit out of their shareholders. Robinhood’s executives caught some flak, but bizarrely it was over payment for order flow (??), instead of the fact they pushed and encouraged a retail-trading boom until it came back to bite them, or the shoddy risk management that led to the sudden $3bn margin charge from the National Securities Clearing Corporation and triggered the meme stock trading halts.

In slight defence of the movie’s writers, there is one (we counted) acknowledgment that people didn’t just sacrifice gains but lost real money if they listened to the carnival barkers exhorting them to hang on to the stock indefinitely. And it has the good sense to focus on Keith Gill, who seems significantly less grifty than many of his peers.

It’s also more entertaining than one might fear, in large part because of some big-name actors chewing scenery as fund managers. (It left us wanting to be friends with Vincent D’Onofrio’s Stevie Cohen. Romeo the pig makes an appearance! Let’s go Mets! Keep posting, king!) Also Pete Davidson is in it. But expectations were and should be low, because the movie is about lines on screens and numbers going up and down.

Financial markets aren’t going to be the source of fuck-you money for any statistically significant number of people. But instead of showing the pernicious consequences of the GameStonk mania, the writers and directors decided to make the movie an incredibly stupid rallying cry for the Little Guy. 

Was this really “about class warfare plain and simple” as the movie seems to claim? Class warfare . . . in the stock market? That doesn’t make sense because, as we described above, trading stocks mostly just creates revenue for financial intermediaries! It’s like encouraging people to go to Las Vegas to stick it to The Man through the slot machines. The reality is that no one loves retail investors more than Wall Street. “Superstonk” is basically QAnon for people with brokerage accounts.

There are various reasons one could decide to be mad at hedge fund managers, of course. But the movie doesn’t provide any coherent ones.

It has a vague distaste for short selling, but committed short sellers reveal frauds and actual corruption quite often. One character monologues about the “Wall Street” firms that restructured her dad’s company and gutted his pension, but hedge funds don’t do that type of thing. Private equity does! And while hedge funds have been known to use the carried-interest tax loophole that has so benefited private equity, it doesn’t seem like WallStreetBets is the place to fight that sort of battle.

It is equally nonsensical for an individual investor to get mad at Ken Griffin for PFOF. Questions about PFOF are mostly an issue of quality of competition between market-makers and more rarely a few microseconds of difference in stock pricing between trading venues. This doesn’t really affect individual investors, other than abstract questions about price discovery and a vague feeling of being used for profit — and if you happen to be a retail trader who thinks today’s market-makers are gouging you, I have some bad news about the old set-up.

One could instead choose to be angry that the billionaire spent tens of millions of dollars successfully lobbying against Illinois’ proposal for a graduated income tax — it’s one of just 13 states with flat income tax rates — and moved to Florida shortly thereafter. He told a Miami official he didn’t move because of taxes, but because of Illinois’ government corruption, crime and the collapse of social services in Chicago. (The latter may have something to do with the state’s ability to collect revenue, but what do we know?)

Instead the movie decides to focus on a disproved and byzantine conspiracy theory about equity market structure, because individuals decided to try organised action in financial markets, of all places. Hm . . . how did that Audre Lorde quote about the master’s tools go?