Interactive brokers chairman Thomas Peterffy told CNBC on Wednesday that the US financial system was more tense during the GameStop trading spirit than is generally acknowledged.
“We have come dangerously close to the collapse of the whole system and the public seems to be completely unaware of it, including Congress and the regulators,” Peterffy said in an interview on ‘Closing Bell’.
Peterffy’s remarks come one day before the House Financial Services Committee will hold a hearing on the epic short print on GameStop that took place in late January. Among those who will testify are general managers of the app app Robinhood and the hedge fund Melvin Capital, which were short shares of GameStop.
Representatives of Interactive Brokers are unlikely to be part of the hearing Thursday.
At the height of the trading mania, Robinhood, along with other brokers, including Interactive Brokers, has placed different levels of temporary restrictions on GameStop and other speculative stocks, favored by users of forums like RedStit’s WallStreetBets. The investments have received fierce criticism from retail investors, claiming that it harms institutional investors.
But those associated with brokers, such as Robin Ten CEO Vlad Tenev and Peterffy, have repeatedly defended the decisions as necessary to meet different capital requirements and protect the financial system in the face of volatile trading activities.
Peterffy, who founded Interactive Brokers more than four decades ago, said on Wednesday that the vulnerability of the market stems from the fact that there is so much short interest in GameStop along with large amounts of options.
Short selling is a clumsy strategy in which an investor borrows shares in a stock and then sells them immediately, hoping to buy back shares later at a lower price. They then return the borrowed shares and earn the difference. If the opposite happens, as with GameStop, short sellers could try to buy back the stock at the current higher price in an effort to limit 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 raising the underlying stock higher than it does in many speculative situations.
In the case of GameStop, there was an upward momentum from both the short sellers trying to cover, as well as Reddit traders buying the shares straight or buying options in the name. Together, these forces helped push GameStop stocks up from less than $ 20 in early January to an intraday high of $ 483 on January 28th. The stock is now less than $ 50 after the short print ended.
But without restrictions limiting the upside pressure on GameStop shares, Peterffy said the situation could get to a point where both short sellers and the market makers who act as middlemen in option transactions could not meet their different obligations.
There were particular risks for market makers to meet their option contract requirements if all the contracts were to be exercised, Peterffy said. This creates a possibility for ‘the brokers who default the cleaning houses so that you have a complete mess that is practically impossible to sort out, so that’s what almost happened,’ he said.
He added that affirmative action corrections should be implemented to reduce the likelihood that something similar will happen in the future. Peterffy, for example, said that businesses should report a short stake in a stock on a daily basis, instead of the required twice a month. He also said: ‘I think they should increase the margin requirement for shorts by 1% for every person who shorts [a stock]. “
“No one is to blame” for what happened in the GameStop frenzy, Peterffy said. “There’s a hole in the system that we need to stop immediately.”