Sept. 6, 2021

Robinhood and His Merry Memes

In this episode we go deep on Robinhood and the gamification of retail investing. Is it a passing fad that rescued us from boredom during lockdown, or, and it's a big question, a new foundation for how markets will work in the future?


In this episode we go deep on Robinhood and the gamification of retail investing. Is it a passing fad that rescued us from boredom during lockdown, or, and it's a big question, a new foundation for how markets will work in the future?

Transcript

Richard Kramer: Welcome to Bubble Trouble. Conversations between the economist and author Will Page and me, independent analyst Richard Kramer where we lay out some inconvenient truths about how financial markets really work. Today, we go deep on Robin Hood and the gamification of retail investing. Is it a passing fad that rescued us from boredom during lockdown? Or, and it's a big question, a new foundation for how markets will work in the future? More in a moment.

Will Page: Welcome back to Bubble Trouble with myself, Will Page, and the analyst Richard Kramer.

Richard Kramer: Hey, Will.

Will Page: So, during lockdown, we saw the GameStop episode and during that period, you taught me a lot about what was going on and we'll get into that in a minute. But we have to buckle up a little bit, because Robin Hood's just gone public and that suggests that GameStop wasn't the stop, it was the start. There's gonna be more of this coming down the pipe and as we see GameStop using gamer-type culture to hype up stocks, what I'm really interested with this podcast is to understand what happens to Robin Hood now. Critics are writing up to say it's a fad, it's a broken system, it'll all end in tears, but then again, how bad is it compared to what was there before? The hypocrisy of the criticism is what I wanna uncover in this week's podcast.

But before we turn to that, let's just step back and get to the basics of what Robin Hood is all about. So, there's this expression I heard once, which is, “There's a gap in the market, but is there a market in the gap?” And I want us to use that as a hook for my first question I'm going to throw your way, Richard, which is can you tell us, what was the problem that was there before Robin Hood became part of the conversation? Was it just a boredom thing or was it something much deeper?

Richard Kramer: Well, I think there's two ways to look at Robin Hood, whether you want to look at it as a glass half-full or glass half-empty. And I don't think the problem that Robin Hood solves is any different than if we go back 20 to 25 years and see the rise of E-Trade or Charles Schwab or other ways that simply allowed the average consumer to trade stocks. And the cost of trading stocks for the average consumer has been consistently dropping ever since those electronic platforms came into being. And it's really enabled a new cohort of consumers, in this case relatively younger people, to trade stocks in the same way as their parents were probably trading them 20 years ago on E-Trade.

Will Page: So what we're seeing here, and we've discussed this when we had hyper-competition conversation is, the removal of barriers to entry, I guess. You know, what Robin Hood is doing is taking those barriers and eliminating them just like DistroKid has done for musicians. [inaudible 00:02:49].

Richard Kramer: Yep. Look, the glass half-full is that this is democratizing stock market investing and opening it up to new cohorts of younger people, and helping them learn a bit of financial literacy. The glass half-empty side of Robin Hood is that they're clearing making the majority of their money by getting people to pay them for order flow which is a form of front running. In a way, trading against the interests of the users of Robin Hood. There are very limited investor protections. And by gamifying the buying and selling of stocks its created the sense that, well, you know, this is just another form of gambling and, and it should be combined with other forms of, of information gathering and sharing, as you see on Reddit. But you know, hey, this is just a bit of fun.

And of course, we saw a tragic episode where Robin Hood, which had woefully inadequate customer service, incorrectly informed a user that they were deep in loss and that young user committed suicide. So, you know, those investor protections that exist on other platforms are there for a reason and Robin Hood certainly hasn't paid a lot of attention to those as they've turned the stock market into a giant casual video game.

Will Page: Right, but we'll come to that in part two because you, back in the Wall Street Crash, you know, investment bankers were throwing themselves out the window. All of this has to be kept relative. Let's pull over to the hard shoulder. So I get what the problem is that Robin Hood is trying to solve, now I want to get my head around the terminology. When somebody says a meme stock, when somebody talks about gamification if I was to assume you were talking to me about a cartoon character in Sherwood Forest and I learn I can actually put it on my phone, what does the app look like? Just treat me as a complete dummy and walk me through what some of this terminology actually means.

Richard Kramer: The idea for Robin Hood is to make trading in stocks as simple as playing Candy Crush or any other casual mobile video game.

Will Page: Good analogy.

Richard Kramer: The, a meme stock simply reflects a stock in which the narrative has become completely divorced from any of the fundamentals of the company and become a matter of, uh, crowd perception of the, the potential of the, the stock itself to rise or fall almost irrespective of what the company does.

Will Page: So it's kind of removing the friction. If I was a gamer you said, “Try using [inaudible 00:05:18] or Charles Schwab.” There'd be too much friction in leaving Candy Crush and going to Charles Schwab. But what Robin Hood has done is instead of bring the horse to water, it's brought the water to the horse. It's said, “This is identical to what you're doing on gaming, only you're doing it with real money and real markets.”

Richard Kramer: Indeed. And a lot of those other platforms that you had mentioned, they will ask you this long series of questions about what your investment objectives are, what your time horizons are, what portion of your net wealth are you?

Will Page: [laughing].

Richard Kramer: Likely to invest? And indeed, do you have the technical chops to trade in options, which are obviously more complicated forms of buying and selling a share. So instead of buying and selling the share itself, you're buying the likelihood that the share will rise or fall. And these are not the most simple things for people to get their head around but in the Robin Hood app, they've been presented as just another level or another aspect of the game.

Will Page: I'm just wondering whether your average Robin Hood customer has the attention span to discuss a time horizon [laughing].

Richard Kramer: Yeah, and, and, and indeed, maybe one of the things, very much like the legalization of sports gambling in the States and, and in other markets, is this aspect of problem gambling. And gambling sites cannot just willy-nilly advertise to anyone. They have to ascertain that you know the risks involved in gambling and, and Robin Hood probably hasn't done that kind of due diligence with its customer base who signs onto the app, loads up a bit of money into the account. I think the average account has something like $250. And starts to play the game which is known as the stock market.

Will Page: [laughing] I like it. And of course, legalized gambling has to respect counseling services and. When I last left a casino, there was a bit billboard saying, “Gambling addiction counseling services. Buy one, get one session free."

Richard Kramer: Mm-hmm [affirmative].

Will Page: So you can kind of see how there's a market within a market there. Bubble Trouble as a podcast has this recurring theme of we've been here before. We've had bubbles before. We've got into trouble before. I mean that's.

Richard Kramer: Mm-hmm [affirmative].

Will Page: The purpose of the title of the podcast. I'm curious to see whether that applies here with Robin Hood. I mean, you're a three-strike veteran of this game. When you look at the hype around Robin Hood right now, is there an element of deja vu going on in your head?

Richard Kramer: Well, absolutely. And that's not just with respect to the evaluation of Robin Hood's stock itself or the growth that it's showing. But this was something we saw back in the late 90s, early 2000 tech bubble. The Fidelities of the world were setting up high street shops alongside the traditional Merrill Lynch brokerages in the U.S. You had TV ads all over the place for E-Trade and Charles Schwab and other online trading platforms and people were discussing the finer points of optical networking stocks with their dentist. This was a frenzy and a craze that was indeed a time very divorced from the fundamentals of the companies people were investing in. And that's the nature of bubbles. Whether it's the South Sea Bubble, the Dutch Tulip Bubble, or tech stocks. That the intrinsic value of what's being traded in the market gets completely divorced from the underlying value, if you will, of the assets that are being traded.

Will Page: Thank you, Richard. That brings us to close part one of this week's episode of Bubble Trouble, Robin Hood, and his merry memes. I'm certainly hearing an element of deja vu here. Just like you say Richard, Charles Schwab back in the 90s did this, Robin Hood is doing it 2021 on a far bigger, far more fascinating, and exciting scale. In part two, I will turn to some of the positive and negative outcomes of this incredible story. On one side, know, the shareholder activism that could come of this. On the other side, what happens if it's too big to fail? We'll be back in a moment. Back again in part two of Bubble Trouble where this time we go to Robin Hood and his merry memes. We've discussed, you know, how we've been here before, we'll be here again with Robin Hood. Just like we've been here before with past bubbles, we'll be here again with future troubles.

But I'm still interested around the hype around Robin Hood. I'm interested in the critics. You know, I'd been reading up before we prepared for this podcast about people who are dismissive of Robin Hood. They think it's dangerous to market, who thinks everyone's going to get burned from this model. And I'm just wondering whether those critics are actually just a little bit embarrassed about their own imperfections. Richard, when you see criticism of Robin Hood, do you feel a little bit like people in glass houses shouldn't throw stones?

Richard Kramer: Absolutely, Will. There's uh, an element of leave the market to the professionals and the people who really know what they're doing. Now, one of the things that has happened in the combination of Reddit and Robin Hood is this challenges the notion of market manipulation. It's fair to say funds of all sizes, whether hedge funds or long-only funds have been doing for a long time. We talked in a previous podcast about getting long and loud. You buy a big position in a stock, you put out an investor letter which lays out the reasons you took the position, and try to convince everybody that the future prospects of this company are much better than you'd ever imagined.

Will Page: More than that, in our very first podcast, you introduced the term knowledge of sycophants and stenographers which is exactly that whole way of manipulating markets. It's a soft form of manipulation, but it's manipulation nevertheless.

Richard Kramer: And one of the things that makes these meme stocks uh, stand out is they tend to have a limited liquidity, and the meme stocks tend to be selected out of ones that traditional professional investors have heavily shorted. So they realize that the more that they are betting against those who have bet against the company, the more likely they are to succeed. Now, in the case of Robin Hood, their top legal officer was the highest-paid executive in the company last year. He's an ex-SEC investigator that made $30,000,000.

Will Page: A poacher turned gamekeeper. We discussed that in past podcasts, too.

Richard Kramer: Absolutely. And one of the reasons you need to pay this chief legal officer so much money is because so many aspects of the Robin Hood business model are sailing close to the wind. They've already been subject of multiple fines and whether there will be a further crackdown on this gamification of the, the way in which markets are supposed to function in an orderly fashion remains to be seen.

Will Page: Now, we'll get to our infamous smoke signals in a moment. But I got two more questions for you, Richard, and they come under this umbrella of just asking how big this Robin Hood model can get. And when is it too big to fail, or when is it just too big for its own good? I mean, where does it go next? So the first question is really to understand about choice. And that is choice of information. Information is how we make decisions. And I could go to a conventional broker with conventional analysts and research notes galore coming out of those banks or I could go to Reddit and follow what's being said there. There's pros and cons to either side. So can you just help balance them up for me?

Richard Kramer: Sure. I think the choice that you posited there is one of, do you believe the experts, so to speak. Whether that's the investment banks or research and other tools that are provided by platforms like Charles Schwab or E-Trade or other consumer platforms. Or do you source your information in a crowd-sourced fashion from platforms like Reddit? And whether those platforms have any real expertise behind them or instead just have an aim to hype things up and change perceptions of companies by a, in a, in a self-fulfilling prophecy type of way. I.e, the stock goes up, it must be worth something.

Will Page: Do you believe in the herds or the slight subtlety here, do you believe in the herd? That is, do you want to be part of the herd? A herd creation mechanism versus, or following the herd mechanism?

Richard Kramer: One of the things the meme stocks and Reddit crowd have taken aim at is heavily shorted stocks where professionals have done their research and realized that a company is in deep difficulty and have a large short interest in the stock. And the meme stock crowd knows that that will make it more and more painful if that stock keeps going up. So they're betting against the people who are betting against the company.

Will Page: Fascinating. So that's almost like a battle of the herds. You need a herd to make a short strategy work and then you need an even bigger herd to make that short strategy come undone. So it, it comes back to this overarching theme when I look at Robin Hood of just hypocrisy. Is it a lesser of two evils? You could have the sycophants and stenographers in the current model or you could flip it to Reddit and herd-like behavior in this new model. I'm not sure which one is worse. Second question is just to tease out a potential positive here. And I want to credit Merryn Somerset Webb and the Financial Times for putting this argument forward which is we talk a lot about shareholder activism. I think it's fair to say we talk a lot more about the lack of shareholder activism. And could Robin Hood be a force for good here if it channels energy into positive shareholder activism where there's not enough at present? Do you see a role for Robin Hood in filling that gap?

Richard Kramer: Absolutely, Robin Hood could be a force for good in terms of shareholder activism but that sort of activism requires far more sustained engagement with companies. Now, there was recently an activist which won some board seats on the board of ExxonMobil which is the largest oil company in the world, or one of them. And their premise was that Exxon simply is not doing enough to address climate change. And they waged a very successful activist campaign. But this took months and years of effort to win over shareholders and bring them on board and get their votes. And it's not at all clear yet that the Robin Hood or Reddit crowd has any real desire to have that kind of in-depth engagement with managements and business prospects to produce that kind of shareholder activist role.

Will Page: So it's like, regulatory for tea. You could have regulation, it just takes a long time. Does it work? The time it took for GameStop to take off was just a matter of days as opposed to weeks, years, that you refer to there. So I think it's interesting in terms of shareholder activism is a good thing, I would argue. Perhaps not enough of it. And perhaps one of the reasons why there's not enough of it is because it takes so long. If Robin Hood can speed that process up, you may have a positive role for this platform in the future. Now, smoke signals. Richard, you usually [inaudible 00:16:06] smoke signals out to warn people about troubles ahead. There may be trouble ahead. I want to put you on the spot here and say, can you give us one positive smoke signal that suggests that Robin Hood is here to stay and one smoke signal that says, “Wait a second. This is a house of cards”? Can you split your smoke signals into positives and negatives this time?

Richard Kramer: Sure. I'll give you the positive smoke signal which is you know, Robin Hood has showed a whole cohort of users you can do it. You can invest in the market. Don't be put off by all the expert jargon. You can get stock in and play around a little bit. And I mean, there is some theory yet to be proven that this is a positive thing that's helping improve financial literacy. Again, whether this is simply a form of legalized gambling remains to be seen but the idea that you're creating a generation of financially literate people who are comfortable investing in the market's probably a very good thing.

Will Page: And going back to part one just briefly there, that's exactly what Charles Schwab did back in the 90s, I guess? Of just widening the market, removing the barriers for investors to come in.

Richard Kramer: And, and also the fact that the extremely high costs of participating in the market in terms of hefty commissions on stock trades have been a major deterrent. Hey, well hang on a second, if I buy this stock, I'm gonna lose 1% already in my commissions. That doesn't sound like a great deal. This allows a form of trading which is much lower cost directly to the consumer, although there are unfortunately very many hidden costs that most Robin Hood users will be unaware of. For example, this payment for order flow. In terms of the negative smoke signal, the vast majority of trading on Robin Hood is going to be completely unmoored from valuation fundamentals and all the bedrock underpinning of the markets that we've relied upon really for hundreds of years. I mean, what do AMC or GameStop do? What are their cash flows?

What are their prospects? Who cares? This is frankly extremely dangerous. And you know, when one thinks of investing one expects that you would have some level of intrinsic value underpinning that investment. And instead, the likes of Robin Hood are relying more than ever on greater fool theory. That if I buy the stock at this price, someone else will be around to buy it at a higher price irrespective of what the company does, what of the news flow in the market comes out, or what the fundamentals of the, the backdrop of the industry.

Will Page: Thank you, Richard, for those two smoke signals and giving us a balanced perspective of where this fascinating story of Robin Hood could go next. Just bringing it to a close, my big takeaway from this week's podcast is firstly, we've been here before and we'll be here again. Secondly, as we've seen in so many other markets affected by technology, barriers to entry have fallen. And that's allowing new participants to enter the market. A new cohort of traders have entered the market. And that's got to be seen as a good thing. And thirdly, I'm just fascinated by what signals do you want to trust? Is the belief that you can learn about markets more on Reddit a function of a lack of trust in what you can learn from more authoritative sources as well? So it's definitely here to stay.

I definitely think we're going to be back again in a future episode of Bubble Trouble discussing Robin Hood and his merry memes. Thank you very much. This has been Will Page and Richard Kramer and you've been with Bubble Trouble. If you're new to Bubble Trouble, we'd encourage you to follow the podcast wherever you listen. Bubble Trouble is produced by Eric Nuzum and Jesse Baker at Magnificent Noise. You can learn more at bubbletroublepodcast.com. See you next time.