Record High Margin Debt Fueling U.S. Markets

Why are the stock markets and bond markets rising? For the only reason that there is: Because there are more buyers than sellers! Hahahaha!

Okay, I am sorry about laughing, but if I may be so bold as to make a suggestion, perhaps your question would have been better phrased as, “Where are the buyers getting the money to buy all of this stock and bond madness and act like a bunch of morons?”

If that had been your question, I could have saved us both a lot of time by merely sending you to, which reports that, “‘Margin Debt’ Hits Record $353 Billion on NYSE”, which means that, “Investors are borrowing record sums of money to finance trades on the New York Stock Exchange.”

How much money? The Journal continues, “So-called margin debt, a broad measure of leverage, jumped 11% to $353 billion at the NYSE in May, up from nearly $318 billion in April.”

The news that margin debt increased 11% in one month, to a new record, so surprised and alarmed me that I accidentally swallowed my tongue in horror! But, thankfully, it turned out to be okay, since it was soon forced back up by my reflexively puking up blood at the sheer horror of so much speculative debt.

And broker-dealers suddenly find themselves with more money, too, as from Jim Grant’s Interest Rate Observer we learn that thanks to the new regulatory system for broker-dealers called Consolidated Supervised Entity, “the broker-dealers (in voluntary fashion) are implementing the risk-based capital rules known in the trade as Basel II.

“The liberating feature of Basel II”, he continues, “is that the financial institutions to which it applies may hold more assets per dollar of equity capital than they previously could – provided that a ratings agency judges the assets to be top-flight.”

By this time I am so bored by one more story of one more bunch of sleazy operators in cahoots with corrupt regulatory supervision that I am thinking “Yadda yadda yadda” and trying to stick my pencil in the ceiling just to keep from nodding off. I was yanked back to cruel reality when Mr. Grant said. “Specifically, under Basel II, a broker-dealer must set aside just 56 cents in capital to hold US$100 of triple-A-rated securitizations.” Yow! Fifty-six lousy cents?

Shocked, I am too, too, too nonplussed to comment, so I turn to Junior Mogambo Ranger (JMR) Phil S., who says that only putting up 56 cents to hold $100 in assets seems a bit much, as “That is 1/18th of the 10% stock margin equity required in 1929”!! Hahaha! The exclamation points were added by me, utilizing my awesome editing powers (“If there is nobody here to stop me by force, I can do whatever I want”) to add that essential Mogambo Stylistic Flourish (MSF) to give it the dramatic emphasis that it truly deserves.

And the stock market may be going up because there is a huge, towering overhang of short interest, and if there is one trick that the sharks of Wall Street reliably pull to eat their fill when short interest expands like this, it is by suddenly running the market sharply up and squeezing the shorts, who buy in a panic to cover their enormous short positions and to keep from losing more money if the stock price continues to rise, making prices go up even more, spooking more shorts, who then buy to cover, making prices go up some more, spooking more shorts.

And a lot of buying is resulting from lots of foreign investment money coming here, too, as an article quotes Alan Ruskin, chief international strategist at RBD Greenwich Capital as saying “One reason why the dollar has responded in such a negative fashion is that corporate bond inflows have made up half of the current account financing in the past year.”

In fact, he says, “In the 12 months to April, the US received $509bn in corporate bond investment inflows that helped finance the current account deficit.” Half a trillion a year!

And the market is also going up because the Plunge Protection Team and the entire rest of the governments, banks and financial services industry are busily intervening in the marketplace, desperately trying to keep stock, bond and housing prices up and rising.

And they can intervene with good effect at those times when prices have been recently down, and the charts of the market price start hitting the lower bound of their up-trend channels, making technical traders get nervous that prices will fall some more to penetrate the lower channel, meaning that lower prices lie ahead and now is a good time to sell!

But nowadays (just in time, every time!), the markets suddenly turn around, bounce off of the lower bound of the channel, which is a bullish signal, and the technical traders launch into “buy mode”! Mission accomplished!

But the real reason that markets are going so bizarrely up is because excess money and credit are constantly being created around the world, by central banks around the world, and thus money supplies around the world are expanding at double digit rates around the world, and all this new money has to go somewhere, or why would anyone borrow it in the first place?

And it is going into stock markets, and bond markets, and housing markets and commodities markets around the world, driving up (by bidding up) the prices of everything. How far away from “price stability” can you get before you just say “Ugh!”?

Until next week,

The Mogambo Guru
for Markets and Money

Mogambo Guru
Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter - an avocational exercise to heap disrespect on those who desperately deserve it.

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Deron Kawamoto

The SEC altered Regulation T, governing margin debt effective April 2. Institutional margin accounts can now purchase stock with as little as 15% margin. That is what allowed the explosion of margin debt from April to May. Kind of reminds me of the foolish subprime lending that allowed the housing bubble to live beyond its natural span. The margin changes seem likely to have a similiar, and similarly short-lived effect.

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