Margin Requirements, Margin Loans, and Margin Rates: Practice and Principles - analysis of history of margin credit regulations - Statistical Data Included

New England Economic Review, Sept-Oct, 2000 by Peter Fortune

This complicates the interpretation of changes in debit balances because, other things equal, the amount of margin loans will move directly with security prices when short positions are substantial. This can reinforce the impression that margin loans are rising when stock prices rise, even though the initiating source of the margin loan increase is a sale of stocks.

Another source of debit balances is a customer's withdrawal of cash from his margin account, typically through a check-writing authority or through credit card use. While the first tranche drawn on is the customer's cash (typically a sweep account), overdraft privileges allow a customer to withdraw cash up to the value of his "free credit balances" (defined below). This is treated as a loan against his securities and added to his debit balances. Thus, debit balances can increase because customers are taking cash from their accounts, not because they are buying securities using brokers' loans.

Have Investors Relied More Heavily on Margin Loans?

Many types of accounts do not allow margin loans. Chief among these are retirement accounts such as IRAs, Keoghs, SEP-IRAs, and 401(k) accounts (unless specifically allowed). Also excluded are trust estate accounts, fiduciary accounts (unless specifically allowed), and accounts established under the Uniform Gift/Transfer to Minors Acts (UGMA/UGTA). While an investor's mutual fund shares are marginable, the brokerage account of a mutual fund is excluded from margin status by the Investment Company Act of 1940 (see Fortune 1997). (7)

The mix of accounts will affect judgments about the relative size of margin loans. A firm with low margin loans relative to total customer assets might have a smaller share of customer assets in margin accounts, Although those margin accounts might be fully margined. Thus, the ratio of debit balances to stock market capitalization, shown in Figure 2, might understate the importance of margin loans because stock market capitalization is an aggregate amount including cash accounts as well as margin accounts. Unfortunately, many firms do not report the value of assets in margin accounts, and no data are available on the aggregate value of margin accounts.

Figure 3 addresses the question of intensity of margin loan use by focusing only on margin accounts. This figure shows the aggregate amount of debit balances at broker-dealers per dollar of potential margin debt. We define potential margin debt as the sum of actual debit balances at margin accounts and free credit balances at margin accounts, as reported by broker-dealers to the NYSE. Free credit balances are defined under Rule 15c3-3 of the Securities Exchange Act of 1934 as "liabilities of a broker-dealer to customers which are subject to immediate cash payment to customers on demand ...." The amount of cash that can be withdrawn from a margin account, the free credit balance, is calculated as the excess of the value of margin securities over the Regulation T margin required by the Fed; it is equivalent to the "margin excess" as defined in Regulation T. For example, suppose that an account has $100,000 of margin securities and $25,000 of debit balances. Suppose also that Regulation T requires a 50 percent m argin, or equity of at least $50,000. The customer can borrow up to $50,000, and, having borrowed only $25,000, he has $25,000 of additional debt capacity that he can use for cash withdrawal. (8)