They are dreaded words on Wall Street, and they’re becoming more common: margin call.
More money invested in the stock market is borrowed from brokers than ever before, and some investment houses are asking for theirs back through what are known as margin calls. It’s one of the reasons why Wall Street has sold off so sharply in recent days.
“It’s being referred to as the biggest global margin call in history,” said Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors. A flood of margin calls is typical in a market correction, he said, and “it can turn small declines into large declines. That’s why leverage is dangerous.”
When a stock dips below a certain point, brokers who lent investors money through margin agreements demand that the investors sell part of the stock or pony up cash to cover losses. When that happens, investors often have to liquidate other assets, which can magnify stock market drops. It’s also partly why the selloff in equities is hurting other markets, like metals and energy.
Investors are “margined out, and that’s exacerbated the selling,” said Ryan Detrick, senior technical strategist at Schaeffer’s Investment Research. “People are just selling everything. It’s a downward spiral.”
Margin debt on the New York Stock Exchange was at a record $378 billion as of June, up 36 percent from the previous peak in 2000 of $278 billion, according to Schaeffer’s data. Margin debt on the Nasdaq Stock Market is also at a record $30 billion, up 33 percent from the 2000 level of $20 billion.
The NYSE’s level of margin debt has surged 37 percent just this year — the biggest six-month increase since April 2000. This means about 1.94 percent of the money traded on the NYSE is borrowed money. Percentage-wise, however, there was more margin debt in February 2000, when a record 2.4 percent of the NYSE’s total market capitalization was margin debt.
With less than 2 percent of the NYSE’s $19.5 trillion market cap in margin agreements, it may not seem like margin calls could cripple the market. But Johnson noted that the numbers don’t account for hedge funds who borrow money from banks and aren’t NYSE member firms.
Furthermore, there’s margin debt in other markets, like bonds, and other factors at play — investors taking their yen out of dollar-denominated assets, for example.
The Dow has fallen about 1,000 points in six trading days, reminding investors how risky stocks, especially stocks on loan, can be.
Most investors who buy on margin are large institutional investors, especially hedge funds, but Johnson noted that there are some aggressive individual investors who do so, too.
Buying stocks on margin is riskier than using one’s own cash. People do it, though, because when the stock rises, the gains are huge — they essentially make money on money they never had in the first place.