Marginal Risk
As the Fed frets, brokers trim lending against some stocks
By JACK WILLOUGHBY
Alan Greenspan may not be willing to do much to curtail the amount of money
that investors are borrowing from their brokerages to buy stock, but the
brokers themselves have been taking action. The Fed dictates that an investor
can't take loans from a brokerage to finance more than 50% of the value of
any stock he buys. If the price of that stock declines by 30% or so, the
borrower usually must put up more cash to keep the loan in force and to
maintain ownership of the stock. Otherwise, the brokerage will sell the shares,
repay itself for the borrowed money and hand the remaining funds, if any,
back to the investor. In recent months, several securities houses have been
tightening the lending limits on scores of stocks, a lot of them highflying
Internet plays.
The stricter lending limits are primarily
intended to protect the brokerages
against losses, though they could also
curb some of the market's more
speculative excesses.
In response to Greenspan's public
expressions of concern about
Americans borrowing heavily to buy stock, Pat Mercurio, chairman of Fleet
Securities' Quick & Reilly clearing operation, recently convened a special
meeting of his credit committee to make sure his operation was in order. "The
message forced all of us to go back and retest our riggings," he says. "We
reviewed our entire risk position because of that exchange. And I'm sure
other firms did, too."
Fleet Securities had already slapped 100% "maintenance margin
requirements' on super-hot issues, such as Akamai Technologies, Juniper
Networks, VA Linux Systems, Qualcomm and Red Hat. This means
essentially that Fleet will not lend customers money to buy these stocks.
As shown on the accompanying table, Fleet has put 65% maintenance margin
requirements on a range of other Internet stocks, including Broadcom,
DoubleClick and Lycos. When customers borrow to buy these issues, they
cannot borrow more than 35% of the market value of the stocks. If they
borrow the full 35% and the stock falls, they have to kick in more cash or
have the position liquidated.
Although Fleet's approach is the most conservative among the firms we
reviewed, figures from Datek, Charles Schwab and Ameritrade also indicate
that tighter margin maintenance requirements have been placed on hot stocks,
particularly Internet issues. "Many of the initial public offerings last year have
had very little float and tremendous volatility," explains John Mullin, president
of Datek.
While all brokerages require a minimum of at least 50% cash when first
buying a stock, the cash level is reduced as the price of a stock falls and the
investor absorbs the losses. On the vast majority of stocks, brokers don't call
in margin loans until the cash portion shrinks to 30% of the value of the
customer's entire position in the stock. But lately brokers have been raising
this 30% limit, called a margin maintenance requirement, on lots of Internet
stocks, as reflected in the table nearby.
Why not raise the initial margin requirement on all
stocks from its current Fed-mandated 50%?
Chairman Greenspan has said that it wouldn't do
any good, and some in the industry agree. "Initial margin is just the table
stakes to get into the margin game," says Jack McDonnell, president of
Ameritrade. "Tinkering with initial margin requirements is not a very effective
way to influence investor behavior."
Still, there may yet be some regulatory changes that make it tougher to buy
stocks on borrowed money. Concern about the matter was raised by the
recent revelation that such borrowings, known as margin debt, have nearly
doubled in the past year to $229 billion. While taking no action itself, the Fed
did ask the Securities and Exchange Commission to study the surge in margin
debt. And Sen. Charles Schumer, the New York Democrat who elicited
Greenspan's comments on margin borrowing in recent testimony before
Congress, has called for the Senate's banking panel to hold hearings on the
matter.
More government oversight is not something Wall Street wants. "What we
don't need is one more tier of margin regulation," says Steven Levine, chief
credit regulator of Dallas-based Southwest Securities and former assistant
chief of credit regulation at the New York Stock Exchange.
The rising margin maintenance requirements could be interpreted as a sign that
the brokers are sure today's Internet darlings are headed for a fall. But they
don't want their customers betting on precisely when that fall will take place.
Fleet, for one, refuses to make margin loans to customers who are selling
short any of the scores of stocks on its list of especially volatile issues.
"There's just so much risk with taking a short position in today's market," says
Leslie Quick, president of Fleet Securities.
Of course, not all of America's margin debt is owed by day-traders. A
substantial portion of it is taken out by professional arbitrageurs who bet on
stock-price movements related to the merger frenzy sweeping the country.
So far, margin losses have been limited, as would be expected with the
popular market averages so strong. But that doesn't mollify critics old enough
to remember a bear market. Former Democratic Congressman Henry Reuss
recalls that William McChesney Martin -- who served as chairman of both the
Fed and the Big Board and whose motto was to take away the punchbowl
before the party got too rowdy -- frequently used margin-rate adjustments to
cool investors' enthusiasm. "I don't understand Greenspan's position," says the
88-year-old onetime member of the House Banking Committee. "Is he inviting
the small investor to borrow so he can be wiped out in the next correction?"
The stakes are higher today than in the Great Depression because back then
only 2.5% of American households owned stocks. Today an estimated 50%
do. Observes Reuss: "A major correction could have a very dangerous effect
on the economy." And on the brokers who hold all those margin loans. That
explains the rush to take precautions.
Barrons on line. |
