Bill, here's the article I mentioned from last Sunday's NYT. The rule seems to be 50 % margin for initial purchase, but 25% margin after purchase before the call goes out. I'm sure most people here understand this better than I do, though. From NYT, 4/9/2000
MARGINAL BEHAVIOR
This Bubble Sure Looks Familiar
By FLOYD NORRIS
In the spring of 1928, when the Federal Reserve was trying to restrain
stock market speculation by tightening credit, a visitor to the office of
Roy Young, a Fed governor, found him chuckling as he stared at the
news ticker, which was reporting that stock prices had risen sharply that
day.
"I am," he explained, "laughing at
myself sitting here and trying to keep
125 million people from doing what
they want to do."
What they wanted to do was buy
stocks and get rich, and they were
borrowing more and more money to
do so. So it has been over the past
year, as share prices have soared.
Last week, as Wall Street briefly plunged and then recovered, some of
the selling came from investors who had borrowed money to buy stocks
and now had to raise cash to pay their loans. But new money came into
the market, and prices soon stabilized.
When Mr. Young was laughing, the volume of such stock market loans
was up 67 percent in less than two years. Many analysts feared that a
crash would ensue if a fall in prices forced many of those speculators to
sell their holdings.
By the fall of 1929, however, this newspaper was taking note of the fact
that even larger increases in such loans no longer alarmed people. "One
of the most striking features of the present chapter in stock market
history," The New York Times wrote on Sept. 1, "is the failure of the
trading community to take serious alarm at portents which once threw
Wall Street into a state of alarm bordering on demoralization. In
particular, the recent disregard of the succession of 'smashed high
records' for brokers' loans astonishes the older school of market
operators."
Borrowed money unquestionably played a role in the speculation of the
late 1920's, and after the 1929 crash Congress set out to enact limits on
it. Whereas speculators in 1929 could put down as little as 10 percent of
the purchase price to buy stocks, the new law left it to the Federal
Reserve to set limits. For decades the Fed diligently raised the borrowing
requirement when it thought speculation was on the rise and cut it when it
perceived less need for restraint.
But the last adjustment -- a reduction in the down payment for stocks
from 65 percent of the purchase price to 50 percent -- came in 1974, in
the midst of a severe bear market when few wanted to take the risk
anyway. Since then, the Fed has been on the sidelines.
Now, with margin lending having risen sharply since last fall, there are
renewed worries about margin debt -- the money borrowed from
brokers to buy securities.
Under current rules, if an investor's stocks fall so far that he or she owes
more than 75 percent of the value of his or her account, a margin call
must go out, forcing the investor to come up with more money or sell
some shares.
Some brokerage houses impose stiffer rules, typically pulling the plug
when the debt hits 70 percent of the value of the account. To translate
that into Wall Street jargon, the brokers require a "maintenance margin"
of 30 percent. The Securities and Exchange Commission has been quietly
trying to persuade all brokerage firms to set the level at least that high for
investors who own the most volatile stocks.
A look at the two eras -- the 1920's and now -- shows some similarities
and some great differences in the use of borrowed money to buy stocks.
Now, as then, the Fed has been trying to tighten credit by raising interest
rates but has seen stock prices soar as more and more money has been
borrowed to buy shares.
"The lure of stock market profits had caught the public imagination," the
economist Benjamin M. Anderson wrote of the late 1920's in his 1949
book, "Economics and the Public Welfare." "And the change in Federal
Reserve policy, designed to restrict the supply of money, met with an
overpowering increase in the demand for money."
Margin debt is now rising faster than it ever did in the 1920's, when the
peak annual increase was 56 percent. Over the 12 months through the
end of February, the latest data available, the increase was 75 percent,
and most of that came after the Nasdaq market began to take off in
October. The big runup in prices that saw the Nasdaq average double
from last summer through its peak last month was fueled in part by
borrowed money.
Still, the total volume of margin loans at last report was $252 billion, or
just 1.7 percent of the value of stocks traded on the New York Stock
Exchange and Nasdaq, the two major stock markets. On Sept. 1, 1929,
by contrast, the $5.8 billion in brokers' loans, as margin loans were then
known, amounted to 9.5 percent of the value of the stocks then traded.
That would seem to indicate there is far less leverage now, but that may
not be true. Today's investors have many more choices. They can buy
options and futures on stock indexes, each of which allow a speculator to
make a lot of money on a small investment -- if the market goes up.
Those who want to borrow money to buy stocks can take out a margin
loan, or they can use their credit cards or home equity loans. And, as
everyone learned when the Long-Term Capital Management hedge fund
nearly failed in 1998, it is possible for clever traders to borrow huge
amounts of money to use in playing the markets.
Alan Greenspan, the Federal Reserve chairman, has so far resisted
suggestions that the Fed raise the margin requirement from the current
level of 50 percent, arguing that such a move would not affect the
wealthier and more sophisticated investors who can use the many other
financial products now available.
That means investors will be free to keep borrowing. And, history shows,
they will continue to do so if they remain confident that stock prices are
going to keep rising. |
