UNIDENTIFIED PERSON, BYLINE: This is PLANET MONEY from NPR.
(SOUNDBITE OF COIN SPINNING)
NICK FOUNTAIN, HOST:
MARY CHILDS, HOST:
OK, do you have the app?
FOUNTAIN: I downloaded the app. Market just opened. It's 9:38 a.m. Eastern.
CHILDS: Yesterday, Nick, you had an unprecedented, never-before-seen life event.
FOUNTAIN: I became a father. No, I became a stock trader - kind of. I downloaded what is suddenly one of the most popular apps in America - maybe you've heard of it - Robinhood.
CHILDS: Which, of course, is the stock trading app at the center of the whole GameStop-Reddit wallstreetbets mania.
FOUNTAIN: So I created a stock buying and selling account on the app. I put some money into the app.
Let me make a deposit from my checking account for $50.
And I asked you, Mary, for some help picking a random stock to buy it. Give me a letter A to Z.
FOUNTAIN: So I'm typing N into the app - Netflix. This is a stock I could buy. Norfolk Southern, Norwegian Cruise Line. Wow, has this stock had a wild ride in the past year (laughter). Oh, my goodness.
CHILDS: Oh, bless.
FOUNTAIN: I've never...
CHILDS: So it's at a discount, I assume.
FOUNTAIN: It seems like it. OK, so there's a little button that says trade.
Norwegian is trading at $22.57 a share, which means I, with $50, can buy 2.2 shares of Norwegian Cruise Line stock.
CHILDS: Yeah. Nick, do it. Do it. Lean in.
FOUNTAIN: Swipe up to submit.
FOUNTAIN: Order received. OK.
CHILDS: You're a young investor.
FOUNTAIN: I think I bought a stock. There is confetti all over my iPhone screen right now, Mary.
CHILDS: That's so exciting. So I hate to be the one to break this to you, but weirdly, you do not yet own this stock. There is a delay between this moment, this beautiful moment when it seems like you just bought your stock, and when you actually do own it. And this delay is what sort of blew up Robinhood and the stock market and the Internet last week.
Hello, and welcome to PLANET MONEY. I'm Mary Childs.
FOUNTAIN: And I'm Nick Fountain, proud owner of 2.2 shares of Norwegian Cruise Lines Holdings Ltd. stock - or at least soon-to-be owner, I guess.
CHILDS: Yeah. Today on the show, we're going to follow your trade to explain how an app that lets you trade for free makes money and how that delay between buying a stock and actually owning a stock caused so much trouble.
FOUNTAIN: We are not actually experts in the inner workings of how the stock market works, but we do know someone who is.
ANNIE MASSA: I am Annie Massa, and I'm an investing reporter at Bloomberg News.
CHILDS: And you have a lot of experience covering, like, the stock market's structure, right?
MASSA: I do. I covered for years this beat that was called equity market structure. And most of the time you're like, OK, no one cares. But then something will happen, like whatever happened with Robinhood in the past week will happen, and then it's the biggest story in the nation.
CHILDS: Market structure is the pipes of trading. And much like the pipes in your house, you never think they're that interesting until they explode. And then suddenly, they're the most important thing.
FOUNTAIN: And Annie says before we get to how the plumbing works or doesn't work today, it's helpful to understand how making a stock trade used to work.
MASSA: I mean, you would be calling someone on the phone. You would be calling...
FOUNTAIN: Ring, ring. Ring, ring. Hi, my broker. I would like some of this cruise company.
MASSA: Remember? Yeah, like, that old-school - the telephone.
CHILDS: You would call your stockbroker and say, I want to buy some shares of Norwegian Cruise Lines - whatever. Your broker then calls someone who works on the trading floor at, say, the New York Stock Exchange, who has a weird, hand-wavy negotiation with yet a third person on the trading floor. That third person sells the stock to your broker's person, and then you have bought the stock. And eventually, you can get a physical little piece of paper, a certificate of ownership.
FOUNTAIN: And because the whole process was so labor intensive back then, making a trade cost a lot of money.
MASSA: So your broker would be charging you a commission. And commissions used to be - I mean, they could be $75, and that was, like, a discount broker.
MASSA: You know, the broker is charging you for going through the trouble of purchasing these shares on your behalf.
CHILDS: And because this was so expensive, there was plenty of room for people to offer cut-rate services, to come up with cheaper ways to buy and sell stock, and then people would flock to that.
FOUNTAIN: So a bunch of companies came in and automated different parts of the process. You might have heard of Nasdaq. This was this new, mostly electronic stock market exchange that was sort of automating that room full of guys waving their arms and turning it into computers matching buyers and sellers.
CHILDS: And then online stock brokerages started to pop up, companies that let ordinary people buy and sell stocks for much lower fees. Many of these companies are NPR sponsors, we should note - TD Ameritrade, E-Trade, which had a very famous tagline.
MASSA: So easy a baby could do it. You know, that's the whole idea.
FOUNTAIN: Right. And at - like, how much would it cost?
MASSA: By then, let's say, like, somewhere in the ballpark of 20 bucks.
CHILDS: That's, like, crazy.
MASSA: And then, I mean, like, over the next decade, it would come down to, like, 10 bucks and then seven and then five and then just, like, you know, completely nothing.
FOUNTAIN: Completely nothing, which how is that possible? How is it possible that a company like Robinhood could make money by letting people trade stocks for free, no fee? How is that even a business?
CHILDS: To explain how, we asked Annie to walk us through that stock trade that Nick made yesterday morning.
MASSA: Maybe that was your first trade, and you get a little confetti burst and you're like, hooray. Like, now I own this share of stock.
FOUNTAIN: I got the confetti, yup.
MASSA: You got the confetti, yes.
MASSA: You love it. OK, so that all looks very simple. And you're like, now I own this share of stock. What's going on - or at this point, two shares of stock, as it might be (ph).
FOUNTAIN: Two point two. Two point two.
CHILDS: Two point two.
MASSA: Two point two, oh.
CHILDS: Nick is very rich, I should point out.
MASSA: (Laughter) OK, big spender. So what happens behind the scenes, though, is actually a little bit more complex.
FOUNTAIN: Annie says Robinhood or pretty much any of these trading services, they are not in the business of executing these trades. Instead, when I pressed buy, they sent my order to these other companies that are actually in the business of making the trades happen.
MASSA: It's actually going to some kinds of firms that maybe you haven't heard of or maybe aren't, like, that widely known or sound a little scary, like Citadel Securities or Wolverine or Virtu Financial.
CHILDS: Citadel Securities, by the way, is a sister-ish company of a hedge fund called Citadel LLC that was also part of the wallstreetbets drama last week - a different part of it. But they're separate, and the key actor for this story is Citadel Securities. So...
FOUNTAIN: Don't @ Mary, wallstreetbets.
CHILDS: Really anyone, just don't @ me.
The key to understanding how Robinhood makes money without charging you, Nick, is because of companies like Citadel Securities. These companies pay Robinhood for the privilege of executing your stock order and the orders of millions of other Robinhood users.
FOUNTAIN: So, for example, when yesterday morning I put in my order to buy 2.2 shares of Norwegian Cruise Lines, Robinhood sent my order to Citadel Securities or one of these companies, and that company paid Robinhood. And this seems backwards, right? Citadel Securities is the one doing the service for Robinhood. Robinhood should be paying Citadel Securities.
CHILDS: So here's why Citadel Securities was willing to pay to execute your trade. The company is in the business of matching people who want to buy stock with people who want to sell stock. They're basically middlemen. And they make money when there is, like, a little, tiny, one-cent difference between what a buyer is offering and what a seller is asking. They want to buy that stock and then immediately turn around and sell it for a tiny profit.
FOUNTAIN: Now, Citadel Securities and other companies like them, they don't just make money off traders like me. They also make money executing trades for big institutions. Think hedge funds, pension funds, whatever. And there's a lot of money in that, but it's riskier.
CHILDS: Because hedge funds and pension funds, et cetera, have a lot more information than people like Nick, people who just want to buy a stock that starts with the letter N. So often, all of the high-information traders will be taking one side. They'll all be, say, selling.
FOUNTAIN: And Citadel Securities needs people on both sides of the trade. They need buyers and sellers. So they pay Robinhood to basically get random trades from randos like me.
CHILDS: So is it basically that - not to be unkind to Nick here, but is it basically that Nick is a little dumber than a lot of the other traders? I'm so sorry, Nick.
FOUNTAIN: No, it's fine.
MASSA: Nick, I would never say you were dumb. But since your colleague did...
MASSA: ...You might be dumber than the hedge funds and the big institutions that a lot of - you know, with these behemoth trades to make. So you might be a little dumber than that money.
CHILDS: One other thing about trades from people like Nick - the trades are way smaller. These behemoth institutions that buy and sell millions of shares at once can have a dramatic effect on the price of a stock. So when a middleman like Citadel Securities tries to get in the middle of those giant trades, they can end up losing money. So that's why firms like Citadel Securities pay Robinhood to get in between you, Nick, and the rest of the market. By the way, Citadel Securities declined to comment for this episode.
FOUNTAIN: OK, we did it. We told the story of how we got from a world in which trading stocks meant high fees to low fees to no fees - because someone made a fraction of a penny off my trade and paid Robinhood for the privilege. The question is, should I feel bad about that?
CHILDS: I mean, not really. Like, you bought $50 worth of Norwegian Cruise stock with essentially no fee. In the olden days, you would've paid $75 to buy it on top of the price of the stock. So which do you rather?
FOUNTAIN: The answer is obvious. I love cheap stuff. I love free stuff even more, even when I am the product.
(SOUNDBITE OF MARC FERRARI AND MATT HIRT'S "TUMBLEWEEDS")
CHILDS: (Laughter) So, Nick, now the trade is done, and we get into that weird delay between when it seems like you bought the stock and when you actually own the stock. And that delay is about to be a big deal. That's after the break.
(SOUNDBITE OF MARC FERRARI AND MATT HIRT'S "TUMBLEWEEDS")
FOUNTAIN: OK, so I bought the stock, right? It says right here on my app. There is confetti. But actually, I don't own this stock yet.
CHILDS: You won't actually be the owner of the stock for two days. And that two-day delay explains why last week, Robinhood poop emoji-ed the bed emoji.
FOUNTAIN: In the jargon, the trade has been executed. The seller and I agreed on the deal. But I have not actually paid the seller yet, and the seller has not actually given me the stock. Again, in the jargon, the trade has not been settled yet, and it won't be settled for two business days.
CHILDS: So some of the reasons for this are kind of antiquated. They have to do with the world that we described earlier where there were paper stock certificates that changed physical hands. Sellers had to deliver the stock certificate to the buyer, and the buyer had to transfer the money to the seller. And all of that could take days.
FOUNTAIN: OK, so back to my trade of Norwegian stock. Me and my stock are in this limbo where I've executed the trade, but I don't own it yet and I haven't paid for it yet. And this creates some risk, right? What if in two days the seller shows up with the stock, but I suddenly decide that I do not want to pay? That would be bad for the seller.
CHILDS: And if this does happen, there is a system in place to prevent disaster. All the brokerages get together and agree to post money to guarantee that they'll make good on the trades, even if people like Nick change their minds and decide to bail at the last minute. Classic Nick Fountain.
FOUNTAIN: And the more people who are trading, the crazier the day is, the more stock prices are moving around, the more money brokerages have to post to guarantee the trades. These guarantees are put into what's called a clearinghouse. And there's basically one clearinghouse for the entire stock market.
CHILDS: And last week, very suddenly, the whole Internet was trading on Robinhood. Hundreds of thousands of people were downloading the app, and the stocks they were trading - GameStop, AMC, yada, yada - were swinging all around.
FOUNTAIN: Annie says a crucial part of this story happened last Thursday in the middle of the night. We know this because Robinhood's CEO, Vlad Tenev, has talked about it.
MASSA: And he was, like, asleep. It was like 3:30 a.m. Pacific time. And all of a sudden...
CHILDS: Robinhood gets this demand from that clearinghouse, the one that tells companies like Robinhood every day how much money they have to post to guarantee their trades. In an interview on social media, Vlad said how much money they were demanding from Robinhood.
(SOUNDBITE OF ARCHIVED RECORDING)
VLAD TENEV: And the request was around $3 billion, which is, you know, about an order of magnitude more than what it typically is.
FOUNTAIN: That's like 10 times the normal amount. And Vlad, Robinhood - they do not have $3 billion lying around, and they need it before 7 a.m. Pacific, 3 1/2 hours.
CHILDS: So remember, the more Robinhood users are buying the stock and the more that stock is moving around, the more money Robinhood has to put up at the clearinghouse. So Robinhood is thinking, what can we do so we don't have to put up so much money at the clearinghouse, so much money that we don't have?
FOUNTAIN: And they decide they're going to temporarily block their users from buying stock in GameStop and a few other of those super volatile companies so that they don't have to come up with that $3 billion right then.
MASSA: By shutting off the spigot and by preventing people from putting new buy orders in for a while on those stocks, they were able to lower that risk a little bit. They were able to bring down the temperature a little bit.
CHILDS: So just to recap, because of that two-day delay between when you execute the trade and when the trade settles, companies like Robinhood have to post money to a clearinghouse to make sure you're good for the money. And when GameStop shares went wild last week, the clearinghouse demanded more money than Robinhood could come up with, so Robinhood temporarily blocked people from buying shares of GameStop.
FOUNTAIN: To bring down the temperature a little bit. But when Robinhood did this, the Internet exploded in a fiery rage because buying and buying and buying was the way Internet stock traders thought they were pumping up the stock. And so when Robinhood stopped letting people buy, everybody on Reddit and also some prominent members of Congress were like, this is market manipulation on behalf of your hedge fund cronies - or something like that.
CHILDS: It wasn't just Robinhood. Other brokerages had the same problem and did similar things. And to be clear, there is no evidence that it was market manipulation on behalf of any hedge fund cronies. It was just this weird thing that happened because Robinhood and some of these other brokerages couldn't come up with the money overnight.
FOUNTAIN: The next day, Robinhood found some extra money to post to the clearinghouse, and they did start to allow some trading of the stocks in question, but the damage had been done. Lots of people are now suing Robinhood. Robinhood declined to comment.
CHILDS: Vlad Tenev, the CEO, wrote a blog post yesterday trying to spin all this forward. He said, listen; the problem you all had last week - if you're looking for something to blame, it's definitely that two-day waiting period between execution and settlement. That waiting period is not necessary, he says. The world has computers. What if we all get together and come up with a new system where when you make a stock trade, you own the stock just as soon as you see the confetti on your screen?
(SOUNDBITE OF ROBERT JAMES AITKEN'S "BAYOU RISING")
FOUNTAIN: If you want to invest in PLANET MONEY, we do not sell stock. One way to help us is, weirdly, to buy swag. We have T-shirts and tote bags available at the NPR shop - shop.npr.org/planetmoney. That's shop.npr.org/planetmoney.
CHILDS: If there is something happening in the world that is not GameStop, please let us know. Send us an email - firstname.lastname@example.org. We're also on Instagram, Twitter, Facebook, TikTok, yada, yada.
FOUNTAIN: Today's show was produced by the great James Sneed - thank you, James - also engineered by Gilly Moon. PLANET MONEY's supervising producer is Alex Goldmark. Our editor is Bryant Urstadt. Today's show was edited by Jacob Goldstein. I'm Nick Fountain.
CHILDS: And I'm Mary Childs. This is NPR. Thanks for listening.
(SOUNDBITE OF ROBERT JAMES AITKEN'S "BAYOU RISING")
FOUNTAIN: Speaking of that beautiful confetti, Norwegian, as we record this, is a little bit higher than what I bought it at. It's at...
FOUNTAIN: Yeah, I bought it at 22.57, and now it's at 23.43.
FOUNTAIN: It sort of, like, ticks and goes up and down because the stock market. So I don't know. Should I try selling it?
CHILDS: Nick Fountain, day trader. I think you should sell it. I think we should really - we should lock in these profits for the PLANET MONEY Capital LLC. We're finally turning around the fortunes of PLANET MONEY's investing track record.
FOUNTAIN: All right, I'm going to click sell. It's weird to me because we just did a story about how it takes two days for me to own the stock, but I bought it yesterday morning. But order received. Order completed. So I sold the stock that I bought for $50 for $1.94 more.
CHILDS: Nick, I think you just made almost two whole dollars for never owning anything at all.
FOUNTAIN: I am the next Warren Buffett. What can I say?
CHILDS: This is not investing advice.
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