Interactive Brokers Chairman Thomas Peterffy told CNBC on Wednesday that the US financial system faced more stress during the GameStop trading frenzy than is generally acknowledged.
“We have come dangerously close to the collapse of the entire system and the public does not seem to be fully aware of this, including Congress and regulators,” Peterffy said in an interview with Closing Bell.
Peterffy’s comments came a day before the House Financial Services Committee convened a hearing to examine the short GameStop epic that took place in late January. Among those to testify are the executives of the Robinhood stock trading app and the Melvin Capital hedge fund, which were short shares of GameStop.
Representatives from Interactive Brokers are not ready to be part of Thursday’s hearing.
At the height of trading mania, Robinhood, along with other brokerages, including Interactive Brokers, placed various levels of temporary restrictions on GameStop and other speculative stocks, which became favored by users of forums such as RedSit’s WallStreetBets. The moves were met with fierce criticism from retail investors, who claimed it put them at a disadvantage for institutional investors.
But brokerage affiliates, such as Robinhood CEO Vlad Tenev and Peterffy, have repeatedly defended the decisions as necessary to comply with various capital requirements and protect the financial system from volatile trading activity.
Peterffy, who founded Interactive Brokers more than four decades ago, said Wednesday that market vulnerabilities stem from such a short interest in GameStop combined with large amounts of options activity.
Short selling is a top-down strategy in which an investor borrows shares from a stock and then sells them promptly, hoping to repurchase shares later at a lower price. Then return the borrowed shares and take advantage of the difference. When the opposite happens, as in the case of GameStop, short sellers can try to buy back the shares at the current higher price, in an attempt to minimize losses.
A call option gives investors the right – but not an obligation – to buy a share at a predetermined selling price. It is essentially a bet that a certain stock will increase, while short selling is a bet that a stock will fall. Retailers during the Reddit frenzy have aggressively bought GameStop call options, which can have the effect of pushing higher base stock when it happens in highly speculative situations.
In the case of GameStop, there was an upward momentum from both short sellers trying to cover and Reddit traders buying direct stock or calling options. These combined forces helped increase the GameStop stock from less than $ 20 in early January to an intraday high of $ 483 on January 28th. The stock is now less than $ 50 as the short pressure is over.
But without restrictions that limited upward pressure on GameStop shares, Peterffy said the situation could have reached a point where both short sellers and market makers serving as intermediaries in options transactions would not have could fulfill various obligations.
There are particular risks for market makers who may meet their contract option requirements if all contracts were exercised, Peterffy said. This creates the possibility for “brokers to engage in clearing houses by default, so you will end up in a complete mess, which is virtually impossible to solve, so it almost happened,” he said.
He added that regulatory solutions need to be implemented to reduce the likelihood of something similar sweating in the future. For example, Peterffy said firms should report short interest rates on a stock daily, instead of the twice-a-month requirement currently in place. He added: “I think it should increase the margin requirements for shorts by 1% for every person who has a short circuit. [a stock]. “
“No one is to blame” for what happened in the GameStop frenzy, Peterffy said. “There is a hole in the system that we need to stop immediately.”