A Margin Debt Bomb?

Greenspan is jawboning stockbrokers to tighten credit

If the denizens of Wall Street fear that the Federal Reserve Board's expected rate hikes will bring the stock market to its knees, it's understandable. But brokers could lend Fed Chairman Alan Greenspan--and themselves--a hand. They have a simple tool at their disposal to take some of the pressure off the Fed: raising the margin rates they use to determine how much they will lend customers as their portfolios gyrate.

In recent years, investors have been on a borrowing binge sparked by--and, in turn, fueling--the Nasdaq's torrid rise. A sharp spike in margin debt has raised concern among regulators and brokers alike. "People have leveraged themselves to the hilt," frets Charles Biderman, CEO of Trim Tabs Financial Services in Santa Rosa, Calif., a financial-consulting firm.

The statistics are eye-popping. Investor borrowing skyrocketed 27% in the fourth quarter and a further 7% in January, to $243.5 billion. On Mar. 15, when the New York Stock Exchange reveals how much money investors borrowed in February, little drop-off is expected. Richard B. Berner, Morgan Stanley Dean Witter's chief U.S. economist, estimates that the 43% rise in the tech-heavy Nasdaq in the three months ending in January attracted hordes of investors who borrowed money, using stock as collateral, to dive into the market. Berner says these investors accounted for a third of the jump in margin debt during that period. And with much of that borrowed money pouring into the frothy Net stocks that day traders follow, the increased margin debt has made a hot sector hotter. Frank A. Fernandez, chief economist of the Securities Industry Assn. (SIA), notes day traders are three times as leveraged as average investors.

STEADY RATE. In recent months, Greenspan has come under pressure to cut the amount of money investors may borrow when opening an account. That rate, the so-called initial margin rate, is the only margin-debt rate the Fed controls. Since 1974, the Fed has kept it at 50%, and Greenspan rejects moves to change it. One reason, Fed watchers say: He thinks a change by the Fed would disrupt the market--even though it would be largely symbolic because the Fed's rate covers only a small part of outstanding margin debt.

Instead, Greenspan is jawboning brokers to tighten their rules. In part, he'd rather see a private-sector solution to regulatory action. More important, brokers' margin rules govern accounts already open--a far larger volume of trading--and the rules are much more generous than the Fed's. Brokers often let clients borrow 70% of the value of securities in an account, a rate Greenspan wants to see fall.

A Margin-Debt Bomb?

Recently, some firms have imposed levels of 50% or even 65%. Charles Schwab & Co. has toughened margin rules on 272 stocks. Datek Online Holdings Corp., a broker many day traders use, requires collateral up to 50% of the value of 148 stocks.

While the SIA says margin rules have been tightening steadily since late 1999, many firms have not done so. Tightening margin rules, of course, could cut into commissions. But that's better than the stampede from the markets that soaring interest rates could spark. Brokers need to choose between a little pain now and a lot later.

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