Margin debt, once a dirty word, is now passe
01:31 p.m Dec 19, 1999 Eastern
By Elizabeth Smith
NEW YORK, Dec 19 (Reuters) - As U.S. share prices surge to near record highs and investors borrow more to expand their portfolios, experts seem unfazed by the rocketing growth of the new debt in an era when such economic data is closely examined for clues about the sustainability of the long-booming market.
``Yes it's (margin debt) growing like gangbusters, but you are starting with something that was tiny to begin with,' said Steve Slifer, chief U.S. economist for Lehman Brothers. ``It is really a tiny piece of consumer debt in total.'
Margin debt, a brokerage's loan to investors collateralized by shares they own, indeed has mushroomed.
By the end of October, the New York Stock Exchange said, margin debt held by its member firms had shot up to $182 billion -- roughly 2 percent of the U.S. gross domestic product.
But in 1998, the amount investors borrowed to buy stocks on margin edged up only 2.3 percent from 1997 to $130 billion from $127 billion. At the start of decade, margin debt stood at $30 billion for NYSE firms.
ECONOMISTS UNRATTLED BY MARGIN DEBT IMPACT ON MARKET
Measuring fallout from margin debt is tricky because no good numbers exist to track other forms of debt flowing into the stock market, Slifer said. One reason is that consumers applying for bank loans need not always reveal what they are doing with the money.
Even if margin debt is growing at an alarming pace, other economic aspects would offset the extent of any market fall, said John Puchalla, an economist at Moody's Investor Services Inc.
Steadily climbing corporate earnings, increasing U.S. exports and an abundance of cash in corporate coffers to buy back company stock are some of those factors, Puchalla said.
``Any time there is an increase in margin debt, there is some
concern,' Puchalla said. ``But we don't think it will be the straw
that broke the camel's back in terms of this long economic
expansion.' MARGIN DEBT WAS ONCE AN
IMPORTANT FINANCIAL GAUGE
The Federal Reserve Bank once deemed margin debt so critical
a measure that it fought to control how much cash brokerages
could lend to clients.
In 1934, The U.S. Congress gave the Fed the authority to
oversee margin debt. Today, the U.S. central bank maintains
control over margin requirements, but is less concerned with
margin oversight.
Margin lending became a sullied practice in popular culture in
the wake of the 1929 market, when some ruined speculators
committed suicide when unable to make good on their margin
calls.
A margin call occurrs when a firm demands a margin-borrower
pay back the debt. If borrower needs to sell stock in order to
do so, the added selling pressure in the market can exacerbate
a market decline.
Prior to the 1929 market crash, investors could put up only 10
percent of the total cost of stocks, margining 90 percent of the
costs.
The Fed deemed margin regulations a useful monetary tool to
curb speculation up until the 1980s. But with the advent of
home equity loans and credit cards, margin debt became a less
important indicator of investor debt and, setting limits on it, a
less valuable tool.
``Margins (limits) have an important role in ensuring the
soundness and safety of lenders, but we have doubts about the
effectiveness of margins for limiting ability to leverage,' a
Federal Reserve spokesman said.
``Although in 1934, many investors had no other means of
borrowing funds to invest in securities, today investors have
many alternatives,' he said.
The Fed has not changed its minimum margin level requirements
since 1974. As it stands today, people would have to put up 50
percent of the assets to take a position in a stock on margin.
If an investor with $2,000 in cash or stock -- the minimum to
open a margin account -- he can borrow up to $2,000 in cash
from his broker. If the stock's value drops to $2,000, the
investor must sell off his holdings, or come up with the cash
elsewhere, to repay the brokerage firm.
SOME CONCERN STILL EXISTS OVER MARGIN
DEBT
The top U.S. stock markets have started to show some
concern about rising levels of margin debt. At the urging of
member firms, the New York Stock Exchange and the National
Association of Securities Dealers, NASDAQ's parent, are
seeking to tighten margin requirements for so-called day
traders.
Day traders, who buy and sell shares quickly, and within a
single day, are a driving force behind the dramatic price swings
seen mostly in highly-valued, volatile Internet stocks.
The NYSE and NASD proposals, which have been submitted
to the Securities and Exchange Commission for clearance,
would mandate that day traders keep at least $25,000 in their
margin accounts, compared with current $2,000 minimum for
ordinary investors.
Charles Schwab Corp., the No. 1 U.S. discount brokerage,
has worked to rein in its exposure to margin debt since
November 1998, when it first tightened margin levels required
for certain stocks.
Schwab upped maintenance margin rates for certain stocks to
70 percent. Thus, customers must put up 70 percent of the
amount to keep investing in the stocks Schwab deems risky.
The online brokergae went a step further recently and decided it
would not lend any money to clients to invest in certain stocks
such as Internet venture capital firm CMGI Inc. . CMGI's stock
price opened 1999 at nearly $29 per share, and has
appreciated nearly 730 percent to trade recently at about $220.
``We did that primarily to protect the interests of the firm ... ,'
Schwab spokesman Dan Hubbard said. ``This is something we
always keep an eye on. Are we worried about it? No.'
Slifer also questions whether the market is truly vulnerable to
rising levels of margin debt. The Internet sector experienced a
correction in August, but rebounded without word of major
losses due to margin investing, he said.
Undoubtedly, some investors will forfeit gains from stocks
bought on margin, he said. Also, investors who buy stocks on
margin make up a minority of the total U.S. investor base, he
said.
``We've have a couple of whacks in the last couple of years,
and nothing has happened,' Slifer said. |
