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Strategies & Market Trends : MDA - Market Direction Analysis -- Ignore unavailable to you. Want to Upgrade?

To: Les H who wrote (44310)	3/29/2000 2:52:00 PM
From: Les H	Read Replies (2) \| Respond to of 99985

SAN FRANCISCO FED STUDY DOUBTS UPPING MARGINS WOULD CURB STOCK MARKET SPECULATION 11:37 EST 03/29 By Steven K. Beckner Market News International - There is no reason to believe that raising margin requirements would have much lasting effect on the stock market, according to a San Francisco Federal Reserve study. There might be some initial "announcement effect" on share values from a rise in margin requirements, but the effect would probably be ephemeral because of the ready availability of other forms of credit and other ways of speculating in stocks, the study maintains. Without ruling out a change in margin requirements, Fed Chairman Alan Greenspan and other Fed officials have minimized the utility of that 66-year-old policy tool in countering stock market speculation. Nevertheless, market talk has persisted that the Fed might resort to changing margin requirements. Critics of Fed rate hikes argue that, if the Fed wants to dampen the stock market wealth effect, it should target stocks with margin requirements rather than impact the entire economy with higher borrowing costs. But fresh doubt is cast on the merits of margin requirements by San Francisco Fed senior economist Simon Kwan, writing in the Bank's latest "Economic Letter." "The recent run-up in margin credit has prompted some policymakers to debate the idea of changing margin requirements to stem possible speculative excesses," Kwan writes. "However, the effectiveness of using margin requirements as a policy tool is questionable." "Investors can use financial derivatives to obtain exposure to equities without owning stocks, and they also can substitute margin credit with other types of credit," Kwan continues. "Finally, the bulk of the research on margin requirements indicates that changes in the requirements do not have a significant permanent effect on the behavior of stock prices." Kwan finds that the rise in equity prices cannot be explained by the growth of margin credit. "The growth in stock market capitalization precedes the growth in margin credit, not vice versa," he writes. "...The lagged growth rates in margin credit have no explanatory power for the growth in stock market value." "The data do not suggest that, in general, the growth in margin credit fuels the stock market gains," Kwan continues. "Rather, the data are consistent with investors reacting to a rise in stock prices by borrowing more against stocks and, likewise, reacting to a fall in stock prices by borrowing less." In January, Kwan notes, margin credit continued to rise to $243 billion, a 6.5% increase from December, even though stock market value dropped 4%. He also observed that "a portion of the growth in margin credit could be associated with mark-to-market losses on short positions as equity prices rose" and that margin credit data include all credit extended against non-equity collateral, such as government and agency securities, corporate bonds and some foreign securities. What's more, Kwan questions "whether changes in margin requirements would be expected to have a measurable effect on stock market activities." Kwan concedes that "if speculation in the stock market becomes a concern to policymakers, changing the margin requirement can send a signal to the market about their view of equity valuations." However, Kwan goes on to say that margin requirements have "a number of problems as a policy tool." For one thing, since margin requirements were mandated by Congress after the Crash of 1929, other means of profiting from stock price movements have been developed that bypass the cash equity market and margin requirements, namely stock options and stock index futures. Moreover, "credit is fungible," writes Kwan, echoing a point made by Greenspan last month in Congressional testimony. "Investors can easily substitute other types of credit for margin credit using non-securities collateral, such as a home equity loan." "To the extent that investors can obtain credit from other sources to purchase stocks, the margin requirement becomes a non-binding constraint," Kwan continues. "Thus, changing margin requirements may not have the desired effects on stock market activities." "Given these limitations, it is not surprising that the vast majority of studies investigating the effects of margin changes on securities behavior conclude there is little evidence that changes in margin requirements have significant effects on the price, volatility, volume and liquidity of stocks beyond the announcement effect," Kwan goes on. Another reason why the Fed is reluctant to raise margin requirements, not mentioned by Kwan but confirmed by Fed sources, is that Fed policymakers are reluctant to appear to be second-guessing the stock market, particularly having denied that they are targeting the market. Since 1934, the Fed has changed the initial margin requirements in stocks 23 times. The rate has been 50% since 1974.