SEC To Ease Margin Rules

It’s not often that the SEC does something I like, but this one is long overdue. The SEC is likely to approve the New York Stock Exchange’s request to alter its margin rule. Under current rules, the margin requirement is the same no matter what kind of asset you hold; stocks, options or futures. This is truly unnecessary, and what’s worse is that it put us far behind bourses in other countries.
Margin has gotten a bad rap ever since John Kenneth Galbraith identified it as one of the major causes for the stock market crash in 1929. The market eventually dropped by nearly 90%, but even in those loose days, margin buying probably represented less than 10% of the market’s total value. If anything, the level of margin buying is actually negatively correlated with stock volatility.
The Federal Reserve sets the margin rules under its Reg T. The Fed used to move the margin requirement around a lot. In fact, it completely banned margin during World War II. In 1974, the Fed set the margin requirement at 50%, and it hasn’t touched it since.
I should also mention that investors who use margin should also consider how much leverage the stock itself is using. Most investors never think of this. Take a company like FactSet Research Systems (FDS). The company doesn’t have a nickel of long-term debt. I’m not advocating buying it on margin, but it’s balance sheet is something to consider.
On the other hand, we can look at General Motors (GM). According to GM’s balance sheet, the company has $11.6 billion in equity and $457.7 billion in liabilities. Yikes! That’s about $800 a share in liabilities for a $32 stock. Call me crazy but I think that’s margined well enough.
If we mathimaticate the Dow divisor, that means that $1 in share price is about eight Dow points, so GM’s liabilities are about 6400 points on the Dow.
Talk about debt relief! Forget Africa; send Bono to Detroit.

Posted by on October 16th, 2006 at 10:27 pm


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