Thanks to the folks at the NYSE, we have a historical recap of monthly outstanding margin debt going all the way back to the 1950s. Most of you will be aware of this already but margin is the means by which an investor can lever themselves into purchasing additional volumes of stock that they don't have cash for.
From the SEC website, here is some background information on how much you can borrow and the requirements regarding maintenance margin (i.e. the dreaded "margin call"):
1.) Initial Margin: "According to Regulation T of the Federal Reserve Board, you may borrow up to 50 percent of the purchase price of securities that can be purchased on margin. This is known as the "initial margin." Some firms require you to deposit more than 50 percent of the purchase price. Also be aware that not all securities can be purchased on margin."
2.) Maintenance Margin: "After you buy stock on margin, FINRA requires you to keep a minimum amount of equity in your margin account. The equity in your account is the value of your securities less how much you owe to your brokerage firm. The rules require you to have at least 25 percent of the total market value of the securities in your margin account at all times. The 25 percent is called the "maintenance requirement." In fact, many brokerage firms have higher maintenance requirements, typically between 30 to 40 percent, and sometimes higher depending on the type of stock purchased.
Here's an example of how maintenance requirements work. Let's say you purchase $16,000 worth of securities by borrowing $8,000 from your firm and paying $8,000 in cash or securities. If the market value of the securities drops to $12,000, the equity in your account will fall to $4,000 ($12,000 - $8,000 = $4,000). If your firm has a 25 percent maintenance requirement, you must have $3,000 in equity in your account (25 percent of $12,000 = $3,000). In this case, you do have enough equity because the $4,000 in equity in your account is greater than the $3,000 maintenance requirement.
But if your firm has a maintenance requirement of 40 percent, you would not have enough equity. The firm would require you to have $4,800 in equity (40 percent of $12,000 = $4,800). Your $4,000 in equity is less than the firm's $4,800 maintenance requirement. As a result, the firm may issue you a "margin call," since the equity in your account has fallen $800 below the firm's maintenance requirement."
Here is a chart showing the end of month margin debt (in millions of dollars), free credit cash accounts and credit balances in margin accounts for all of 2013 and the first two months of 2014:
Since January 2013, margin debt has grown from $364.107 billion to $465.720 billion at the end of February 2014, an increase of $101.613 or 27.9 percent. In the month of February 2014 alone, margin debt increased by $14.42 billion! At the same time, credit balances in margin accounts declined from $170.229 billion to $159.52 billion, a decrease of $10.709 billion or 6.3 percent.
Here is a graph showing the increase in outstanding margin debt since the Great Recession began in December 2007:
Just prior to the Great Recession, margin debt hit a peak of $381.370 billion in July 2007. It fell rather abruptly throughout 2008 and early 2009, hitting a low of $173.3 billion in February 2009 as investors were dropping like flies. This brought outstanding margin back to the level last seen in December 2003. Since its Great Recession low point, outstanding margin has increased by $292.42 billion or 168.7 percent, a rather phenomenal increase!
If we look at this graph showing the increase in margin outstanding that runs from 2000 to the end of 2007, we can see how the increase in margin was closely associated with what turned out to be an unsustainable rise in the stock market:
Note that over the period between 2000 and 2007, outstanding margin increased from a low of $130.21 billion in mid-2002 to $381.37 billion in July 2007, an increase of 192.9 percent.
In the past, excessive levels of margin debt have exacerbated the drop in stocks as investors who are facing a margin call must make the decision between selling at a loss to prevent a further loss of capital or paying up to cover their margin shortfall. Increases in margin do one thing very well; they provide fuel for further stock market gains. Whether the gains are there to stay or not is anyone's guess. It all depends on whether the current rise was the result of a margin-fueled feeding frenzy or can be attributed to factors that have some connection to economic reality.