OPTION FOR THE FED
October 15, 2008
Among the actions the Federal Reserve is expected to announce imminently, it should include an immediate, but temporary, reduction in margin requirements for stock purchases, says Bob McTeer, a distinguished fellow at the National Center for Policy Analysis and former president of the Federal Reserve Bank of Dallas.
The current requirement is that no more than 50 percent of value of stocks purchased and held should be with borrowed money. A 50 percent margin rate seems conservative and appropriate during normal times, but it's necessarily adding to the downward spiral of today's stock markets.
In the late 1990s, Chairman Alan Greenspan rejected calls to raise margin requirements during the stock-market boom saying it would hurt the small investor, but margin requirements are pro-cyclical, in that a decline in the market increases the fraction of the holdings carried by debt and reduces the fraction owned outright by the investor, says McTeer:
- Often, a margin call requires investors to sell stock to restore the required margin percentage, or someone receiving a margin call may sell another asset to raise cash to meet the margin call.
- Either way, it puts further downward pressure on an already declining market.
- Moreover, they are pro-cyclical, as are limiting the amount of bank capital held on the books during good times and raising insurance premiums during bad times.
- So is strict application of mark-to-market accounting rules on assets that temporally have no market.
Therefore, the Board of Governors could reduce margin requirements from 50 to 40 percent, 35 percent, or even 25 percent until the crisis passes and then gradually restore them partially or entirely. Since no permission from Congress or coordination with other regulators is necessary -- Congress gave the Fed authority over margin requirements in the 1930s precisely for this reason -- what do we have to lose, asks McTeer?
Source: Bob McTeer, "Option for the Fed," Washington Times, October 15, 2008.
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