Something to think about:
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Margin Debt: Are Too Many Too Close to the Edge?
Regulators are concerned about the startling jumps in margin borrowing by investors
Hedge-fund managers, large Wall Street trading desks, and other professionals have long known what many individual investors only recently discovered: You can buy twice as many shares of stock by borrowing half the purchase price from your broker.
Since last fall, individual investors have seized on the convenience of these loans from brokers, known as margin debt, to buy stock. And with retail investors making up an increasingly large share of those buying stock on margin, borrowing has soared, much to the surprise and chagrin of regulators. Margin borrowing jumped 7% in January, to $243.5 billion -- and that was only for one month. There was an eye-popping 27% increase in the fourth quarter of last year, when the Standard & Poor's 500-stock index climbed only 15%. Margin-debt figures for February are due out from the New York Stock Exchange in mid-March.
Driving the runup in debt is the increased popularity of online brokers and the growing attraction of Internet stocks. Online and discount brokers currently account for 20% of the total lending on margin, up from 10% in 1995, says Sanford C. Bernstein & Co.
GREENSPAN UNFAZED. A cause for concern? Yes, if the borrowing continues at its recent robust pace. While margin-debt buys account for less than 2% of all stock buying, many of these new leveraged investors, enamored of the market's double-digit returns, seem to have an unlimited appetite for risk. "There is an increase in speculation going on, fueled by the most speculative traders," says Guy Moszkowski, managing director at Salomon Smith Barney & Co.
Strangely enough, Federal Reserve Chairman Alan Greenspan, who for years has sounded the alarm about market excesses, seems unfazed. For now, he has no intention of revising the Fed's margin rules. By law, the Fed sets the maximum amount of money investors can borrow from their brokers, called the initial margin. Since 1974, the Fed has kept initial margin rates at 50%.
Brokers, however, control maintenance margins, or the amount of money investors must keep in an account, as their shares increase or decrease in value. Maintenance margins currently are set at about 30% of the value of securities in an account. Brokerage firms can require customers to put up more money. Charles Schwab & Co., for example, has targeted 272 stocks as risky investments, which are subject to tighter borrowing rules.
A BIT OF JAWBONING. Greenspan's reluctance seems largely philosophical. As a believer in free markets, he often is hesitant to resort to regulation. Plus, Fed watchers say, at a time when the Central Bank is raising interest rates, boosting margin requirements now could be too disruptive to the markets.
Still, while the Fed is reluctant to tinker with its own margin rules, it doesn't mind doing a bit of jawboning to persuade brokers to tighten. In Greenspan's view, raising maintenance margins -- as opposed to initial margins -- is a more effective way for firms to protect themselves against a market plunge.
Securities & Exchange Commission Chairman Arthur Levitt Jr. agrees. Together, the two persuaded the NYSE and Nasdaq to issue a joint statement on Feb. 24, urging brokers to review loans made to individual investors. The statement warned that if the market swoons, some may have to sell their holdings and take heavy losses.
TINY SIGNAL. Greenspan can take comfort in one important fact: The total number of investors who borrow on margin is still tiny. According to a Lehman Brothers Inc. analysis, only 0.8% of all U.S. households borrowed against their stock holdings in 1998. And only about 1% to 1.5% of households do now.
Nevertheless, Greenspan must keep close tabs on borrowing. Margin debt as a share of total market capitalization rose in January, to a record 1.41%, eclipsing the previous high of 1.38% set in September, 1987, a month before the market crashed, according to Trim Tabs Financial Services of Santa Rosa, Calif. While that percentage may seem minuscule, it's an important signal, says Charles Biderman, CEO of Trim Tabs. "People have leveraged themselves to the hilt to buy as much as they can," says Biderman, adding that the growth in margin debt has made him bearish.
So for now, officials are betting that industry moves, plus interest-rate hikes, will slow the rush to leverage. But if they're wrong, the Fed may not be able to sidestep the issue much longer. |
