'Stupid Prices'

I promised listeners. If you needed to get to explain, give me a call and he'll give you his personal number alongside the podcast hotline at the end of the show. Just wait for it. But this week was really a week like no other. A short squeeze for the record books, shares of game Stop AMC costs, Bill the Bear and others going to the moon to use the term and now infamous sub credit that might just referenced called Wall

Street bets. I'm sure you've heard of it. By now going private then making the foreum public once again, brokerage is restricted trading and representative AOC and Senator Ted Cruz actually agreed on something that had to do with the stock market, and the list just goes on. Mike right, Sarah, And you know, I think some of our listeners might

have game stop fatigue and Wall Street Bets fatigue. I've gotten a few tweets saying, please, please do not make any of the crazy things about game stopper Wall Street Bets. I've got good news and bad news for those people. My crazy thing will not be about Wall Street Bets, but the whole podcast will be so so so good news and bad news. But luckily for us, we've got a really great guest to give us some insight on

all of this craziness. He's really one of the world's leading experts on the complicated structure of the stock market, where trades are getting executed dark pools and exchanges and wholesalers like Citadel. He's the founder of the research firm, the Tab Group, and for the last couple of years we've been lucky enough to call him our colleague here at Bloomberg. He is our head of market structure research at Bloomberg Intelligence, and his name is Larry Tab. Larry,

Welcome to the show. Oh great to be here, Mike and Sarah. Great so Larry. I let's obviously dig into this whole game stop and Robin Hood and Wall Street bet scenario. The question I keep getting, and I keep asking people like yourself over and over again, is, um, it's obviously been so wild these moves in these stocks, hedge funds getting burned left and right, stocks up thousands of percent in a month. It seems like on first

blush that there's something illegal going on here. But you know, the more I look at it on these forums, it's hard for me to really pinpoint anything illegal. I feel like the regulators have have their work cut out for them. Um. I mean imagine, if they dig far enough, maybe they'll find,

you know, something here or there. Um. But when you have a brokerage like Robin Hood, who all of a sudden starts restricting trading of some of these stocks and interactive brokerage, um, you know, heightening their margin requirements both on the on the short and the long end. I feel like, all of a sudden, it's it's forcing the issue to some degree with regulators that they have to sort of get on the school board here somehow about

this issue. How do you sort of look at it from the regulators standpoint, Um, is there anything they can do? Is there anything they should do? Um? Yeah, the halting of these stocks is not particularly nefarious. The issue has

to do a clearing and how the clearing mechanisms work. Basically, stocks settled in a two day period and and in those two days, the brokerages are responsible for ensuring that those stocks set and so the question that becomes is, um, they can't pledge their customers cash or securities to ensure that they settle, so that they have to come up with a basically a margin, you know, their margin, just like you know, just like you know an individual investor's

margins if if they're doing margin loans or at they're short or whatever. So they have to come up with a bunch of capital to basically, you know, put aside over at dt c C. And what dt c C basically said is is that these stocks have become so risky that you know, if you're buying Game Stop at three sixty uh and tomorrow it's a one d are you really going to pay three sixty for this um

if it goes down the one hundred. So they put up the margin on a lot of these these uh um you know, high flyers or whatever, uh so high that they that the brokerages can't afford really the margin to to set aside so their clients can actually even buy this stuff. So it's not really caba all, it's not really Robin Hood dwin fairious stuff. It's the DTC

s C saying this stuff is just too risky. We don't trust that these guys have the cash to be able to withstand settling these things two days from now, because in two days, who knows what the price could be could be zero, right, I mean, just and I'm just gonna throw it out there because things are moving

so quickly these days. We record on Thursday. So in the morning on Thursday, for example, game Stop shares are trading above five hundred dollars a share, and then all of a sudden we're back down towards one hundred dollars a share. So so it's just things are moving at such a quick pace. So I want to double down

on something you just said. There's obviously a lot of rumors swirling around that maybe the hedge funds got together, or Citadel or the market makers got together and are are telling Robin Hood and the other brokers that they have to halt trading on these sites. And you've also seen the likes of AOC and Ted cruz Uh and Dave Portnoy of Barstool Sports come out and kind of shooes you this and say this is an issue. We

need to look into this. It shouldn't be allowed. So what you're saying is there's a structure issue behind the scenes, and it's not up to the brokers. So no, it has to do with how how securities are cleared and so UM basically I buy something today, it settles in two days. Basically there's an IOU out there for two days that somebody has to basically put cash behind UM. And it can't be UM me the individual investor that my broker can't take my cash to pledge against their

overall health or their overall margin account. It's got to be capital, you know that the that that the broker

puts up. And given the increase in capital and the increase in risk in clearing these items, they up the capital ratio for these tremendously and and none of the brokers can afford the risk in case the price of this goes down and basically wipes out all their clients, and they don't have any cash to basically settle the trades, you know, Larry, Unfortunately, uh, we live in the golden age of the conspiracy theory as as I'm sure you know in politics as well as markets, and obviously people

looking very heavily now at the role of a wholesaler like Citadel Um. Citadel obviously being an unusual situation in that, you know, half the firms a hedge fund, half the firms a market maker wholesaler um. So walk us through how their market making sideworks. I mean, my understanding is basically Robin hood sends all their orders to Citadel, who pays them a fee, not all of them, but a percentage, uh, to Citadel and firms like that who who these orders

never actually make it to a stock exchange. They're matched by these internalizers, as they're called. My impression is, you know, maybe they're making I don't know what half a cent a share something like that in this way less so, you know, and they the reason it's lucrative to them though, is they're just getting so much fune. I mean, they're they're getting however, many millions or even a billion shares a day. I guess to to some of these, Um,

but I don't wonder. You know, it's got to be a tough time to be Ken Griffin with all this uh scrutiny. You know of a business that, okay, on one side of the businesses is bailing out a hedge fund that got run over by these day traders. The other side of the business is making a lot of money by matching the orders. Um. I mean, is there a case to be made for for separating the hedge fund from the market making business? Do you think that is kind of where this is going that there might

be certain calls for that. I think that's Ken Griffin's view. There's been rumors for years that they're trying to take the market maker the security side of the business public. So uh, currently the security side of the business is mostly in New York or moving down to Florida. The hedge funds still in Chicago and elsewhere. They run pretty separately. Um. You know, Uh, Joe McCain runs the equities business over at the security side. Yeah, he's in Chicago every once

in a while, but it's a pretty separate business. Now. Yeah, people are saying Oh yeah, you know we're going to get you know, Citadel, because you know we're gonna do all this game stop trading and it's gonna run over Citadel. UM. It's you know, it could hurt the hedge fund side if they're short. But UM market makers don't lose money

on their trading. What they're doing is they're selling liquidity UM and and when UM spreads widen and the and the valuable liquidity becomes more precious, they actually make money. So UM the security side of the business of Citadel or Virtu or two Sigma or uh Susquehanna g One g One Execution, which is the other major market maker, I'm saying they have. They had a pretty good week.

They've had a pretty good year. Uh. The in fact, the financials for Citadel securities were leaked for last year and I think they made six point seven billion last year, which is up from I think like a billion or two maybe a year or two ago. So UM, I'm not sure they're harden Ken Griffin too much more fuel for the redditors. So I was I was hoping, Larry, because you've done so much work on on price improvement

and payment for order flow. If you could kind of break down for us at our listeners how this actually works here, because I know there's there's Before any of this happened, there's been a lot of back and forth about how, yes, Robin Hood's all about democratizing investing, then they're going ahead and selling all their customers orders and Citadel's profiting anybody any anytime anybody says anything about democratizing Wall Street, you would need to run the other direction.

That's okay, But I'll talk about payment for water flow and how those mechanics were and how this stuff and why this stuff is not you know that nefarious. It's not perfect, but it's not in the fairest um the market UM the market has become. The market now is not NASDAC in New York, with NASDACK stocks trading in NASDAC and New York stocks trading in New York. There are sixteen different exchanges. Those exchanges are mostly located in

three different areas in northern New Jersey. UM and there's a lot of back and forth and trading between all these exchanges. There are thirty two dark pools UM and and there's a whole fragment, fragmented world. The way that the way the SEC regulates exchanges is generally there's a minimum a minimum tick size of a penny. For a lot of the stocks trading at a penny, that spread is too wide, UM that that they'd actually traded less than a penny if if UM, if they were allowed UM.

And so what happens is market makers can can actually improve the price of these things. Now getting back to the market overall um because of all this electronics and complexity um uh. The market, the lit markets are really

geared for institutions. And so if you're posting a price on Nastack or New York or CEBO or any one of the sixteen exchanges, you have to be ready that it's going to get executed by you know, Stevie Cohen or some very sophisticated, very smart guy UM or some very large guy like Fidelity is going to come in and buy a million shares. So so you have to be prepared when you're when your quotes are accessible to everybody, that you're going to get hit by the most sophisticated

guy in the world. And so your quote better be your quote better be good, and it better be ready for for the market to move forward. That said, when you or I or Mike or Sarah or whoever come in and buy their hundred shares of game stopper. You know, let's say Apple, Um, you know you're hunter chairs of Apple or your five shares of Apple are not going to influence the price of Apple. So in effect, the price that's being displayed on Apple is actually too wide

because it's geared for the institutions. Because of this, um, market makers who know that that waterflow is coming from Robin Hood, or it's coming from e Trade or coming from Schwab, they know that it's not a million shares behind it. It's not Stevie Cohen hitting the enter button. Um. You know, they might not know it's Sarah or Larry or Mike, but they know it's a retail guy. And and because of that, they can actually give you a

better price than they can give Stevie comb Um. And so they can price it better and so um, the pot of money that they make on your apple trade gets split basically three ways. One a portion goes to them. They keep it for making you know, for servicing your waterflow. The the other balance is broken out into price improvement. When you get your your your share price back from your execution. A lot of times you'll see fractions to the right of pennies. Um, that means that your price

got improved. That means you've got a better price than then was displayed in the marketplace. Um, that price improvement goes to you. And then a little bit of that what's left over from from from that profit the market maker makes, goes back to the broker to pay for that order and that's that's payment for water flow. Now, payment for order flow tends to be about a quarter of what's not kept by the wholesaler. So you've got the whole salar portion, and then you've got the price

improvement and the payment for waterflow of that bucket. The broker usually gets a quarter of that, and two thirds of that or three quarters of that goes to the client. In terms of those little pennies or subpennies that go to the people say oh that's demnimous. It's not necessarily dementimous. It's adds up to you know, billions dollars a year. It's just you know, shows up in your accounts for

actions of assent. Yeah, Larry, I wanted to get back to that you mentioned the dt c C, the Depository Trust and Clearing corp UM, and it sounds like, um, you're thinking that robin Hood probably got a call from them, and that is sort of what motivated Uh. Chances are m robin Hood got a call from their clearing firm, who got a call from DCCC. Right, So, I mean would that lead you to expect more discount brokerages to

to follow suit and restrict these talks? I mean, does it depend how well capitalized you are as as a brokerage. I guess it depends on how well capitalized you are. It also it depends on what your your percentage of volume of If you know, if you're only doing shares of one of these names, it's not a big deal. But if you're doing a billion shares, then you're probably need to pony up some more margin. So it really

depends on your mix a client basis. So I kind of you know, if you think about it, you know, is Bank of America, Merrill Lynch or their clients you know, you know being funneled into the game stop Probably not um so if you know, but if you're in the Merry Trade or robin Hood or whatever, you know or it could very well be. And those are the brokerages that at this point have placed the restrictions. It seems so it's the customer base that would be trading these

types of shares, which makes sense. I also just wanted to get your take clear. I mean, there's been a lot of talk this year or not this year, this week about the stock market feeling like it's broken, that we shouldn't be seeing shares of costs or game stop or a MC we shouldn't be able to see markets move like this, And there's been a lot of comparisons made to the late nineties and the dot com bubble, But have you ever seen anything like this? And is

the market equipped to kind of go forwards? If if this is going to continue? And let me put in, Sara, this this week actually lasted a full year, so you're right on your right on both terms. That thank you, It's that is true. I think five I think every every week, you know, in the last year and a

half has felt like a whole year. So I'm I'm tempted to say though that with everyone weighing in this week, I mean, jaw Rule was even coming out the rapper talking about this, I mean already feels weirder to me. St started to stopping your question there, Sarah, I've forgotten what it is. I've ruined the whole thing here and shortly, have you ever seen this before? I have not seen

this before. Um. You know, you've got to kind of harken back to the Pets that got pets dot com days of the of the thousand's, but it wasn't like this, um. And is the market broken? No, the market is not really broken. This is what markets do. When there's a lot of buying demand, the price goes up, and when there's a lot of selling demand, the price goes down. Are there issues with short selling rules and riggings show and some of the infrastructure the price should be looked at?

Should should affirm or should a company be a hundred and forty or of its float be short? You got us think that there's some problem with rig show and borrows and locates and things like that, which is basically the mechanism you need to actually go short. Um. Uh, you know that. You know, it seems like that would be a good place to look first off, But the market, that's what the market does. The market responds to buying

and selling pressure. And and people are saying, oh, get rid of those electronic market makers, blah blah blah, we should go back to the days when stch lists were on the floor. Well, those guys got arrested and taken away for handcuffs, you know. And um, you know, and and put it this way, nobody no market makers in the business to provide liquidity at a loss. They're not

there to basically let you profit and pillage their balance sheet. Um, They're going to react as quickly as they can to the buying and selling pressure to find what the new price should be. That's what markets do. And and you know, back in the the fractional trading days, those guys were making a killing on every trade get relatively, you know, if you compare it to the spreads now. But you know, you you mentioned the pets dot com And I made

the joke about the Yahoo chatboards at the beginning. I mean, it's it's similar in a way. You know. I remember lurking in those chat rooms twenty years ago when I worked at a different news service and didn't have access to a Bloomberg, just trying to figure out what's moving each individual stock. I mean, I guess it's it's sort of just the natural evolution of the hive mind, the

the hive trader mind to some degree. Well that that's actually a really interesting question because if if you would have done this ten years ago, it would have been a Long Island boiler room shop and it would have been done. It would have been done, you know, by talking up ant ant selma, you know, go buy some stock that doesn't really exist, or you know, now now you got basically the same thing going on, you know, you know, short squeeze on game stop by all three, um.

You know, is you know, you know, what's the difference between that and being done and being done in a you know, Long Island boiler room. I don't know. I think SEC's I think that's a you know, that's an interesting thing for the SEC to look at. Is this

market manipulation. I remember in the early days of cell phones you used to get random text pump and dump text messages saying, you know, by by this this and that stock, let's just pretend play play make believe for a minute here, and we'll pretend I'm Joe Biden and I just called you up and I said, Larry, what the heck do I do about this? I don't understand it. I know something's wrong. Can I fix this? Do I need to fix this? You know what? What's what's your

response to Joe? What's my response to Joe? I think as adviser of the president promoted Larry, it's long overdo Overdo I have enough pressure being from under now? You know? Now I got to Biden. Um, you know, I think this is what I would be looking at his rig show. You know, let's you know, let's start off with, you know, is the short side of this business operating properly and where they you know, because that's kind of what started it.

It was like, oh there, you know this company, this float is a short or short let's go charge it. The second thing may actually be, you know what, you know, what happened you know on Thursday, is maybe we can speed up the settlement process. Because if you can speed up the settlement process, then the marchin we don't have these issues with you know, basically you know, stopping out

the brokers from letting you trade these names. But in terms of the market structure, you know, it's hard to it's hard to say that there are things wrong with it and that you know, when a lot of people come and buying, the price goes up, When a lot of people sell, the price goes down. You know, you have callers on these from the exchanges to stop them. If they're volatile, you might want to tighten some of them so that there are more stops. So, but I

don't think that's the problem. These aren't These aren't air pockets, these aren't order book abnormalities. That's making this. This is clearly buying and selling demand. You know. The other issue is the linkage is possibly between the options and the equities market, but I'm not that seems what happens there is that if you buy an option, then it gets hedged in the equity side. That's actually that's what That's a good thing. That's that's how the markets supposed to work.

So I'm not sure you want to do anything there. I'm not I'm not sure there's some massive amounts of change I would make. Um. You know, you know people are allowed to pay stupid prices for things. You know, you go into the local convenience store milk is you know three times would cost in the supermarket. Are you're not supposed to be able to you know, charge charge that. Actually in the stock market, UM, it's way better than that, because you can go to any one of the sixteen exchanges,

you'll all pay the same price. So so I'm not sure there's a ton of stuff to do. Stand clear of the craziest things we saw in markets this week. Well, Sarah, I believe we did get a voicemail into the what Goes Up hotline. This is a message for what throes up And this is something crazy that happened on the

Australian Stock Exchange this week. Uh. There is a ticker on that exchange g m E, which is a Perth based resources, a Perth based minor, and the ticker is the same as a ticker in the US that has been going a little crazy this week. And on January twenty second, UH just over four hundred thousand shares were traded, but on January eighteen million shares were traded and the stock reached a fifty two week high of twelve cents.

So this is a this is a um a penny stock UH with a sort of a not very well known minor. And the chief executive has spoken to the Australian Financial Review and basically said, we have no idea what was going on. We think that um, in the future there may be some rocket potential. But there was no real statement from the compan me to explain why, uh this doc did this on Thursday, except for the fact that uh, some people might have thought that it was called g M E For another reason, I for one,

never get tired of wrong ticker trade stories. It's it's it's a great h a great of the crazy thing genre for sure, classic ticker confusion. And I'll also point out, and maybe this is just a coincidence, but whereas you had gm E Resources in Australia going crazy because it has the same ticker as game Stop in the US.

Even in the US, if you look at companies that all start their ticker with two bees, so BlackBerry, build a Bear, BBW, bed bath and beyond b b B, why it makes you wonder like, do we have some fat fingers there? How does that happen? Yeah? Stunks? I think the answer is stunks. Let's me answer to everything. Also a shout out to uh the Twitter users short term capital Management great Twitter name at term mg M two pointed out record volume on Wednesday, almost twenty four

billion shares. I believe it was Larry. Yeah. You ever think you'd see a twenty billion share day? Yeah, I don't know, they don't. I have a surprise we haven't seen it sooner because because really the record the record day was UM. The record day before this was uh uh so when you look at at total volumes UM, you know, the high was out of the global financial crisis,

we did UM nineteen billion point seven shares. Then uh you know, the next UM was was UM end of February early March of last year when the pandemic just decimated the whole market place. And then the real volume day is yesterday Game stop. So so so which one of these three days don't look like each other? You know? Um, you know January, you know, the global financial crisis or the pandemic. You know, I don't know how much for the S a T. Guys are are going to get

that one, right? Yeah? If Game Stopped makes its way into the economics textbooks and that, I don't know. I think I might retire at that point. But uh and I do want to remind our listeners to of course, you can give us a call on our podcast hotline. That number is six or six three two four three four nine. Oh, and you can leave us a voice smail and maybe we'll play it on the show, just

like we recently heard yep. And of course you can tweet at us, at podcasts or at Sarah and I will give you our handles at the end of the show. And that's where I got mine. This week, Sarah, I'm going to to the Twitter user at Jeff Billbrow at Jeff Underscore Bill Brow in New Zealand. We've we've we've mentioned him on the show before. He's pretty good at this. And uh, hes us something in my favorite asset class, the the alternative asset class. And when I say alternative,

I really mean alternative. This I guess is you could consider in the alternative commodity space. Um. So, you might be a little too young to remember the show Cheers, the sitcom Cheers that might be before your time. I know of it, but I can't say I've ever actually watched it. Larry remembers it. Larry might remember the episode where the Cliff the mailman found a potato that looked like Nixon and it was, uh, you know, basically the

whole topic of the show. Well, this story is courtesy a c Net and it's about a rock that looks like the Cookie Monster from Sesame Street. It's a chunk of blue agget and if you cut the I get down the middle, it looks and I'm not I'm not exaggerating. This thing looks exactly like Cookie Monster with the Google eyes and everything. It's hard to do with justice on a on an audio only podcast, but Google, I don't know, Cookie Monster Rock or aged or something. You'll find a

bunch of stories on it. Um found in Brazil last fall, will summer in Brazil, I guess, uh, or spring in Brazil, of course, Sarah. It's already been sold once. Um. The guy who owns it now is a guy named Mike Bowers. Uh. He had an awesome quote in the story that was something like, you know, I've seen a lot of cookie Monster rocks in my day, but this is the most perfect Cookie Monster rock. I don't know if I've ever seen a Cookie Monster rock before in my life. So

he's getting he's getting offer sward, of course. So you know what time it is, It's it's time to play prices right here, Sarah, considering how frothy markets are right now, what would you pay for not just any cookie rock monster rock, but the perfect cookie Monster Rock. Well, I have a question, and you might not know the answer to this, but do we know what material the rock is made of? Because that's got to impact value. It's blue AGGT A gate. I'm not sure A G A T.

I'm not sure how you pronounce it. Yeah, the raw material I think is irrelevant here we're talking about the cookie monster. Um, but of course that I'm not sure you're gonna make a ring out of blue egg it. Yeah. So okay, so last week I really low balled it. This time, I'm really gonna up a rock that looks like the cookie Monster. I'm gonna go with eight thousand dollars, eight thousand dollars. I'm gonna keep a poker face, Larry,

What is your bid for the perfect Cookie Monster? Can remember prices right, rules are in effect, So you can go one dollar or twenty eight thousand and one dollars. So, so what's my bit or what do I think the greater full theories? So is the greater greater full theory? And and and it's truly truly a greater full in this case I think is appropriate. I don't know. That's a pretty good bid. I don't know. I've been thirty

five grand. I got gonna buy this. I'm gonna arb this trade and sell to one of you guys ten grand. What I would pay for it is, you know, I don't know what what did pet Rocks go for? But that's again before Sarah again, before Sarah was born, the fields pet Rock I know, I know pet Rocks. Well, you know it's you might you guys might be right though, because the the bid is ten grand. This guy hasn't disclosed his his offer price though, so so it could be high. He hasn't sold it yet, so very very

a liquid market for cookie months. And I have a Beanie Baby that I can sell. And I still have my Pokemon cards that was revilable. I think, I know, I need to check I need to check out. I don't think I have any valuable is going to be a billionaire, I know it, don't you know what? That's the truth. That's the truth, all right. I know we've been talking about crazy things all podcasts long, though, but Larry,

do you have anything else? You know? I My craziest thing is, you know how how a bunch of rag tank guys living in their mom's basement could basically bankrupt the hedge fund. You know, um, you know, in my world, it doesn't get a whole lot more crazy there, crazier than that. Yeah, that's true. You know. To your point though, who shorts of stock that's already a short interests? I just don't get it if the value is thirty and

you think it's zero, Alright, I'm not. I'm not going to let myself off the hook though, because I feel like I was about to get passed by and not have to share a crazy thing. And it's happened before. But I'm not gonna not gonna slide away that easily. Uh. This is also just within this year round of craziness. This week, but also on Wednesday, thirty million call options traded, as we talked about hash equity trading volume, but that was also a record by far um Well that that

actually could be a whole another podcast. I'm gonna be writing some something about you know how this with these options, all this stuff comes together, especially around game stop. That's it's insane. The great Gamma squeeze of We'll have to get you back on for that, because that's that would be a good one. That'd be interesting. Uh yeah, we'll certainly have to have you back, Larry. Let us know when it's out. But Larry Tad, thank you so much for joining the show, especially in what was a week

to remember. Sarah am I happy to be happy to join it, happy to be on the Bloomberg team, and call me whenever I'm in the pandemic. I'm not going anywhere, None of us are. I haven't been going anywhere for twenty years, Larry, What Goes Up We'll be back next week. Until then, you can find us on the Bloomberg Terminal, website and app, or wherever you get your podcasts. We'd love it if you took the time to rate and review the show on Apple Podcasts so more listeners can

find us. And you can find us on Twitter, follow me at at Sarah Pontzack Mike is a reaganonymous, and you can also follow Bloomberg Podcasts at Podcasts. Also thank you to Charlie Pellett of Bloomberg Radio and the voice of the New York City Subway System. What Goes Up is produced by Tobra Foreheads. The head of Bloomberg Podcast is Francesco Levie, thanks for listening, See you next time.