Do we need better laws for buying on margin?

[Spungo]

The rules of marginal investing seem really weird and backward. The only way to explain it is to use an analogy. Suppose you get a mortgage and you buy a house. You bought the house while the market was up, but that's ok because you still like the house and you don't plan on moving anytime soon. The market starts to decline, but that's ok because you still have a good job and can easily make the mortgage payments. One day you get a phone call from the bank. They say the value of your house has dropped $50,000 and they demand that you pay $50,000 within 1 week or they will evict you, sell the house, and you owe the difference between the liquidation price of the house and the balance on the mortgage. All of your neighbors get the same phone call. The entire real estate market crashes because of this and poverty soars.

How on earth is this legal? This is the single biggest cause of the stock market crash in 1929, and it's still the law of the land. If you look through the terms of agreement for any trading account, it will say exactly what I just posted. A margin call can be made at any time, for any reason. If your account does not have enough cash to cover the margin call, your stocks or bonds will be forcibly sold at market price. It's almost like the system is designed to cause market crashes since no other form of borrowing works like that. I bought my condo using borrowed money, and I'm about 99% sure the bank will never make a margin call on it. Most people buy new cars with credit, and I'm pretty sure none of them get margin calls. That new car you just bought? It's worth 30% less since you just drove it off the lot. We need you to pay $9,000 or we're going to take the car and sell it.

I realize not everyone is familiar with marginal investing. Watch this video for a couple minutes.

 

[boomerang]

Is this politics, or is this news?

 

[Spungo]

Nope. Laws clearly have nothing to do with politics since both major political parties are run by criminals.

 

[Anarchist420]

How on earth is this legal?

It does sound like theft on the part of the banks.

Anyway I think it is common practice because of the Fed Res and it's legal because rulers need the support of the banks. And I also think that the largest banks need the govt.

 

[Mark R]

The bank has made you a loan, secured on the stock you have bought.

If the value of the stock falls, and there is a risk that the value of the collateral might fall below the value of the loan, then they can require you to provide additional cash collateral. If you can't provide the additional collateral, then you have the option to sell the stock, and repay the loan.

This is different to car loans. In car loans, loss of value is expected and calculated into the price of the loan. (You might not see it in the headline figure, as the cash price of cars is typically inflated to make the finance look cheap). You will either need to pay a cash deposit equivalent to the depreciation of the car, or you can finance only the depreciation and return the car at the end of the loan.

Home loans are tightly regulated, and margin calls are not permitted.

However, commercial mortgages for business premises usually do include a margin call clause, where if the value of the real estate falls, the bank can demand immediate payment of cash collateral.

 

[IGBT]

it's for mad money gambling only. now go ahead and make rules based on that.

 

[Hugo Drax]

What happened? Got a margin call

 

[Spungo]

What happened? Got a margin call

Nope, I'm going to invest on margin the same way everyone else does. Instead of paying down my mortgage, I'm stockpiling cash and waiting for the market to crash since we're due for one. I'm still technically investing with borrowed money, but the mortgage company won't do any margin calls.

It's such a weird system we have. You can put a mortgage on your house and use that to buy stocks if you want, and there's no risk of a margin call. If you make the same exact loan for the same amount at the same interest rate through a broker, your stock could be forcibly sold at any time. It just doesn't make sense.

 

[glenn1]

The rules of margin investing are actually pretty detailed (look up Reg Q). The Federal Reserve can change the margin maintenance requirements at any time. I have no strong feelings about whether the the the typical requirement of 50% (for equities) is appropriate but margin accounts in general should be limited to sophisticated investors, not Ma and Pa Kettle with their $5k eTrade accounts.

 

[glenn1]

Nope, I'm going to invest on margin the same way everyone else does. Instead of paying down my mortgage, I'm stockpiling cash and waiting for the market to crash since we're due for one. I'm still technically investing with borrowed money, but the mortgage company won't do any margin calls.

It's such a weird system we have. You can put a mortgage on your house and use that to buy stocks if you want, and there's no risk of a margin call. If you make the same exact loan for the same amount at the same interest rate through a broker, your stock could be forcibly sold at any time. It just doesn't make sense.

Actually using proceeds from a mortgage or refinance to purchase securities is generally prohibited. Your broker could lose their license and the firm could be liable for recovery of any losses you sustain.

 

[Zaap]

Actually using proceeds from a mortgage or refinance to purchase securities is generally prohibited. Your broker could lose their license and the firm could be liable for recovery of any losses you sustain.

This. I think the OP might be listening to some seriously flawed advice.

 

[OverVolt]

A margin call is like a car repossession or house short sale. Metaphor fail

I agree with you though Spungo in that this causes overshoots to the downside. I consider this a good thing, its the best time to buy.

Margin calls are never directly the cause of the crash though. The price has to fall despite people borrowing to the hilt to buy whatever it is they are buying. I guess an example would be BP stock during the drilling disaster. Margin didn't cause the crash, the profit loss from the drilling disaster did that. The margin calls caused it to overshoot to the downside. It was a great way to almost double your cash if you bought at $27 a share.

Its a good example of trade volume spiking right before the bottom of the crash. Ah well.

 

[destey]

Margin calls definitely can contribute to a crash. As a stock goes lower and lower, more people are getting margin calls and that further pushes the stock lower. This is what happened in Mid August to November of 2008 of a stock I held, INTC.

The only thing the 50% margin did to me was force to sell at the bottom, INTC @ $12-14, cementing my losses. The stock went back up, but govt regulations sealed my losses. I lost a lot of money, (forgot exactly, I think >$20k). I would have only lost about $5k if govt regulations had just let me hold. I barely went below 50% also, and TDAmeritrade sold 1/3rd my shares (2500)

 

[Spungo]

Actually using proceeds from a mortgage or refinance to purchase securities is generally prohibited. Your broker could lose their license and the firm could be liable for recovery of any losses you sustain.

I'm pretty sure that's not true. During the housing boom, millions of Americans mortgaged their house to do dumb shit like go on a vacation. None of those people are in jail, and the government rewarded the lenders by bailing them out.