Stock Markets Sit Blithely on a Powerful Time Bomb: Margin Debt

Stock Markets Sit Blithely on a Powerful Time Bomb: Margin Debt, by Wolf Richter.

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. …

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.

This forced selling occurs across the spectrum during a sharp market downturn and drives prices down further and begets more forced selling. Margin debt is the great accelerator on the way up, and it’s the great accelerator on the way down. Crashes feed on margin debt.

Margin debt is in an uncanny relationship with the stock market. It soars when stocks soar, and it crashes when stocks crash. They feed on each other. …

Margin debt, as the charts show, has the unnerving habit of peaking right around the time the bubble turns into a sell-off.