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Margin Debt Concerns Heightened
Due to Recent Market Selloff

By Dunstan Prial    Associated Press
NEW YORK — Last week's harrowing stock market selloff confirmed fears that the growing amount of debt held by investors who borrow money to buy stock — known as margin investing — can exacerbate a free falling market.

But since stocks bounced back as quickly as they fell, little sentiment exists for new regulations that might prevent another domino effect of selling should a similar stock plunge occur in the future.

Instead, market analysts hope the attention focused on margin debt in the wake of the turbulence will alert investors to the perils of buying stock on credit.

"The definition of speculation is when investors borrow money to purchase overvalued stocks in the hope and prayer that those same stocks will become more overvalued," said Hugh Johnson, chief investment officer at First Albany Corp.

If a big drop occurs, as it did last week, margin debt can "turn a rational decline into something disorderly," Johnson said.

Investors who had purchased volatile Internet and other risky high-technology stocks on margin needed to sell stock last week to cover so-called margin calls when the stock market began to plummet, which put additional pressure a sliding market.

Margin debt has soared recently, jumping 50 percent in the last six months, as investors have borrowed money to speculate on volatile technology stocks.

On Feb. 29, total margin debt stood at $265.2 billion, up from $176.4 billion at the end of August; and up from $151.5 billion a year earlier. In February 1990, the figure stood at just $31.5 billion, according to Ned Davis Research, a Venice, Fla., market data firm.

Analysts have fretted for months that widespread borrowing would perpetuate a market slide when margin investors sold stock to pay off their loans during a decline. Those concerns were realized last week.

"When the stocks that had gone up the most started going down the most, those are the ones that triggered the margin calls," said Sam Burns, a research analyst at Ned Davis.

Margin calls are issued by lenders, usually a stockbroker, who want to ensure that the loans they make to investors are covered.

Here's how it works.

Investors borrow money to buy stock in the hope that the stock will increase in value. The stock purchased on margin is used as collateral against the value of the loan.

If the stock goes up, the investor can use the profits to pay back the borrowed money plus interest charged by the lender.

But if the stock price falls, thus lowering the value of the lender's collateral, the lender can make what's known as a margin call, which requires the borrower to put up more cash to ensure that the loan is repaid in full.

Margin calls are usually covered by selling the stock purchased on margin, a dynamic that helped contribute to last week's sharp — if brief — selloff.

Despite the scare, neither the New York Stock Exchange or the Nasdaq Stock Market have immediate plans to make it harder for investors to buy stock on credit. And officials at several major brokerage firms said no further restrictions were planned to curb margin investing.

The Federal Reserve Board, which regulates margin borrowing, currently requires investors to have at least $2,000 in a trading account to buy on margin. In addition, investors are limited to purchasing $2 of stock for every $1 in their account.

Most major firms, acting independently last year, made it harder to buy risky technology shares on margin by increasing the amount of money investors needed to put up in advance.

Now, some are calling for an increase in so-called maintenance accounts, or the amount of money an investor must keep in an account to serve as collateral against stock bought on margin.

The NYSE and Nasdaq currently require that the portion of the account held with the investor's own funds be no lower than 25 percent of the total value of the account. If it falls below that, a margin call occurs.

For instance, an investor buys $10,000 in stock, with $5,000 cash and $5,000 borrowed.

A margin call could be expected if the value of the stock falls below $6,666. The investor still owes $5,000, but his cash stake in the overall portfolio has fallen below $1,666, or below 25 percent of the total value of the account.

Mike Dunn, a spokesman for online firm Datek, said Datek has no plans to increase maintenance account requirements.

Dunn said last week's selloff affected just a small percentage of investors who have purchased stock on margin. "Investing in the markets has certain risks to begin with," Dunn said. "When you buy on margin, you add to that risk."

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