Interactive Brokers chairman Thomas Peterffy told CNBC on Wednesday that during GameStop’s trading frenzy, the U.S. financial system was under more stress than is generally acknowledged.
“We have come dangerously close to the collapse of the entire system and the public seems to be completely unaware of it, including Congress and regulators,” Peterffy said in an interview on “Closing Bell.”
Peterffy’s comments came a day before the House Financial Services Committee was scheduled to hold a hearing on GameStop’s epic short squeeze that took place in late January. Among those who will testify are chief executives of stock trading app Robinhood and hedge fund Melvin Capital, who were short-shares in GameStop.
Interactive Brokers representatives will not be part of Thursday’s hearing.
At the height of the trading craze, Robinhood, along with other brokers including Interactive Brokers, placed varying levels of temporary restrictions on GameStop and other speculative stocks, which had become a favorite of users of forums such as Reddit’s WallStreetBets. The moves met fierce criticism from private investors, who argued that it put them at a disadvantage for institutional investors.
But those affiliated with brokers, 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 on Wednesday that the market vulnerabilities stemmed from the fact that there was so much short-term interest in GameStop coupled with large amounts of options activity.
Short selling is a bearish strategy in which an investor borrows shares of a stock and then sells them immediately, hoping to buy back shares at a lower price later. They then return the borrowed shares and take advantage of the difference. When the opposite happens, such as at GameStop, short sellers can try to buy back the stock at the current higher price in an effort to minimize losses.
A call option gives investors the right – but not an obligation – to buy a stock at a predetermined strike price. It is essentially a bet that a certain stock will rise, while short selling is a bet that a stock will fall. Retailers aggressively bought GameStop call options during the Reddit frenzy, which could have the effect of pushing underlying stocks higher when this happens in highly speculative situations.
In the case of GameStop, there was upward momentum from both the short sellers trying to cover and Reddit traders buying the stock directly or calling options in the name. These combined forces helped push GameStop’s stock from less than $ 20 in early January to an intraday high of $ 483 on January 28. The stock is now below $ 50 when the short squeeze ended.
But with no restrictions limiting the upward pressure on GameStop stocks, Peterffy said the situation could have gotten to the point where both short sellers and the market makers acting as intermediaries in options transactions were unable to meet their various obligations.
According to Peterffy, there were particular risks for market makers to meet their options contract requirements if all contracts were exercised. That creates the possibility that “the brokers default on the clearing houses, so you get a complete mess that’s practically impossible to fix, so that’s what almost happened,” he said.
He added that regulatory fixes must be implemented to reduce the likelihood of something similar happening in the future. For example, Peterffy said that companies should report short-term interest rates on a stock on a daily basis, rather than the current requirement of twice a month. He also said, “I think they should increase the margin requirements for shorts by 1% for every person who goes short [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 have to stop immediately.”