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A good article from the Industry Standard on margin debt. Margin debt
as a percent of the market is higher now than before the crash in 1987.
JW
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http://www.thestandard.com/article/display/0,1151,12960,00.html
March 24, 2000, 07:36 AM PST
Borrow Money, Buy Stocks
Afraid to miss the Net boom, investors are buying stocks with borrowed
money. Regulators are worried.
By Eileen Buckley
It's one of the first things investors learn: Exposure to high risk can
bring big gains – or devastating losses. As many Internet stocks soar to
uncharted heights, tales of windfalls are more common than losses. Who
can ignore the $290 billion in new wealth that Nasdaq stocks have
created this year?
But if history is any gauge, times of investor euphoria are when risk is
greatest. Officials from the Securities and Exchange Commission and the
Federal Reserve are increasingly concerned about one indicator in
particular: the explosive growth of margined stocks.
Individual investors are buying more stocks on margin – buying shares
with borrowed money by plunking down a deposit, usually 50 percent. In
February, brokerages loaned $265.2 billion to investors, a 75 percent
surge in 12 months. More unsettling, margin debt rose 16 percent in
January and February while the value of all stocks on the three major
exchanges fell 2 percent. As a result, margin debt as a percentage of
the stock market rose to 1.53 percent, higher than in the days before
the 1987 stock market crash.
Soaring margin debt signals the speculative frenzy that often precedes a
market downturn. "There is so much speculation in this market," says
Mike Macchiaroli, associate director of investor responsibility at the
SEC. "People begin to wonder, is this like 1929 when everyone was
borrowing to buy stock?"
Even the exchanges are worried. The New York Stock Exchange and the
Nasdaq issued a memo this month urging brokers to review the need for
higher margin requirements: "In the event of a severe market
contraction, some investors may not be in a position to sustain the
leveraging and will be required to liquidate their positions under
unfavorable market conditions."
While the data on margin debt can't be broken down to individual stocks
or sectors, many analysts say Net stocks are leading targets of the
margin trading. In response, some brokers are setting tighter margin
requirements. Charles Schwab requires an 80 percent deposit for some Net
shares.
And for those investing in the highly volatile Internet sector, margin
trading piles risk upon risk. Last week served as a reminder that
individual Net stocks can easily tumble more than 20 percent in a day,
enough to make brokers urge customers to either sell their margined
shares or beef up their deposits. Often, the leveraged customer must
also sell other stocks to pay back the loan.
A seasoned investor will hedge risky margined positions with safer bets.
But these days, seasoned investors are far outnumbered by novices as
online trading draws new hordes into the markets.
"There is a huge increase of new entrants to the marketplace," says
Frank Fernandez, chief economist at the Securities Industry Association.
"Some of these online trading firms, like E-Trade, have already reached
their annual targets for new accounts for the year."
Today's stock market is significantly more regulated than the market of
1929, when people bought stocks with 10 percent down, one-fifth of
today's ratio. Still, many say the amount of margin trading is more than
what brokerages report to the SEC.
Fernandez points to a recent SEC report that said a quarter of
brokerages surveyed were keeping accounts open overnight that were in
excess of margin requirements. This practice isn't illegal, but it means
the debt figures alarming regulators don't tell the whole story; the
market is even more leveraged than it appears.
And one thing hasn't changed since 1929, or even 1987: When stocks keep
surging, many investors throw caution to the wind. When that happens,
it's only a matter of time before the wind changes direction.
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Margin Debt as a Percentage of Stock Market Value
DATE MARGIN DEBT
Sept. 1987 1.38%
Dec. 1987 1.21%
Dec. 1988 1.12%
Dec. 1989 0.10%
Dec. 1990 0.09%
Dec. 1991 0.08%
Dec. 1992 0.09%
Dec. 1993 1.10%
Dec. 1994 1.14%
Dec. 1995 1.05%
Dec. 1996 1.09%
Dec. 1997 1.09%
Dec. 1998 1.02%
Dec. 1999 1.34%
Feb. 2000 1.53%
Source: Trim Tabs Financial Services
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Eileen Buckley is a writer in Oakland, Calif.
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