Roaring Twenties Redux

0 Comments | Insight on the News, March 13, 2000 | by Patrice Hill

Debt among stock investors has soared as traders attempt to maximize their gains in a go-go market. Regulators are contemplating tighter lending rules, especially for day traders.

Americans borrowed 62 percent more last year than in 1998 to buy stocks, the biggest increase in 15 years -- a trend that worries federal regulators and even some high-flying financiers on Wall Street.

The amount of credit extended by members of the New York Stock Exchange to individual investors jumped by $88 billion, to $228.5 billion by the end of last year, according to Ned Davis Research, a market-data firm in Venice, Fla. The level of debt has been soaring in a way that reminds some analysts of the Roaring Twenties, when buying stock "on margin" was popular and largely unregulated.

While borrowing enables investors to double their stock purchases and maximize any gains in stock prices, it also doubles the pain when stock prices fall and poses a danger of extreme tumult and financial ruin if the market crashes. Many historians blame the crash of 1929 on widespread margin buying.

Since that crash, borrowing has been regulated by the Federal Reserve, which requires investors to have a minimum of $2,000 in their trading accounts and borrow no more than twice their assets. But the central bank has not tightened its rules on borrowing since 1974, and some law-makers and financial experts are starting to ask why.

"Is there a speculative bubble in the stock market?" asks Edward Yardeni, chief economist with Deutsche Banc Securities in New York. "One way to find out is to raise the margin requirement. If investors believe in the new era of perpetual prosperity, they should be willing to invest more of their own money in the stock market."

Some Fed watchers are perplexed that the central bank has not used its regulatory hammer to stamp out the borrowing binge, especially in light of Fed Chairman Alan Greenspan's frequent criticism of soaring stock prices and fears of inflationary spending. Greenspan has admitted that the central bank is concerned about the phenomenal growth in the leveraging of stocks. But he argues that tightening the lending rules will not accomplish what many advocates want, which is to temper the increase in stock prices, while it would hurt small investors who do not have the financial wherewithal that big investors have to get around the rules.

The increase in borrowing to buy stocks was particularly pronounced at the end of last year. Double-digit growth in margin lending in November and December helped propel the stock market to record levels and catapulted the National Association of Securities Dealers Automated Quotations, or NASDAQ, Composite Index to a record 86 percent gain for the year.

The activity appears to be concentrated increasingly among day traders betting on stratospheric gains in the stocks of Internet start-up companies and other go-go technologies. Some day-trading companies have devised ways for their clients to get around the Fed margin requirements.

To curb abuses, the New York Stock Exchange and the National Association of Securities Dealers, which oversees NASDAQ, have proposed increasing to $25,000 the minimum amount that active day traders need to keep in their accounts. While the Fed argues that raising, the bar primarily will hurt small investors, Sen. Charles E. Schumer, New York Democrat, says that may not be so bad, since small investors are the ones who are most likely to get hurt if the market turns down.

"Probably the people who are most overextended, should the market begin to fall, are the smaller investors," he says, noting that small investors often invest in only one stock and can be left "holding the bag" if that stock suffers a losing streak.

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Foreign businesspeople believe that Washington applies political and diplomatic pressure to create an uneven playing field, according to Transparency International, an anticorruption organization.

American businesspeople usually do not pay bribes themselves because they enjoy enormous business advantages, according to a report by the organization based on a Gallup Poll. The U.S. government pressures foreign governments for tax breaks and ties U.S. aid, arms deals and educational scholarships to business deals, the report claims.

"The United States exerts its superpower pressure to press other governments to use its contractors," says Frank Vogl, vice chairman of the Washington-based Transparency International. "There is a very negative perception of U.S. business practices among international executives."

Foreign business executives ranked France as second to the United States in the use of unfair practices. According to Vogl, small European companies argue that since U.S. influence on emerging countries is so powerful, they have to use bribes.

By Ines Capdevila