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The Bailout's Unfair Bad Rap

Stocks in this article: AIG GM FNMA

Ok, so the bailouts weren't necessarily a "bad" thing. After all, why does a bank loan money to people and companies in the first place? In hopes that the borrower will repay the loan over time, with interest. And why do people borrow money? Sometimes it's because they simply don't have the funds to make a purchase. Other times, it's because they intend to use the funds for purposes that will earn them a higher rate of return than they will be paying in interest.

Not all loans are emergency loans.

Headlines this week hollered that margin debt was at its highest point ever. Meaning, investors are borrowing more today than ever against their portfolios to buy more securities.

That sounds scary, doesn't it? I don't know. The more important data point, in my view, is that margin rates are at their lowest point ever. We hear lots of horror stories about how greed begets trading on margin which leads shortly thereafter to bankruptcy and public humiliation. However, what we don't hear a lot about is how sophisticated investors utilize margin not just to bolster returns, but also to reduce their risk (by choosing to lever up at opportune times and hedge portfolios with short positions).

It seems relevant that the actual interest being paid on today's margin debt could actually be less than that of two years ago? Or how about the fact that, in relative terms, the outstanding margin balance today is a lower percentage of stock market capitalization than it was one, two, or even three years ago.

There is no report demonstrating what securities this record level of margin is being used to purchase. We assume these must be loose cannon retail investors doubling down against their dilapidated portfolio of gold mining stocks. But what if these are institutions intelligently and thoughtfully utilizing low interest rates to enhance the effective yield on their fixed income portfolios? If you are able to borrow at 1% and invest in a stable, diversified portfolio that yields 2.5% -- keeping all risks in mind, including the fact that margin rates are not fixed -- you may be making a timely investment decision. You are getting paid to borrow money. 

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