For four decades, the Federal Reserve Board episodically changed margin requirements to reflect its view of the financial markets. When speculation appeared to endanger the economy, the Fed would raise the amount of money that had to be put up to buy stocks. When pessimism abounded, it did the contrary. It was a tool that had a great deal of power, both directly and as a symbol.
As the financial world evolved, the Fed abandoned changing initial margin requirements. It felt there were alternative markets that circumvented direct purchases or sales of shares, markets such as options, futures and indexes. The thinking was that those other exchanges and forms of securities undercut episodically altering margin requirements as a means of controlling speculation. As a consequence, since 1974, initial margin has been 50%. In other words, an investor had to put up $500 to buy $1,000 of a listed security. (Maintenance margin is a different story; each Exchange sets the lowest equity percentage permissible before their members are required to liquidate client’s positions. In general, maintenance margin is 25% of the value of the position plus the amount lent on it).
The abandonment of “accordioning” initial margin requirements is a mistake and may well be rethought soon. Margin loans today are a record $722 billion. They are big, they are growing and they are a bit daunting. There are multiple markets and multiple types of investments, but the ownership of listed securities is still the major component of investment.
Right now, there are many experts expressing concerns about market excesses and bubbles. The Fed is doing everything it can to keep the economy and jobs forging ahead. It is using quantitative easing, low interest rates, purchases of all types of assets and any number of other monetary steps to avoid greater unemployment, business closures, loan defaults, housing evictions and severe consequences to specific segments of the population. However, some of those weapons have the side effect of inflating the value of financial assets, like stocks. The Fed—and others—have seen overpriced asset classes create an aftermath of devastation, time after time. Just think back to mortgage backed securities in 2008 and the then generation of technology stocks in 2000 for recent, rather cataclysmic examples.
Reintroducing changes in margin requirements would be a powerful tool on two levels. One is the direct rationing of credit for those buying stocks. It can dampen the animal spirits, or at least limit the imbibing of those spirits. It can also be focused on particular sectors, if desired. For instance, the initial margin needed to buy low priced shares could be set above that for higher priced one, or ETF margin below that for individual stocks. There can be flexibility in the application, if focus is desired.
Perhaps more important is the symbolic value. Changing initial margin permits the Fed to signal its concerns—positive or negative—about the state of the markets and stockowner mindset. “Don’t fight the Fed” is a truism understood by all, as it should be. The leaders of monetary policy can impact the behavior of those who participate in the equity arenas in a fashion that does not directly interfere with the workings of the stock or bond market places. It employs suasion rather than the central bank’s balance sheet to influence institutional and retail investors.
In short, a once actively used tool is likely to be utilized once again as a part of the Fed’s weaponry. It can have a constructive influence in popping bubbles before they become destructive.
George Ball is chief executive officer of Sanders Morris Harris in Houston.