There's a lot of craziness on Wall
Street. A clue? Investors are borrowing money like a bunch of
drunken sailors so they can buy already overpriced stocks.
Buying on margin, the Street's version of charging stock
purchases on a credit card, went up at a heart-pounding pace in
January, climbing to a record $243.5 billion from $228.5 billion
in December. A decade ago, the debt load amounted to just $35
Smart move? Probably not.
Some experts say investors are doubling up on their bets,
increasing the danger that they could suffer huge losses if
The market's high valuation has created enough of a risk for
investors. But add the huge margin load and the risk together?
Forget about it.
Common sense says that people who borrow up to their
eyeballs to trade stocks have no staying power when the market
turns against them.
The risky business in stocks has attracted the attention of
the pinstriped suits at the Federal Reserve.
But the central bankers and their chairman, Alan Greenspan,
appear to fear that any attempt to take the air out of this
speculative market bubble could set off an avalanche of selling.
A strong economy has more often than not fostered a strong
stock market. But in this New Economy, the stock market appears
to be pulling the economy and making lots of people feel rich
the so-called wealth effect.
Dangerous? Sure. If the market crashes, then the economy
could go downhill like a speeding bobsledder.
What's the Fed to do? How about raising margins the down
payment to buy stocks on credit?
Last month, Greenspan said Wall Streeters were playing with
fire in using debt to buy stocks.
But the Fed chairman said the central bank did not think
that raising margins investors put up 50 percent of their own
cash before borrowing the other 50 percent is the best way to
pop the market bubble.
Alan Newman, editor of the Crosscurrents newsletter, said
Greenspan has created a financial Frankenstein and the Fed chief
is afraid that if he acts on the margins, the house of cards
will come tumbling down.
"Margin debt versus gross domestic product is the highest
it has been since the 'Roaring Twenties,"' Newman said. "Add
in the resources of home equity lines and second mortgages and
we are looking at a draconian level of debt versus equity."
Still, the jury is out on the effectiveness of margin
increases in skimming off some of the speculative froth from the
In 1951, the central bank raised margins to 75 percent from
50 percent. In 1955, it again boosted margins to 60 percent from
50 percent and months later it raised margins to 70 percent from
60 percent before lowering. In 1958, margins were lifted to 70
percent from 50 percent and in mid-1968 they climbed to 80
percent from 70 percent.
"Only in mid-1968 did any of these margin requirement hikes
remotely coordinate with a deceleration in market momentum or a
market peak," says Warburg Dillon Read Plc. "In short, margin
requirements have been an ineffective tool to control prices or
Others say the market would not be happy to see margin
requirements go up, citing the danger of changing the rules at
this late stage of the bull market.
A boost in margins, which have been unchanged at 50 percent
since 1973, could sucker punch the market because traders are
totally unprepared for such action.
"It would affect the day traders," said John Geraghty of
North American Equity Services, a consulting firm. "Higher
margins would restrict the amount of shares that they can deal
in, which would cut down tremendously on the market's
For example, with the current margin at 50 percent, a day
trader can buy $200,000 worth of stocks with a $100,000 down
payment. If the Fed raises the margin to 75 percent, the trader
would only be able to handle about $133,000 worth of stocks.
"There's no doubt that higher margins are a tool to control
speculation because they force the individual traders to put
more of their own money into the market," Geraghty said.
Wall Street hates surprises and a sharp rise in margins
could send a nasty signal to the market that the Fed is serious
about deflating the market bubble.
"We could see a selloff, if only for psychological
reasons," Geraghty said.
A rising market is particularly susceptible to shocks and
margin increases are one of the time bombs that could unleash a
"Another reason is that this high-flying market has been
under a cloud of fears that a big correction could take it down
quickly after years of incredible gains," Geraghty said. "So
far, it hasn't happened because there have been no fundamental
reasons to look for the correction."
The old-line stocks, such as those in the Dow Jones
industrial average, may stand up better than technology stocks
to higher margins.
"My bet: If they raise margins, New York Stock Exchange
shares may not be hurt as much because the NYSE has been lagging
the technology-heavy Nasdaq," Geraghty said. "Also, the stocks
listed on the NYSE are the buy-and-hold types, not the
speculative breed that rules the Nasdaq."
There doesn't seem to be much of a margin for error in this