But some traders will suffer mightily. The novices who jumped on the GameStop bandwagon after the price had already begun rising and are keeping their shares to the bitter end—an approach known as “holding on with diamond hands”—will probably end up losing most of the money they invested. Many of these investors probably would not have invested without the urging of the social-media campaign and in some cases can ill afford the losses.
Complicating the story further, on January 29, Robinhood imposed restrictions on trading in 50 companies, including those on which the Redditors were betting—a move that caused GameStop and other stocks to nosedive and attracted the ire of Ocasio-Cortez and Cruz. (It has since narrowed the restrictions to just eight Reddit favorites.)
One duty of financial regulation is to protect people who may not know what they are getting into from losing everything. So, the Securities and Exchange Commission released a statement announcing an investigation into the “regulated entities”—not the roulette players, but the house—to ensure that they “uphold their obligations to protect investors and to identify and pursue potential wrongdoing.”
This is not the first time Robinhood has come under SEC scrutiny. In December, the company was fined $65 million for misleading customers about how it makes its money. (Robinhood led customers to believe they were getting the best price for their orders, but actually gave orders to firms that generated higher revenues for the company.)
During the GameStop episode, Robinhood’s problem was that it had been operating with too thin a margin. When faced with both regulatory constraints (in the form of capital requirements) and demands from its market-clearing house that it put up more deposits to back its trading, it faced the prospect of being unable to pay off customers who had won their bets.
Robinhood has been able to raise more capital, and will survive, albeit possibly in a diminished form. But a capable regulator like Gary Gensler, if he is confirmed as the SEC’s new chair, might decide to tighten the regulations that led Robinhood to restrict trading—say, by raising capital requirements.
Robinhood’s customers have already concluded that the platform—supposedly created to democratize finance—stands exposed as a component of the financial establishment. But evidently they still believe in Reddit’s WallStreetBets. They are reminiscent of victims of past Ponzi schemes, who sometimes blame their losses not on the con artist behind the scheme, but on the authorities who shut it down.
Jeffrey Frankel, professor of capital formation and growth at Harvard University, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He is a research associate at the U.S. National Bureau of Economic Research.