With the US stock markets flirting around the all time high mark, I am compelled to share a very scary figure which I have been following for some time now. It is the “Margin Debt” figure published by NYSE on a monthly basis.
Margin debt is simply the amount borrowed by customers to purchase securities. Just to provide some perspective, in March 2000 just before the tech. bubble burst, this figure (sum total of all customer borrowings across NYSE member organizations, which include all brokers) reached a new high of $278.5 billion. In July 2007 just before the global financial crisis, this figure stood at $381.3 billion
The Margin debt as of Feb 2014 stands at a whopping $465.7 billion dollars, dwarfing the last two pre-crisis borrowing levels.
In a raging bull market, participants start feeling confident and borrow from their brokers to buy stocks, in a margin account. As the confidence increases and memories fade, this borrowing level increases even further. The problem happens when there is a slight pullback in the market. With the margin debt at a reasonable level, the market participants easily tide over the pullback. However, when the debt levels are very high, the holders of stocks (purchased with borrowed money) need to sell their stocks to meet their margin calls from brokers. This speed of the market crash accelerates as people now need to sell more to meet the margin calls. This snowballing only eases when the margin debts come down to manageable levels.
They say a picture is worth a thousand words, and this picture (credits to dshort.com) speaks several billion words. An unprecedented negative credit balance of – $177.5 Billion, highlighted by the red area in the picture. Net credit balance = cash balance in cash accounts (accounts where securities are purchased with cash and NO borrowings) + cash balance in margin accounts – total margin debt.
By no means I am trying to forecast anything. I have no idea as to when the music will stop. I will leave the forecasting to the ‘dark suits’ on CNBC :-). All I wanted to remind our readers is that, higher this ‘margin debt’ figure reaches, the more severe the subsequent correction is likely to get. Knowing how interconnected our world is, how are you protecting yourself?