Robinhood offers loans to buy stock — they were 14 times more likely to default

Online brokerage Robinhood touts its willingness to lend money to customers so they can multiply their returns just like Wall Street pros, even likening investing with borrowed money to the thrill of riding a motorcycle. What the company doesn’t say is that its lending strategy has put clients — who tend to be younger and less experienced at playing the market — in financial peril even before many piled into the shares of struggling video game retailer GameStop in January.

Robinhood’s lending so customers could “buy on margin” — in which someone takes out a loan to buy stock, options or other securities — more than doubled in the first six months of 2020, all too often with negative results. Regulatory filings reviewed by CBS MoneyWatch show that investors who borrowed money from Robinhood were nearly 14 times more likely to be unable to repay the loans than investors who borrowed from rival brokerages eTrade, TD Ameritrade and others.

“The margin loans amplified the purchasing power and the ability of those investors to drive up GameStop’s stock price,” said Joshua Mitts, a professor of securities law at Columbia University, when informed about Robinhood’s loan-failure rates described in the regulatory filings. “What people are so upset about is that it was Robinhood’s own risky lending practices that limited its customers’ ability to trade and undermined investors’ confidence in the fairness of the market.”

Experts also say Robinhood’s aggressive lending may have helped inflate the bubble in GameStop shares that caused the stock to soar 2,800% in a matter of days — a spike they say could end up costing individual investors billions of dollars as it returns to earth. The frantic trading in GameStop and other shares driven by Reddit group WallStreetBets also led to a cash crunch at Robinhood, leading it to raise $3.4 billion in new capital.

The speculative spasm has been large enough to rock financial markets. Congress is investigating. Robinhood CEO Vlad Tenev is expected to testify in a hearing of the House Financial Services Committee in mid-February.

Robinhood, through a spokesperson, declined to comment on the firm’s margin loan practices.

“Extra buying power”

On its website, Robinhood says that buying on margin offers customers “more flexibility, extra buying power and less time waiting to access” their account. For just $5 a month, users can borrow up to $1,000 for investment purposes. For anything above $1,000, investors have to pay an annual interest rate on the loans. In mid-December, just weeks before the WallStreetBets craze, Robinhood cut that annual rate in half to 2.5%, making it even cheaper to borrow.

Sources close to Robinhood told CBS MoneyWatch that the trading app’s lending strategy isn’t any riskier than that of its competitors. In addition, RobinHood stopped making loans to purchase shares of theater chain AMC Entertainment, whose shares also surged after being touted on WallStreetBets, on January 25, two days before the biggest jump in the stock, according to sources close to the company. 

Robinhood also tightened the lending requirements to buy GameStop shares last week to just 20% on margin, limiting the potential for amplified loses if the stock were to go down. The trading platform then halted margin loans to buy the retailer’s shares, as the company’s stock price was peaking around $480

Sources close to Robinhood also said stock lending wasn’t a key factor in a capital shortfall that caused Robinhood to curtail the purchases of certain stocks that had put the brokerage…