Margin Debt Is an Issue Everywhere Except at Fed: Caroline Baum(Commentary. Caroline Baum is a columnist for Bloomberg News.The opinions expressed are her own.)
New York, March 30 (Bloomberg) -- While it hasn't made the
cover of Time Magazine or Business Week just yet, margin debt is a
hot issue.
Margin debt is the amount of money borrowed, in this case
from New York Stock Exchange member firms, to buy stocks. In the
last four months, from October through February, margin debt
exploded by 45 percent, fast enough for our elected
representatives in Washington to act concerned. A House Banking
Subcommittee held an initial hearing on the subject last week
while New York Democratic Senator Chuck Schumer has been leading
the charge for the Federal Reserve to raise initial margin
requirements on the other side of Capitol Hill.
By law, the Fed sets initial margin requirements, or the
minimum amount an investor must deposit with a brokerage firm in
order to buy stocks on credit. It's been at 50 percent since 1974.
Brokerage firms require maintenance margin on an account as well,
which tends to be higher than the minimum set by the Fed.
When asked, Fed Chairman Alan Greenspan has a pat answer as
to why raising margin requirements would not curb speculation in
the stock market, thereby containing the wealth effect, which is a
stated Fed goal.
``The problem that I have had with the issue of moving on
margins is ... that there is no evidence to suggest that changes
in margin requirements up or down in the years prior to 1974, when
we did move them, had any effect on prices,' Greenspan
said in the Q&A following his semi-annual monetary report to
Congress on Feb. 17.
Empirically Unsound
His other objection is that it would penalize small
investors, who have ``no alternative means of financing' their
stock purchases.
Paul McCulley, an economist by training and a portfolio
manager at the Pacific Investment Management Company in Newport
Beach, California, had rejoinders to both those objections when he
testified before the Domestic and International Monetary Policy
Subcommittee last week. After pointing out the drastic differences
in the Old, pre-1974 Economy, where the Fed set ceilings on
deposit rates, and today's New Economy, McCulley said that ``there
are no data points on the effect of changes in margin requirements
under the de-regulated, capital markets-driven financial system of
today.'
Privately, McCulley said that if he ever tried to convince
colleagues of the soundness of an argument based on a study that
was at least 26 years old, ``I'd be laughed off the trading
floor.'
Yale University professor Robert Schiller, author of a new
book entitled ``Irrational Exuberance,' concurred.
``It would seem highly unlikely that, if these margin
requirements were set at the `optimal' level in 1974, they are
still at the right level in 2000,' Schiller told the Banking
Subcommittee.
Small Advantage
As far as the question of increases in margin requirements
being discriminatory to small investors, McCulley had a simple
retort: eliminate them.
Advantage McCulley (although the ball is in Greenspan's
court).
Margin requirements do have a symbolic value, however. ``They
serve as a symbol of concern about the dangers of investing on
margin to individual investors,' Schiller said.
For that reason, alone, ``there may be some small advantage
to raising margin requirements ... as a way of dealing with an
overheated market,' Schiller testified.
Just to put things into perspective, margin debt in February
stood at $265.2 billion, which is 1.53 percent of total U.S.
equity market capitalization. While the ratio may sound small,
it's the highest since at least 1965.
Volume Indicator
The subject of margin debt and requirements crops up almost
daily in the press. Don't be fooled by the press coverage: there
is no sense of urgency about this issue at the Fed.
How do I know? You can always tell what's on the chairman's
mind by the quantity of research being produced by the Federal
Reserve System. (While each of the 12 Federal Reserve District
Banks has its own research director and research staff and do not
report to Greenspan, one imagines that his concerns carry much
sway in the system.) When the chairman was concerned about the
inexplicable weakness in the broad monetary aggregates in the
early 1990s, his consternation was reflected in the huge number of
working papers on the subject.
A keyword search of the FRB's Index of Economic Research,
which encompasses publications of the entire Federal Reserve
System, produced just one result for ``margin requirements' since
1997: a San Francisco Fed Economic Letter, dated March 24, 2000,
entitled, ``Margin Requirements as a Policy Tool.'
Not surprisingly, the letter draws the same conclusion as Mr.
Greenspan. Raising margin requirements won't do any good because
1) investors use stock index futures, which are subject to
relatively low margin requirements set by the futures exchanges,
to speculate on the stock market; and 2) investors can substitute
other types of credit -- home equity loans, for example -- for
margin credit, so it wouldn't do anything to damp speculation.
Now Hear This!
Anybody heard of announcement effect? There is a cottage
industry of economists -- so-called Fed watchers -- paid to
interpret every double-negative the chairman utters. Trading in
the financial markets, not just here but around the globe, comes
to a halt in anticipation of a Greenspan speech or testimony,
which has the ability to roil the markets. Imagine what bold
action would do.
Alas, using the volume-of-research rule, margin debt and
margin requirements are not in the forefront of Mr. Greenspan's
pate. Listen to what he had to say in response to Senator
Schumer's question at Greenspan's Jan. 26 reconfirmation hearing.
``I don't want to suggest that we're about to do anything at
this stage, but I would confirm that we obviously are doing a good
deal of thinking about the whole process,' Greenspan said.
Thinking is about a dozen working papers shy of action.
--Caroline Baum in the New York newsroom (212) 893-3369/lw
Story illustration: To graph margin debt, click on
{MARGDEBT <Index> GP <GO>}. To graph margin debt as a percentage
of total market cap, click on {.DEBTCAP <Index> GP <GO>}. |
