Investors Dodge a Bullet As Rebound Saves the Day. Online investors appeared to dodge a bullet Tuesday, as a spectacular afternoon recovery rally in the Nasdaq Composite Index saved them from
facing painful margin calls.
But the experience left many shaken.
"I've been actively trading for two years, so
I've seen this before. But days like today,
they're rough on your soul," said Keith Greenwald, who trades stocks
online full-time from his home in Charlotte, N.C.
By Interactive Journal staff reporters Terri Cullen, Aaron Elstein, Carrie Lee and Stacy
Forster
Mr. Greenwald, realizing he'd be facing a margin call from his broker,
E*Trade Group, has sold about 100,000 shares of stock over the last
three days to raise cash.
The recent debate about the impact of margin lending on the financial
markets was brought into stark relief Tuesday as many novice investors got
their first taste of real market volatility.
At its nadir at about 1:20 p.m. EDT Tuesday, the technology-heavy
Nasdaq composite was down 574.57 points, or 13.6%, at 3649.11, its
worst point decline ever and surpassing, in percentage terms, the 11.35%
loss it suffered on Black Monday, Oct. 19, 1987.
The Dow Jones Industrial Average, which has until recently been seen as a
safe haven from the bloodbath in the technology sector, was swept lower
in the sell-off as well, at one point in early-afternoon trading posting a loss
of more than 500 points, as well.
The plunging markets set off a chain-reaction of margin calls among online
investors that many market observers had feared. Online investors have
shown themselves to be more inclined to buy stocks with borrowed
money, or buy on margin, according to Charles Salmans, spokesman for
FleetBoston Financial's discount brokerage unit Quick & Reilly.
Investors can buy stocks with as little as 50% of the purchase price under
the current rules. The brokerage puts up the rest of the money in the form
of a margin loan, and then charges the investor interest on the debt.
Once the stock purchase is completed, an investor's equity -- the current
value of the stock less the amount of the loan -- must be equal to at least
25% of the current market value of the shares. But some brokerage firms
set even stricter standards.
If falling stock prices reduce an investor's equity below the minimum
margin requirement, a broker may require the individual to put up extra
cash or sell some stocks.
As stock prices tumble, investors who are hit with margin calls are forced
to liquidate their stock holdings, which drives down stock prices further.
"Anybody that's caught in this kind of sell-off
on margin is in a lot of trouble," says Norm
Wolff, a market analyst at A.G. Edwards &
Sons.
But a recovery in the market in afternoon
trading rescued many a rattled investor from
facing those calls, he said. The Nasdaq
composite pared its losses to close down just 74.79 to 4148.89, while the
Dow industrials ended the day off 57.09 at 11164.84.
The rise in margin lending follows efforts by regulators and brokerage firms
to curb investor borrowing. Both Federal Reserve Board Chairman Alan
Greenspan and Securities and Exchange Commission Chairman Arthur
Levitt have voiced concern about the use of leverage. Many brokerage
firms also have set higher borrowing requirements for technology stocks
and other volatile issues.
Total U.S. investor margin debt reached a record $265 billion in February,
according to Trim Tabs, a Santa Rosa, Calif.-based firm which tracks fund
industry data, up almost 50% from September.
Indeed, at Charles Schwab, margin calls "were running about twice normal
levels" at the end of last week, says spokesman Dan Hubbard. Given
Monday's sharp Nasdaq decline, "it would be a fair assumption that
[Tuesday] we will be making a higher number of margin calls," he said.
At Ameritrade Holding, margin calls are up roughly 40% to 50% over
average levels, says Kurt Halvorson, president of the online broker's
clearing division. At Datek Online Holdings, margin calls have "been high,
but not what you wouldn't expect given market conditions," says Mike
Dunn, a Datek spokesman.
Merrill Lynch spokeswoman Susan Thompson downplayed the effects of
margin calls on the broker's clients. "Our clients are very well capitalized,
the vast majority of them are capitalized well beyond their margin
requirements," she says. Merrill Lynch requires full-service clients to have
equity equal to 30% of the margin loan. Merrill Lynch Direct, the broker's
online unit, requires 40% for Internet stocks and 30% for all others.
TD Waterhouse spokeswoman Melissa Gitter says the broker had an
increase in margin calls on Tuesday, but that the dollar impact of the
activity wasn't significant. She adds that through midafternoon on Tuesday,
trading volumes were "consistent with what we've seen in the last few
weeks."
Like other brokers, TD Waterhouse has set margin limits on certain volatile
stocks. There are about 300 volatile issues, mostly technology and
biotechnology stocks, which require a higher than normal asset level, up to
50% in assets, rather than the regular 30%. |
