Source: The NY Times – Shades of 2007 Borrowing
AMERICAN investors have taken out more margin loans than ever before. That indicates that speculative investing has grown among retail investors, reaching levels that in the past indicated the market was getting to unsustainable levels and might be in for a fall.
The amount owed on loans secured by investments rose to $384 billion at the end of April, according to data compiled by Finra, the Financial Industry Regulatory Authority. It was the first time the total had surpassed the 2007 peak of $381 billion, a peak that was followed by the Great Recession and credit crisis.
The accompanying charts show the level of outstanding margin debt since 1960, both in dollars and as a percentage of gross domestic product. The latest total of borrowing amounts to about 2.4 percent of G.D.P., a level that in the past was a danger signal.
Rising margin debt was once seen as a primary indicator of financial speculation, and the Federal Reserve controlled the amount that could be borrowed by each investor as a way to damp excess enthusiasm when markets grew frothy. But the last time the Fed adjusted the margin rules was in 1974, when it reduced the down payment required for stocks to 50 percent of the purchase price, from 65 percent. That came during a severe bear market.
Since then, the Fed has been on the sidelines. The view there, and among professional investors, has been that far greater leverage was available through options and futures, not to mention more exotic derivatives, so changing the rule would have little effect on levels of speculation.
Nonetheless, margin loans have remained popular among many individual investors, who tend to raise their borrowings during times of market optimism and to reduce them when markets are falling. Thus the margin debt levels now may provide an indication of popular enthusiasm for investments.
The first time in recent decades that total margin debt exceeded 2.25 percent of G.D.P. came at the end of 1999, amid the technology stock bubble. Margin debt fell after that bubble burst, but began to rise again during the housing boom — when anecdotal evidence said some investors were using their investments to secure loans that went for down payments on homes. That boom in margin loans also ended badly.
The charts show the changes in the Standard & Poor’s index of 500 stocks during the 12 months before the margin debt level reached 2.25 percent of G.D.P., while it stayed at that level, and during the 12 months after the debt level fell below that figure. The figures are indexed to zero at the end of the first month that margin debt reached 2.25 percent of G.D.P.
In each case, there were double-digit increases in share prices during the year before margin debt got to that level. In the first two, the stock market decline began while margin debt was at the high level, and accelerated as debt levels fell — presumably because investors were liquidating securities that were losing money.
If that pattern repeats, it could indicate that the stock market rally, which carried the S.& P. 500 to record levels in May, will not last much longer.
Perhaps offering some hope that pattern will not repeat is the fact share prices are lower now — at least relative to the size of the economy — than they were at the prior peaks. As it happens, the S.& P. 500 was a little below 1,500 in 1999, and again in 2007, and again this past January, when margin debt rose to 2.25 percent of G.D.P. But corporate profits now are more than double what they were in 1999, according to government estimates.