Thursday, February 15, 2007

Margin Debt

Margin debt tracked by the NYSE has now risen back to its all time high reached in March 2000 (see chart below, 12/06 latest). Back then all popular equity indexes were making new highs, more or less concurrently: Dow Jones, S&P 500, Nasdaq - it was a broad-based bubble. Given that NASDAQ is presently nowhere near its all-time high, margin debt is today more concentrated and probably used for speculative purchases of today’s darlings: the financial stocks that right now make up 23% of S&P 500 capitalization.

A simple comparison: in March 2000 S&P 500 was at 1550 and in December 2006 at 1420, or 8.5% lower, yet margin debt was the same. This means that
as a percentage of capitalization leverage is now more extreme than even during the 2000 top.

Notice also how margin balance growth has gone vertical, just like it did in 2000.


  1. When I saw your post this morning, I checked John Kenneth Galbraith's book, The Great Crash - 1929, originally written in 1954, to see what he had to say about margin in 1929.

    He gives the following as the purpose of margins: "The purpose is to accommodate the speculator and facilitate speculation. But the purposes cannot be admitted. If Wall Street confessed this purpose, many thousands of moral men and women would have no choice but to condemn it for nurturing an evil thing and call for reform. Margin trading must be defended not on the grounds that it efficiently and ingeniously assists the speculator, but that it encourages the extra trading which changes a thin and anemic market into a thick and healthy one. At best this is a dull by-product and a dubious one. Wall Street, in these matters, is like a lovely and accomplished woman who must wear black cotton stockings, heavy woolen underwear, and parade her knowledge as a cook because, unhappily, her supreme accomplishment is as a harlot."

    The interesting implication of what he says is that the hidden purpose of margins is to increase trading -- so that brokers can make a lot more money on commissions.

    Well, if the 1929 market was a harlot, then I can't even imagine what words we'd have to use to describe the incredible level of financial depravity and debauchery exhibited today by financial advisors, hedge fund managers, and real estate public relations people today. About the only positive thing that can be said is that a lot of these people will be going to jail.

    Galbraith gives some amounts of margin credit, or brokers' loans, but they're all buried in the text, and they have to be extracted.

    He says that in the early 20s, they varied from $1.0B to $1.5B, but then they took off. Here are the figures that he gives, where I've sometimes made an inference from words like "slight decline":

    1-Jan-1926 $2.5B
    31-Dec-1927 $3.4B
    1-Mar-1928 $3.3B
    1-Jun-1928 $4.0B
    1-Nov-1928 $5.0B
    31-Dec-1928 $5.7B

    Unfortunately, he doesn't give any figures for 1929, but he says that in the last week of August the increase was $137,000,000 in that one week alone. The above table shows a rate of increase of about $100M per week at the end of 1928, so if that rate of increase continued in 1929, margin debt could easily have reached $10 billion by the end of August.

    I found a NY stock exchange page that gives historical data, but it only starts at 1959.

    However, it is worth noting that in 1959, total margin debt was just $3.4 billion, same as in 1927.



    John J. Xenakis
    Web site:

  2. That's a really great book, I have read it a few times myself.

    The purpose of margin is to make money on the loan - I know for a fact that brokers make the bulk of their profit on such loans and on re-lending to the Street the customers' securities bought on margin. This is perfectly legal - you have to agree to it when you open a margin account. Commissions more or less just cover the costs, amazing as that may sound.

    At the top in 1929 total market cap was around $140 billion. If margin had reached $10 billion then the ratio would be 10/140=7%.

    Today's ratio is 280/27,000 = 1%, seemingly much less, but real leverage these days resides elsewhere: financial futures, options, etc.