Heading Margins Off at the Pass
By Dan Colarusso
Associate Editor
4/3/00 8:26 PM ET
thestreet.com
Here's the nightmare scenario: The Nasdaq continues to stumble. The momentum that accelerated during the first quarter, as money managers and ordinary investors piled into the same short list of New Economy stocks, goes into reverse.
What could turn a correction (after all, the Nasdaq did shoot from 3000 to 5000 in just four months) into a true nightmare is margin. It's one thing when investors who paid for their shares see values decline. At least some of them will hold on, hoping for a rebound. But people who buy on margin -- borrowing from their brokers to beef up their positions -- can be forced to sell when they get a "margin call," which requires the borrower to put up additional cash immediately.
That can accelerate momentum on the downside. After Monday's record selloff in the Nasdaq, investors are bracing for the morning after. Tuesday morning, margin departments around Wall Street will start their calls to inform clients that they need to make good on loans their brokers made to them to buy stocks. "The notifications will begin and clients will be told they have to meet the calls immediately," says one discount brokerage executive.
He says that on Monday "you could hear the money being lost and the fear" through the telephone. And for good reason. The Nasdaq highfliers that retail investors loved were bleeding from every pore during Monday's massacre. Redback (RBAK: - news - boards) was down 61 1/4 to 238 11/16, more than 20%; Nasdaq poster-child Rambus (RMBS : - news - boards) fell 37 9/16 to 256 15/16; webMethods (WEBM: - news - boards) plummeted 51 to 189. These are the names that have been margined and tomorrow, brokerage firms will need to get paid.
A Schwab spokesman says the firm noticed margin calls were up slightly at the end of last week, and that the firm expected today's Nasdaq decline to produce an increased number of margin calls Tuesday.
It's not as if regulators or the folks who run brokerages haven't been paying close attention. The Securities and Exchange Commission is considering new rules proposed by the New York Stock Exchange and the National Association of Securities Dealers, which owns and runs the Nasdaq exchange, to raise margin requirements for daytraders.
Perhaps more importantly, in recent weeks, many firms have tightened margin requirements and even eliminated margin buying of some shares. "We have hundreds of stocks on restriction now, some we have 60% or 70% margin requirements on," says an executive at a discount brokerage. "And when there are margin calls, it's not like the old days when we gave a client three or four days to pay. Because of the volatility in the market, the money has to be here the next day."
Schwab (SCH:NYSE - news - boards), E*Trade (EGRP:Nasdaq - news - boards) and most other leading online brokers have hundreds of stocks for which they require 60% to 70% of the purchase price in cash in order to buy on margin. There are others that can't be margined at all.
Well before the latest Nasdaq slide, Datek had made it impossible for clients to buy some of the highest of the highflying Internet stocks on margin. Among the stocks on the list were Echelon (ELON:Nasdaq - news - boards), VerticalNet (VERT:Nasdaq - news - boards), JDS Uniphase (JDSU:Nasdaq - news - boards) and NextLink (NXLK:Nasdaq - news - boards)
By the end of Monday's rout, many Nasdaq stocks favored by individual investors had fallen more than 40% since last Monday. And even though New York Stock Exchange member firms talked of curbing the growth of margin debt as the Nasdaq rose so quickly early in the year, margin lending by these firms jumped 9%, to $265.2 billion in February.
So far, the market has always snapped back, easing fears that margin-selling will create an uncontrolled market dive. "People are worried that if Nasdaq stocks fall too far, we'll see forced liquidations. We've been fortunate that the corrections have been short-term," says Dennis Fitzgerald, the co-chief operating officer at Wall St. Access. "Right about the time it gets close to being a dangerous situation, the market snaps back."
Fitzgerald says the same kind of margin use that helped push up some Nasdaq names more than 100% can have the same effect on the downside.
Speaking on a day when Prudential Securities issued a wary research report that crushed B2B Internet favorites such as Ariba (ARBA:Nasdaq - news - boards) and Commerce One (CMRC:Nasdaq - news - boards), Fitzgerald noted that those kind of high-flying stocks could become "hot potatoes." Commerce One ended the day down 24 1/16 to close at 149 1/4, while Ariba fell from 220 to as low at 177 15/16 before rebounding to close at 209 5/8.
He pointed to Commerce One as an example. "I'm sure it's a fine company, but we don't give any advice on how to value it -- it has gone from 9 to 350," he says. "Do you want that stock on a 35% margin? We try to use a certain amount of prudence." Wall St. Access' margin requirements on Commerce One and Ariba are at least 50%, he said. On Monday, anybody holding Commerce One on margin was surely feeling the pain: Commerce One lost 20%, falling 31 1/4 to 118. Ariba, meanwhile had 15% skimmed off its stock price, losing 16 1/8 to close at 88 1/16 Monday.
"Generally, the brokers are pretty proactive," says Russell Keene, an online brokerage analyst for Keefe Bruyette & Woods, a New York investment bank specializing in financial-services companies. "The brokers have more stringent regulations than the Fed and they seem fairly comfortable" with their positions, he says.
What's comfortable for brokers, however, feels a bit constraining for some investors. Jim Hines, of St. Simons Island, Ga., says he's ready to close his Datek account because, he says, the firm changed margin requirements on him twice in one week earlier this month.
Hines didn't like it. "I'm not a maniac. Being able to sensibly use margin is important to me," he says. "Hell yeah, I want to use margin."
There's also the question of whether tighter margin requirements would make a big difference in today's markets. "Intraday, there's a huge risk, especially now that we see stocks that can gap 40% in one day," says Virginia-based money manager David Schultz. "Frankly, the risk we have during trading each day is starting to look as high as overnight risk once did."
Schultz, though, has a warning. "When stocks are going up, everyone thinks volatility is their friend," he says. "Traders that haven't gotten hit in their lives don't realize that volatility isn't just an opportunity to make money, it's an opportunity to get sacked."
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