Robinhood Is Cool, But Is It Out of Its Depth?

A pivotal moment in the GameStop Corp. furor a few weeks ago involved Vlad Tenev, the 34-year-old chief executive officer and co-founder of Robinhood Markets. The clearinghouse responsible for settling his firm’s GameStop trades woke him up early one morning and demanded that he fork over an extra $3 billion in collateral to protect it from possible losses.

Tenev managed to whittle that demand down to $1.4 billion before he had to start transferring funds. To protect his firm from further collateral squeezes, Tenev took an added and controversial step: He told the investors who used his popular trading app that they couldn’t buy GameStop shares.

Tenev’s loopy and opaque explanations at the time he halted GameStop trading sparked boatloads of outrage and a round of ill-informed conspiracy theories. Most centered on the idea that Robinhood was a pawn of hedge funds and other short sellers getting crushed by a surge in GameStop’s shares. Some had Robinhood as a puppet, acting at the behest of a client, Citadel Securities, that funnels huge streams of money its way. None of it initially focused on the possibility that Robinhood might not have had enough money on hand to survive the financial frenzy it helped fuel.

Tenev’s machinations were brought up repeatedly during a House Financial Services Committee hearing Thursday, and for good reason. A handful of legislators wanted to know why Tenev chose to hamstring his investors. Anthony Gonzalez, an Ohio Republican, cut to the chase, asking Tenev if he actually had $3 billion handy when his clearinghouse came calling. And, lo and behold, Tenev said he didn’t.

Gonzalez noted that Tenev’s inability to pay up would have amounted to an “enormous catastrophe for Robinhood.” Gonzalez also pointed out that a “vulnerability was clearly exposed” at Robinhood and that Tenev was “unprepared to protect his constituents and customers from nonconsensual liquidation.” Van Taylor, a Texas Republican, had a similar observation, noting that Robinhood appeared to have been “undercapitalized.”

Tenev had various explanations for how he and his firm wound up teetering on the precipice, but one caught my attention. Tenev said that all of the drama, volatility and billions being made and lost because of trading in GameStop and other meme stocks was a “black swan” and a “five-sigma event.”

In his short time in the barrel, Tenev has clearly mastered a long list of Wall Street buzzwords and evasions without fully understanding or embracing the virtues of transparency. But his readiness to indulge in some of the sexier financial terminology used to describe monosyllabic and ever-present realities such as “risk” and “chance” signal that he and Robinhood may not be ready for showtime the next time a crisis emerges. It also offers a reminder of the dangers that sometimes arrive when inexperienced or reckless people are managing cool, important but newfangled things.

A “black swan” event — made famous by Nassim Nicholas Taleb in a best seller that parsed the role of randomness in finance and life — comes as a surprise, has great impact and later becomes rationalized away as easily explained or predicted. Many things that appear to be black swans, however, aren’t unforeseeable and are merely classified as such to avoid responsibility for not spotting them ahead of time in the first place. A “five-sigma event” is a statistical descriptor of something that occurs five standard deviations away from and on either side of the mean in a data set. It describes the odds of something happening, and in five-sigma territory the odds are long.

So was the GameStop frenzy that Tenev mired in truly a black swan? A five-sigma? I don’t know, and certainly some deft number crunchers can take a deeper look than I can, but I’m doubtful. Markets are always volatile, and often that volatility cascades in wild directions around all sorts of different assets. Which assets become ping-pong balls may be hard to predict, but they are always bouncing around the table. Sophisticated market players steel themselves for the unknown, not just the known, and they fortify their reserves accordingly.

Robinhood makes trading easy for the small fry, and that’s a good thing. But if Robinhood’s owners don’t backstop it with enough capital to allow investors to use it, particularly in the roughest of times, that’s both a financial problem and a management problem. Invoking swans and sigmas feels like a dodge to me.

Technological innovation is visiting a lot of this upon us, and it’s worth remembering that market pillars are meant to be there when you need them. Bitcoin is compelling and fascinating, but if it becomes a common currency, who or what takes the place of central banks and backstops it during crises? Robinhood is handy and liberating, but if it seizes up in a crisis, how much should investors really rely on it?

We have had much lately of people invoking various descriptions of the unforeseen to explain away why they weren’t ready for outsized challenges. Covid-19 is an epic pandemic, but it was not entirely unforeseeable, and if our public health apparatus had been properly attended to in advance, the onslaught might have been reduced. Texas is getting creamed by savage weather, but colder weather wasn’t unforeseeable, and if its power grid had been properly winterized, people wouldn’t be suffering through blackouts.

GameStop trading was freaky, but freaky things happen in markets. And if Tenev and Robinhood had been running the business in a more judicious and sophisticated way, that early morning phone call might not have posed such an existential threat. Tenev can describe that moment any way he wants, but he probably shouldn’t swan or sigma when he does.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Timothy L. O'Brien is a senior columnist for Bloomberg Opinion.

©2021 Bloomberg L.P.

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