Margin Debt Set a Record
In January, Sparking Fears
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
The amount of debt that investors took on to buy stocks in January shot up
to another record even as the value of stocks fell, raising fresh concerns
about speculative activity on Wall Street.
It is a staggering statistic: Such debt -- known as margin buying -- rose 7%
among New York Stock Exchange-member brokerage firms, to $243.5
billion in January. Margin levels are now up 36% since September.
The worry? This debt load could magnify any fall in the stock market, as
selling from investors who are forced to meet margin calls exacerbates a
decline.
A somewhat comforting thought -- at least on
a relative basis -- is that much of this piling on
of debt isn't being done by the proverbial guy
on the street. In fact, what is driving it appears
to be not an increase in leverage by the
average investor, but an increase in activity by
investors who already like to use leverage.
Anecdotal accounts suggest the extra debt has
been taken on primarily by a small portion of
investors who trade fast-moving technology
stocks, whose value has skyrocketed in the
past 12 months, and by hedge funds, big investment pools for wealthy
individuals who often use leverage to maximize returns.
At Dallas-based Southwest Securities Group Inc., for example, which
clears for many day-trading firms, whose customers trade in and out of the
same stocks all day from sophisticated workstations, saw margin debt rise
about 35% in the final six months of 1999 to $900 million, said Eddie
Anderson, executive vice president of operations.
But equity in the accounts, he says, remained steady at 49%. That means
about half of the stocks of the average Southwest customer with a margin
account was backed with borrowed money, significantly above the national
average. Mr. Anderson said the rise in margin debt was due not to
customers becoming more leveraged, but to "the volume and the
investment activity in the market in general."
So why the jitters? Margin lending has historically moved in tandem with
the market's value. The recent burst of margin borrowing in the market has
been more alarming because it has outrun the rise in stocks' value, which
actually fell 4% in January and is up just 13% since September. That
indicates a rise in leverage.
Margin debt now equals 1.57% of market value, equal to its peak in the
fall of 1987 ahead of the October 1987 stock-market crash, according to
Bianco Research, although different market value measures suggest the
ratio was somewhat higher in the early 1980s. By comparison, that ratio
approached 30% in 1929.
Under the Federal Reserve's Regulation T, an investor may make up to
50% of an initial stock purchase with borrowed money. Thereafter, he or
she may let the portion of debt rise no higher than 75% of the value of the
stocks in the account.
"There's no fear among individual investors," said Charles Biderman, chief
executive of TrimTabs.com (www.TrimTabs.com), which tracks flows of
money in and out of the securities markets. "They can't imagine that stocks
can go down or they wouldn't be borrowing this heavily."
"That's how you get those panic plunges," said Fred Hickey, editor of High
Tech Strategist newsletter. "When we bottomed in October 1998, it was
on a panic selling margin calls."
Many economists play down the rise in margin debt, noting it remains tiny
relative to stock values and even other types of debt, which are also rising
briskly. Consumer credit stood at $1.4 trillion and mortgage debt at $4.5
trillion in December, both up 10% from a year earlier, according to the
Fed.
At Charles Schwab Corp., the country's largest discount broker, margin
debt has risen only slightly to 2.3% of customer assets at the end of
December from 2.2% at the end of June (although 39% of those assets are
mutual funds).
Regulators have watched the spike upward in margin debt with concern.
Securities and Exchange Commission Chairman Arthur Levitt, in a speech
Saturday, said, "In too many cases, investors are focusing on the upside --
without carefully considering the downside." The SEC recently launched a
study of the issue and is consulting with the Federal Reserve, the Treasury
Department and the Commodity Futures Trading Commission.
People familiar with those discussions said nothing has been decided, but
the latest data will likely accelerate deliberations. Most of the regulators
are skeptical about additional government action, and Fed Chairman Alan
Greenspan, although acknowledging concern, has specifically ruled out
curbing the level of borrowing allowed for buying stocks. The most likely
action from Washington, if any, would be more jawboning by officials, as
well as prodding the exchanges and firms to further limit borrowing activity
in the most volatile stocks. In December, the NYSE and National
Association of Securities Dealers proposed stricter margin requirements
for day traders only. The proposal awaits SEC approval.
Still, the focus on individual borrowing may overlook rising leverage among
professionals such as hedge funds. Not since 1929 has a market collapse
been attributed to overleveraged individuals, historic accounts suggest. By
contrast, 1998's stock plunge was fueled by the near collapse of
Long-Term Capital Management and other hedge funds and the October
1987 crash was aggravated by professionals trading stock-index futures.
Just two weeks ago, the bond market went wonky as the Treasury's bond
buyback plan whipsawed leveraged dealers and hedge funds.
Although margin debt rose 25% from the third to the fourth quarters of
1999 at Schwab, it rose an even sharper 33% at Bear Stearns Cos. As the
country's largest trade-clearing broker, Bear Stearns handles margin
lending for many smaller brokerage firms. It also lends to hedge funds;
indeed, slightly more than half of its clearing business is for institutions such
as hedge funds.
Richard Lindsey, co-president of the firm's clearing unit, said the rise in
margin debt reflects rising value of the stocks in the accounts, not increased
leverage. Furthermore, "We, like many firms, over the past year or so have
raised margin requirements on some of the highfliers." Schwab initiated a
list of 22 volatile stocks requiring stricter margin requirements in November
1998, and it has since grown to more than 200, a spokesman said.
Still, Bear Stearns's Mr. Lindsey said the firm saw more borrowing by
individual investors than hedge funds in the latest quarter. Furthermore,
many hedge funds borrow through "joint back offices" with brokerage
firms like Bear Stearns, thereby obtaining higher leverage that doesn't
appear in margin data.
Some of the rise in household margin borrowing, rather than financing
stock speculation, might be financing consumer purchases through checks
and debit cards drawn on brokerage accounts. Mr. Biderman says a
divorced acquaintance used his margin account in December to make a
payment to his ex-wife. Unfortunately, his position in Internet stock CMGI
Inc. went against him, forcing him to sell some in January.
Christine Callies, market strategist for Credit Suisse First Boston, worries
the economy could take a blow if leveraged investors are forced to
liquidate rapidly. "The particular type of people that have leveraged up
recently seem to be very excitable. We can guess these guys aren't
leveraging up to buy AT&T. As interest rates go up, they have to shoot for
higher returns to pay the service on the debt."
Jim Willsie, a retired engineer in Clearwater, Fla., can attest to that. If a
stock he owns falls, he'll often double his holdings for the day with
borrowed money, on the theory the stock need only retrace half its drop to
break even. But if it doesn't come back, and "You're losing somebody
else's money, it hurts twice as much. That's when the panic sets in." Last
summer he lost about $5,000 when he bailed out of Internet highflier Ask
Jeeves Inc., only to watch it bounce right back.
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