Liquidity crisis due to Gamestonk
I wasn’t quite sure what to think when the brokers stopped allowing buy orders and only sell orders on Thursday the 28th of January. Well… we could’ve had a bad day.
The bottom line is, if the share price of Gamestop is sent to mars, it would cause a meltdown throughout the board where even the custodians may have to raise capital.
It would set off a chain reaction of institutions being forced to sell off unrelated positions to answer the margin call of those who are short on Gamestop and it would cause the entire market to plummet like a house of cards for a few days as hedge funds would go bankrupt.
Here is what happened
Whenever you place a trade, it goes through your broker. Then your broker contacts another party, which contacts the DTCC (clearing house) to issue you the share from a seller.
This explanation has been greatly simplified in the interest of brevity.
It is important to know that for every share you buy there will be a seller. If those sellers go bankrupt they can not deliver your share which means that the clearing house has to deliver yours out of pocket. If the share price goes to 1000 USD the clearing house wouldn’t have enough liquidity to cover that. Which means that we’re now talking about a liquidity crisis.
When Gamestop became the most volatile asset in the world, it created a massive risk to the system. The DTCC views transactions from margin accounts, which pose more risk.
In this case, from the perspective of the broker the risk of margin accounts is mitigated by their ability to close clients out of their positions or liquidating them when thresholds are breached.
Stocks which are extremely volatile increase the odds of those thresholds being breached. Those thresholds are there for a reason, bad if broken under thousands of accounts on margin.
Here is the key of this whole story. The brokers literally own the shares and not you.
If the most volatile stock is now disproportionately part of the assets of your broker the risk of insolvency immediately increases. Brokers can get margin called too. Therefore the DTCC asks to send them more collateral (money) in proportion to the risk that this broker poses.
No moolay because your margin accounts pose a risk? Then no new shares for thee.
This is why brokers such as Robinhood got a credit line of one billion dollars. Well, what’s the solution then, Amin? It’s simple, find a broker with a bigger balance sheet.