Margin Debt Grows; Risk Grows Too

Over the years, we have repeatedly commented on Margin Debt

Its has been our well considered position that that Margin Debt is a normal part of Bull market expansion. Indeed, in the early and middle parts of any bull cycle, margin contributes to rising stock prices. As we have previously written:

"During healthy bull markets, increases in margin debt is not a bad
thing: It provides fuel for further market gains. Its only when debt
reaches excessive speculative levels that it is potentially problematic.

Our prior looks at Margin Debt saw the debt rise, but not to levels that reflected excessive levels (see NYSE Member Firms’ Client Margin and NASD Firm Margin Levels Spikes to Record Levels as examples). We also noted that NASD margin is relatively small when compared to NYSE margin.

When margin worries first started popping up in the press, we observed the total margin was relatively low, both in real terms and
relative to total market capitalization.

As we noted at the time, "We do not read this uptick in margin as a warning sign for the broader market."

More recently, however, the margin situation is getting more worrisome. This time, the borrowed money situation is more serious. Its not just the total amount of margin, but rather, its percentage as a share of total market cap: Margin lending, as a percentage of stock-market capitalization, is nearing levels last seen in the midst of the Internet bubble:
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Margi_20071019205652

Barron’s adds:

"The Federal Reserve is empowered to set the maximum loan-to-value rate (last changed in 1974 to 50% from 65%) for stock loans, an overlooked policy tool. Kaufman suggests that the Fed use its power more often "as a symbolic gesture" that speculation is overdone. If stocks rise much further, he thinks such a gesture would be warranted.

September’s margin numbers should be out shortly. Steve Levine, a former NYSE margin regulator who now consults, expects a $30 billion drop. "Brokers," he notes, have been "reducing leverage through additional margin calls." But rest assured: Your broker’s not necessarily your friend when it comes to debt…

This will be worth watching in the coming months — especially if this past week’s sell off accelrates, and we begin to see margin calls. THATS where things really get ugly . . . 

>

Source:
Margin Debt — and Risk — Is Growing
JACK WILLOUGHBY   
Barron’s, OCTOBER 22, 2007   
http://online.barrons.com/article/SB119284249217965682.html

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What's been said:

Discussions found on the web:
  1. SINGER commented on Oct 20

    Perhaps that recent decline in margin debt shown on the Ned Davis chart will lead the market down…The margin debt chart looks awfully like the “double-top” that appears to be unfolding on the longterm charts of the S+P 500…

    BTW…Did COLBERT just comment on the last article????

    Holla…

  2. Justin commented on Oct 20

    Boy! I’m hearing/reading to much negative market news. The Bulls will just take all this as a contrarian indicator, and run with it! Too many “plug-and-play,” investors out there…

  3. Sam Jacob commented on Oct 20

    Most US stock indexes went above the July highs. But european indexes(FTSE,DAX) weren’t able to go above their prior highs in the recent rally. DAX was really struggling around the 8000 area. I think the european markets are starting to weaken.
    What will happen to Euro !!!!

  4. rickrude commented on Oct 20

    in an inflating enviornment with
    relatively low interest rates and depreciating
    USD, going on margin to buy
    shares of companies with growth is a smart thing to do, esp international companies.

  5. stormrunner commented on Oct 20

    Thats only if the rate cuts actually act as a catalyst toward equities infalation in the short term. A drop in the cost of capital for the banking system does not necessarily equate to a willingless to lend to speculators to drive the market forward as Barry is seeming to point out in this thread. We could actually end up as has been discussed many times is an environment were many asset classes including equities correct here while consummables end up bearing the brunt of the inflation. So far up until this point with regard to equities this has been a bad bet, I believe the tide is receding. So much for prognostication. But with the Big Banks and Treasury in collusion to create a super fund (M-LEC) to sell themselves worthless paper at fictional prices so as to avoid the “Real Market” pricing effects of defaults things really aren’t looking all that positive and investors are not all that naive

  6. F. Frederson commented on Oct 20

    “Kaufman suggests that the Fed use its power more often “as a symbolic gesture” that speculation is overdone.”

    The problem, of course, is once this margin requirement becomes something that can be adjusted, lobbying pressure and thus political pressure will develop to adjust it. And we all know how that will work out.

  7. FredS commented on Oct 20

    Barry,

    you are always too bearish. I wouldn’t worry about it. the economy is fine.

    ~~~

    BR: NOTHING TO SEE HERE FOLKS, MOVE ALONG . . .

  8. Dan commented on Oct 20

    bold closed?

  9. Winston Munn commented on Oct 20

    I would suspect if anything the Fed would lower margin requirements in order to soften the blow of falling equities.

    There has been recent precedent. The waiver of the 23A regulation for some major banks was in essence a lowering of what constitutes margin requirements for SIVs.

    It is quite obvious from reading the papers by Bernanke, but even more so Mishkin, that these two governors believe the central bank can solve any problem with enough early intervention, and any sense of “moral hazard” is secondary to the avoiding a shock to the broader economy.

  10. stormrunner commented on Oct 20

    Winston

    what about the “FAS 157 Fair Value Measurement” slated for the 11/15th isn’t this going to push more ghosts from the closet. Is the “super fund” not intended to create fictional prices for worthless paper by circular trading to obscure a “Mark to Market” of the declining assets of the worthless paper. Is lowering margin requirements and this rouse enough ton offset a correction. Or are they indepenent of each other?

  11. Estragon commented on Oct 20

    I have to wonder how truly reflective of total leverage the NYSE margin stats are anyway.

    Until recently, it would have made all kinds of sense for a high net worth person to max out a jumbo mortgage on the McMansion, put the proceeds in a hedge fund, the fund to short (borrow) yen for USD, then use available margin to buy stocks. Add on some short puts, and Bob’s your uncle. Works until it doesn’t. The margin in this case might only be a fraction of the total gearing, and until recently the returns would have kept everyone fat and happy.

    The prime brokers may start asking inconvenient questions about how much of the funds’ “cash” on account is actually debt. If it’s as levered as I suspect it is, margin calls might only be the start of a much nastier cascade.

  12. UrbanDigs commented on Oct 20

    stormrunner – Im wondering if the fast approaching deadline of FAS 157 is the reason behind the plunge in ABX markets of late?

    or is that just another indicator of round two fo the credit crunch? The super fund is intended to bail out citi’s 7 SIV funds totaling almost $100B; and other SIvs..its to the group’s advantage to do the fund so that they dont have to mark to market at these distressed levels. If they do, the whole group gets hurt.

    If the superfund doesnt work, and take the assets off the books, the banks will have to come up with $$$! That could be a problem.

  13. stormrunner commented on Oct 20

    Urban

    Isn’t what we’re suggesting here fraud at some level. Funds are being required to Mark to Market Level3 assets- ouchhh! a “super Fund” is established sanctioned by the treasury, the credit rating as opposed to the solvency of the players is what dictates access to the manipulation, is this not hand picking the winners and losers, based on favoritism more so than foresight and business savvy.

  14. Winston Munn commented on Oct 20

    Stormrunner,

    The super fund certainly seems to be nothing but a holding organization for losses – to prevent the banks involved from having to mark-to-market real values.
    This looks to me like Enron with the aid and blessing of the Treasury department.

    As for margin requirements, my comment was simply that if they were changed, the track record of this Fed is to add more risk/liquidity rather than less, and thus a lowering of margin would be in keeping with their pattern.

    Whether or not margins change really depends on how much crisis is perceived by the Fed – deflation is their “Great Satan”. How much systemic risk the Fed allows will be dependent on their view of that risk. I am of the opinion that they if they did change margin requirements, it would be to lower them in order to prevent a “fire sale” of equities.

    You can almost hear them now: “To ensure a more orderly process of asset liquidations, the Fed has today altered…yada, yada, yada.”

  15. Estragon commented on Oct 20

    UrbanDigs,

    My guess is that ABX et al are getting crunched again because mortgages aren’t the only things showing signs of stress now. I’ve read recently about expectations for rising delinquencies on other receivables as well (car loans, credit cards, etc.).

    As I was thinking about this being the cockroach theory in action, a vision of Chuck Prince came to mind… standing on a balcony in the NYSE saying “you wanna play rough with me, you FK’n cock-a-roaches…come on”.

    http://www.youtube.com/watch?v=GVuQLDsv8og

  16. UrbanDigs commented on Oct 20

    estragon – ha! Yes, Im hearing same things in credit card and auto payment defaults. Obviously the credit markets are in distress, and I have a feeling we’ll get a few surprises down the road. Perhaps a big corporate failure too.

    stormrunner – its a great question. I certainly am not educated enough to answer. This stuff is so misunderstood, and the complexity of these vehicles are crazy! Im not sure the investors even fully understand them. What IS understood is the ramifications if holdings MUST be sold at these levels, even for those that don’t have to sell but see the markdowns of their holdings as face value reveals itself.

    Its really nutz! makes one think why H Paulson was elected in first place, from GS. I have a hard time believing what we are going through now is fresh news, and not a concern that came about years ago. If this bailout of sorts doesn’t happen, there will be plenty of rattling on the street. Roubini questions its effectiveness even if it does happen.

    I wish I understood more about:

    1. these cdo’s
    2. these complex siv’s
    3. who holds what
    4. who must sell what to meet debt requirements

    there seems to be a lack of transparency here that is right in the middle of the fire.

  17. pmorrisonfl commented on Oct 20

    Questions for people who know these things better than I do: Is there a connection between this off-balance-sheet debt and the current account deficit? Is there a connection between this off-balance-sheet debt and the government’s deficit? And the funding of the Iraq war? I tend to think greed and fear explain most of market behavior, and subscribe to the idea that one should ‘never ascribe to malice that which is adequately explained by incompetence’, but the Street, Fed, Treasury and Administration behavior over the last 6-7 years seem to be linked, at least more and more in my mind as I read this stuff.
    Sorry to soil the thread with ridiculous conspiracy theory political ideas… but talk me off of this ledge I’m climbing out on.

  18. blam commented on Oct 20

    IMO, the market has almost nothing to do with valuation but is dominated by traders pushing it above and below the 200 DMA. Falling interest rates increase the value of equity cash flow, giving the 200 DMA an upwards bias, even if the decline in rates may presage declining earnings growth.

    My personal momentum model suggests that the hedgefunds and wall street gangster banks are likely to move the market back up over the next two months, ending the year at or near a record during the last week of December. If a cyclical decline is in the cards, IMO, it will start in earnest after the first of the year. A downside volatility pattern has replaced a five year old upside pattern.

    Then again, maybe not.

  19. Samuel commented on Oct 20

    Yeah, margin debt is out of control. Even more scary is that hedge funds have bypassed the already generous margin debt allowances of the NYSE and use derivatives so they can get 100 to 1 margin on their positions. Those stats aren’t included in the official margin debt figures. The level of leverage in the financial system and greater economy is of course indicated in the Feds Flow of Funds report which shows a massive debt bubble exceeding three times GDP. God forbid if THAT debt bubble starts contracting,

  20. Estragon commented on Oct 20

    pmorrisonfl,

    I’ll have a go at it, though I assert no special expertise.

    There’s obviously an indirect connection between off balance sheet debt and the current account deficit. In order to finance the deficit, there has to be a financing inflow. As the CA deficit grows, more debt has to be produced to finance it. To the extent the Iraq war increases the CA deficit and requires increased treasury debt to be bought offshore, there is also an indirect connection there.

    What’s far less clear, notwithstanding the obvious arithmetic correlations, is whether there’s also causality and if so, which way it runs. Some would say US overspending on imports requires matching capital inflows. Others would say mercantilist trade policies give rise to “excess” offshore savings, and the CA deficit is a consequence of that “glut” being put to work in the US. Most likely, there’s an element of truth to both arguments, and each requires the other to perpetuate the CA deficit.

    In other words, I think you can climb off the ledge. As you said, ordinary fear and greed can quite adequately explain the events of the last few years. No malice is required.

  21. sujal commented on Oct 20

    SINGER, one assumes he knows how to spell his own name… so my guess is no. :-)

  22. pmorrisonfl commented on Oct 20

    Estragon,

    Thanks You confirm my more generous thoughts, while connecting the dots. I think I’ll still wonder whether Greenspan engineered the low rates for so long in sympathy with the administration’s budget goals, but I’ll do my muttering in private.

  23. rickrude commented on Oct 20

    Ultimately, you take the side of deflation or inflation.
    Those of you equating recession and market correction are betting on the side of deflation.

    I’ve bet everything I ‘ve got on inflation…
    Of hard assets like oil, commodities and corresponding stocks in those sectors.

    Good Luck…
    I feel Bernanke is on my side.

  24. Winston Munn commented on Oct 20

    Rickrude,

    I am certain the Fed is on your side; however, isn’t there some fundamental flaw in being placed into this position concerning inflation – regardless of the outcome, it is a losing bet.

  25. Philippe commented on Oct 21

    “Rickrude,

    I am certain the Fed is on your side; however, isn’t there some fundamental flaw in being placed into this position concerning inflation – regardless of the outcome, it is a losing bet.”

    Not only the Fed is on your side but ECB as well!
    The beauty is when we are culprits we tend to have a cluby atmosphere.

    But Central Banks! Are all the Banks sizes on your side?

    WASHINGTON (MarketWatch) – Top European regulators urged big banks to take voluntary steps to fix weaknesses uncovered in the recent global financial market turmoil and warned any move for quick new laws might cause more harm than good.

  26. David Merkel commented on Oct 21

    Some of the increase is hedge funds, but that doesn’t change the conclusion, because they aren’t all that much brighter than individual investors, who were most of the bubble in 2000.

  27. rickrude commented on Oct 23

    In the history of mankind,
    without the gold standard…..
    what has been the predominant
    long term trend of any currency ???

    Case closed my friends.

  28. Juan commented on Nov 9

    SFAS 157 has to do with establishing a ‘fair value’ framework; it does not result in a strict mark-to-market accounting but does require at least somewhat more disclosure.

    It’s consequences, particularly in conjunction with SFAS 159, are not at all so strict as most media have portrayed.

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