Paris, Friday, June 2, 2000 After Stocks Slide: The Margin Call Demand to Cover Debts Ruins Some Who Borrowed to Buy Shares
By Sharon Walsh Washington Post Service
NEW YORK - The ultimatum comes in a harmless-looking white envelope with blue writing, a Mailgram. ''Either make an immediate payment or close out some of your portfolio,'' reads one. Another one ''reserves the right to take action at ANY time with or without notice if market conditions warrant.''
''Although we are reluctant to take further action, if we have not received the funds by then,'' a third says, ''we will be forced to liquidate a sufficient amount of securities to meet these requirements,'' adding: ''Losses may be realized that you do not wish to take at this time.''
This is the dreaded margin call. As ominous-sounding as it may be, the fear of a margin calls did not keep hungry investors from leveraging their stock portfolios to invest more money than they had when the markets were climbing. At the end of March, the New York Stock Exchange reported that balances in margin accounts were $278.5 billion, the highest level ever.
Regulators and Wall Street analysts were concerned that too many investors were speculating in the market with borrowed ''margin'' money. But margin debt declined in April by $26.8 billion - its biggest dollar drop ever - and it is likely to be flat or down again in May, according to the NYSE and brokerage houses.
The drop did not result from more caution among investors. Rather, many who invested on margin when the market was soaring had to raise cash when the value of their stocks plummeted. Some lost everything.
''I don't think it went down because people paid off margin debt,'' said David Carr Frank, a broker with Financial West Group in Los Angeles. ''It went down because people got wiped out.''
Margin calls rose substantially in May, said Mike Dunn, a spokesman for Datek Online Holdings Corp., one of the biggest online trading companies. ''Some people were closed out,'' he said. ''Some made payments. Some sold stocks. It was not unpredictable. Whenever the market goes down sharply, there are more margin calls.''
''I think that's good,'' said Charles Pradilla, chief investment strategist at SG Cowen Securities. ''I mean, my butcher was on margin. These were speculative investors.''
Margin debt, $251.7 billion in April, has been the fastest-growing component of U.S. private debt in the past year, according to the Securities Industry Association. And new horror stories of investors being destroyed by margin calls are likely to emerge.
''It's like holding the kiss of death in your hands,'' said one investor who has received margin calls and asked that his name not be used.
''You think, 'Oh, God. How will I tell my wife?' Using margin is great when the market's going up, but a margin call is awful,'' he said. ''People don't understand that you can lose your house, your savings, everything.''
Margin calls come to investors who borrow from brokerage firms using their stock portfolios as collateral so that they can invest even more money in stocks. If the value of the stock portfolio declines below the collateral requirement and they are unable to come up with the money, a broker can sell the stocks immediately - without consulting him - to meet the margin call.
The Federal Reserve Board sets U.S. margin rates. The initial rate is 50 percent, so an investor with $50,000 in cash could borrow on margin - take a loan from a brokerage firm - to buy a total of $100,000 of stock.
But if the stocks he has purchased fall substantially, he must meet the brokerage's margin requirement. If the brokerage requires that the value of the margin account not fall below 30 percent of the total value, then the investor must provide additional collateral when the stocks are worth $30,000 or less
Margin calls can nibble an investor to death. If his stocks are going down consistently, he can get daily calls for deposits of thousands of dollars.
''The hardest thing about that phone call is that you have to have the money tomorrow,'' said Michael Stearns, 60, of Long Beach, California, who once invested heavily on margin but now tries to keep his margin account small. ''What if you don't have the $30,000 today? Are you going to take out an equity line on your home?''
Brokers tell stories of investors who go home when the mail is delivered each day to prevent their spouses from finding out they have received a margin call.
''It's a cancerous process in terms of money,'' Mr. Frank said. ''You start out with a little margin call, and suddenly you're losing money you didn't know you had invested.''
A shareholder who had been investing for about 10 years said he started investing on margin, mostly in high-tech stocks, about three years ago. The investor, who asked that his name not be used, said he had bought a stock at $8 a share and ''waited for it to go to the moon.'' But it did not. Instead it fell.
The investor was borrowing from his home-equity line of credit to come up with the cash he needed. And he still had to sell most of his stock before it went back up.
''I owed $80,000 on margin,'' he said. ''And I'll tell you, I had some sleepless nights. That's a sickening amount of money. But I was lucky. I bailed myself out.''