The financial system was “dangerously close” to failure during the GameStop mania, according to the chairman of Interactive Brokers
Interactive Brokers chairman Thomas Peterffy told CNBC on Wednesday that the US financial system was under more stress than generally recognized during the GameStop trading frenzy.
“We have come dangerously close to the collapse of the entire system, and the public, including Congress and regulators, seems to be completely unaware of it,” Peterffy said in an interview on Closing Bell.
Peterffy’s remarks came a day before the House Financial Services Committee was due to hold a hearing examining the epic short press on GameStop, which took place in late January. Among those to testify are executives of the stock trading app Robinhood and the hedge fund Melvin Capital, which were short stocks of GameStop.
Interactive Brokers representatives will not be attending Thursday’s hearing.
At the height of the trading frenzy, Robinhood, along with other brokers including Interactive Brokers, put different time limits on GameStop and other speculative stocks preferred by users of forums like Reddit’s WallStreetBets. The moves met with heavy criticism from private investors, claiming that they had put institutional investors at a disadvantage.
However, brokerage affiliates such as Robinhood CEO Vlad Tenev and Peterffy have repeatedly defended the decisions as necessary to meet various capital requirements and protect the financial system in the face of volatile trading activity.
Peterffy, who founded Interactive Brokers more than four decades ago, said Wednesday that the market weaknesses were due to the fact that interest in GameStop was so low in connection with a variety of option activity.
Short selling is a bearish strategy in which an investor borrows shares in a stock and then sells it immediately in hopes of buying back shares later at a lower price. You then return the borrowed shares and benefit from the difference. If the opposite is the case, as with GameStop, short sellers may attempt to buy back the stock at its current higher price in order to minimize losses.
A call option gives investors the right – but no obligation – to buy a share at a fixed strike price. It is essentially a bet that a particular stock will go up, while short selling is a bet that a stock will go down. Retailers aggressively bought GameStop call options during the Reddit frenzy, which can cause the underlying stock to rise higher in highly speculative situations.
In the case of GameStop, there was an upward momentum in both short sellers trying to cover themselves and Reddit traders who bought the stock directly or canceled options on behalf of themselves. These forces combined helped GameStop stock rise from less than $ 20 in early January to an intraday high of $ 483 on Jan. 28. The stock is now below $ 50 when the short squeeze ended.
Without constraints to limit upward pressure on GameStop shares, Peterffy said the situation could have come to a point where both short sellers and market makers, who act as intermediaries in options deals, could not have fulfilled their various obligations.
There were particular risks for market makers to meet their option contract requirements if all contracts were exercised, Peterffy said. This creates the possibility that “the brokers at the clearinghouses are behind schedule so you end up with a complete mess that is virtually impossible to sort out. So that almost happened,” he said.
He added that regulatory fixes need to be implemented to reduce the likelihood of something similar happening in the future. For example, Peterffy said companies should be required to report a brief interest in a stock daily, rather than the current bi-monthly requirement. He also said, “I think they should increase the margin requirements on shorts by 1% for anyone who has a short sale [a stock]. “
“Nobody is to blame” for what happened in the GameStop frenzy, said Peterffy. “There is a hole in the system that we have to stop immediately.”