Stock Markets Sit Blithely on a Powerful Time Bomb, by Wolf Richter

Speculators on margin add to stock market volatility, because their creditors can force them to either cut their positions or cough up more money when prices go against them. From Wolf Richter at wolfstreet.com:

No one knows the full magnitude, but it’s huge.

How big is margin debt really, and how much of a threat is it to the stock market and to “financial stability,” as central banks like to call their concerns about crashes? Turns out, no one really knows.

What we do know: Margin debt, as reported monthly by the New York Stock Exchange, spiked to another record high of $528 billion. But it’s only part of the total outstanding margin debt – which is when investors borrow money from their broker, pledging their portfolio as collateral.

An example of unreported margin debt: Robo-advisory Wealthfront, a so-called fintech startup overseeing nearly $6 billion, announced that it would offer its clients loans against their portfolios.

“The dream house. The dream wedding. The dream kitchen. The dream vacation.” That’s how it introduced it in a blog post this week. “We want you to have your cake and eat it too,” it said.

Instant debt “without the hassle of paperwork,” it said. “We want our clients to be able to borrow what they need, when they need it, directly from their smartphones.” Secured by “your own investments.”

It’s a great deal as long as stocks are soaring. Clients with at least $100,000 in their account can borrow up to 30% of the account value. It’s seductive: No required monthly payments and no payoff date, though interest accrues and is added to the monthly balance. The rate is as low as 3.25%. “How’s that for flexibility?” it says.

That’s how margin debt is being pushed at the end of the cycle.

This borrowed money can be drawn out of the account to fund vacations or a down-payment of a house. But when stocks spiral down, as they’re known to do in highly leveraged markets, and fall below the margin requirement, clients get a margin call. They either have to put cash into the account to make up for the losses or they have to start liquidating their portfolio at the worst possible time.

To continue reading: Stock Markets Sit Blithely on a Powerful Time Bomb

 

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