Rise in Margin Debt Spurs Concerns
By DUNSTAN PRIAL
.c The Associated Press
NEW YORK (AP) - A sharp increase in margin debt, the amount of money borrowed by individual investors to purchase stocks, has some analysts worried that the unprecedented levels could exacerbate a market downturn.
''It's a serious subject and it's creating concern because it's really a measure of investor confidence,'' said Alan Skrainka, chief market strategist at Edward Jones, a St. Louis brokerage firm.
''When you see masses of people doing it at once, it says the crowd thinks there's very little chance that stocks are going to go down. But we know from history that stock markets aren't a one-way street,'' he said Thursday.
Even Federal Reserve Chairman Alan Greenspan is expressing concern about the level of margin debt, saying Wednesday during testimony before the Senate that the central bank is studying the matter.
Americans had borrowed $228.5 billion to buy stock as of Dec. 31, 1999, up from $141 billion a year earlier - a 62 percent jump, according to Ned Davis Research, a Venice, Fla., market data firm. In 1990, the figure stood at around $35 billion.
Borrowing accelerated rapidly in the last months of 1999, when the technology-heavy Nasdaq Stock Market was surging upward at an unprecedented rate, said Sam Burns, a research analyst at Ned Davis.
Concerns have surfaced over the buying on margin because a significant market downturn could wipe out hundreds of thousands of debt-ridden investors and exacerbate a widespread selling panic.
Here's how the scenario could unfold, Burns said:
Investors borrow money to buy stock in the hope that the stock will increase in value.
The stock purchased on margin is used as collateral against the value of the loan.
If the stock goes up, everyone's happy because the investor can use the profits to pay back the borrowed money plus interest charged by the lender - usually the investor's broker.
But if the stock price falls, thus lowering the value of the lender's collateral, the lender can make what's known as a margin call, which requires the borrower to put up more cash to ensure that the loan is repaid in full.
Margin calls are usually covered by selling the stock purchased on margin, and that's where things get sticky, according to Burns.
Should U.S. stock markets stumble at some point, hundreds of thousands of margin investors would likely sell stock into an already falling market to pay back their margin loans.
Those margin-related sales would only contribute to a selling panic, Burns explained.
Many historians blame the 1929 stock market crash on widespread margin buying among investors who were then forced to sell stock to pay back their loans when the market tanked.
The Federal Reserve Board, which regulates margin borrowing, currently requires investors to have at least $2,000 in a trading account to buy on margin. In addition, investors are limited to purchasing $2 of stock for every $1 in their account.
On Wednesday, Greenspan said the Federal Reserve was reluctant to exercise its authority to tighten limits on such borrowing, saying that studies have suggested that a rising level of stock prices is unrelated to liberal margin requirements.
The New York Stock Exchange and the National Association of Securities Dealers, which oversees the Nasdaq stock market, are seeking changes that would increase to $25,000 the minimum amount some active traders need to keep in their accounts.
The move is designed to ensure that investors who want to borrow money to buy stocks have plenty of collateral to pay back their debts.
The Securities and Exchange Commissions is also discussing the issue with the Fed, the NYSE and the NASD, said spokesman Chris Ullman, ''to get their perspectives on what is the actual margin situation.''
But not everyone thinks changes are necessary.
Jeff Tappan, the co-founder of MTrader.com, an educational online site for active traders, said margin borrowing has traditionally allowed small investors an opportunity to take a larger stake in the markets.
''It's a very valuable tool because it provides leverage,'' Tappan said. ''Without it, you're playing against a stacked deck.'' |
