The many retail investors who ignored the old adage "neither a borrower nor lender be" got stung Tuesday.
slid as much as 13.6% at one point Tuesday, the number of margin calls jumped. That means individual investors at brokers from
are feeling the effects of higher margin requirements.
Most brokers will lend customers money (on interest, of course) to pay for up to 50% of a stock's value. But when the value of the stock falls to a certain level, brokers tell customers to put up cash or securities to keep the borrowed funds at about 30%. (Most brokers require 30% to 35% of the value in cash or securities, unless they raise margin requirements.) If the investors can't pony up, their stocks are sold. (
look at this issue on Monday as well.)
Margin has become a big issue recently because borrowing to buy stocks has reached record levels. Meanwhile, many of the highest-flying stocks have weakened, which, when coupled with the rising borrowing, has multiplied margin calls. And as investors sell stocks to meet these calls, they push the stocks down even more, creating additional margin calls for other investors.
Selling to meet margin calls was suspected of contributing to Tuesday's severe market declines, even though the
and Nasdaq recovered to post modest losses.
Even the prospect of margin calls caused some investors to sell. For instance, one online investor bought shares of
last week at 85. The investor (who asked that his name not be used because he was embarrassed at his lack of trading prowess) had planned to hedge the position but didn't get to it in time. By Tuesday, the stock hit a low of 39 5/8 and he sold at 49 3/4, a loss of 35 1/4 in one week.
"I probably would have gotten a margin call if I hadn't
sold," he wrote in an email. Then again, the stock ended up 2 1/2 at 60 9/16, so maybe not.
Among the online and retail brokers that increased margin calls Tuesday were
brokerage and clearing units,
Quick & Reilly
Even at the end of last week,
margin calls were running twice as high as normal, spokesman Dan Hubbard says. "I expect that we would be making more margin calls today than we did last week," he adds.
Ameritrade said Tuesday that its margin calls were up 40% to 50%.
Here's how margin calls can work:
- An investor wants to buy a $100 stock that has a 35% margin maintenance requirement.
She puts up $50 and her broker puts up $50. Her margin balance is minus $50 (because she borrowed $50), and her equity is $50 (because she owns $100 worth of stock and owes the broker $50).
Now say the brokerage raises the margin maintenance requirement for the stock to 80%. Since the market value of the stock she owns is $100, she needs to have $80 in equity -- so she gets a margin call to add $30. At this point, her margin debt drops to minus $20.
Now suppose that the stock price drops by $30. Now the market value of the stock she owns is only $70, and her equity is only $50 (or $70 - $20), so she will get another margin call for $6 because 80% of $70 is $56, and she only has $50 in equity in the account.
Brokers also were continuing to ratchet down the amount of money they'll lend investors to buy certain stocks.
While Hubbard said one day isn't enough to change Schwab's margin requirements on a particular stock, he said the list of stocks with higher margin requirements has grown to 275 from 25 in November 1998. Stocks get higher margin-maintenance requirements because of volatility, liquidity and fundamentals.
Some hot stocks that couldn't be bought on margin as of Tuesday at U.S. Clearing, which handles the back-office transactions in buying and selling stocks, were
. On the 80% requirement list now are
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