May 11, 2000
SPENCER MICHELS: 49-year-old investment advisor Bill Higgins spends most of his time watching and playing the stock market from his two- room apartment near San Francisco's Civic Center. The financial cable station CNBC plays continuously in his bedroom. He reads "The Wall Street Journal." He goes online and on the phone to follow his stocks. Higgins, like an increasing number of Americans, buys some of his stocks on margin. That is, he borrows money from his broker, paying interest to pay for up to half the price of the stocks.
BILL HIGGINS, Investor: You're expecting... You're anticipating the stock to make a substantial move, if that's correct. It takes guts, but it takes knowledge. I mean, you have to understand that when you're using margin, it's credit, and credit's not capital.
SPENCER MICHELS: With technology stocks pushing the market up the last few years, many investors were tempted to borrow to buy into new companies. But Higgins says he knew buying on margin was risky, so he laid off the volatile tech stocks.
BILL HIGGINS: It's easy to start a dot-com company, so why should it be worth billions of dollars? So if you're crazy enough to buy that on margin, maybe you should get a warning. But you'll definitely get a margin call if you're wrong.
SPENCER MICHELS: A margin call is when the broker-- like Morgan Stanley or Charles Schwab-- fearing it could lose its loan, demands quick payment, forcing the borrower to come up with cash, or to sell stocks. When the market dropped precipitously in April, there were a lot of margin calls.
BILL HIGGINS: I started trading at $38 on the Internet.
SPENCER MICHELS: Higgins didn't get one, but he is disturbed by companies that give loans too easily, and traders who take them.
BILL HIGGINS: A lot of these firms are just encouraging trading left and right, and I don't think it's very healthy. I think it's just a formula for disaster, especially if there's going to be margin trading, because margin gives them the sense that they have more capital than they do have.
SPENCER MICHELS: From 2% to 3% of money invested in the stock market is money borrowed on margin. And although the percentage of stocks bought on margin has remained steady as total investment in the market has soared, the amount of money loaned for stock-buying has increased. It's gone up 58% from last August to a total of $278 billion.
ANNOUNCER: When Barry Hertz created My Track...
SPENCER MICHELS: Sometimes online trading companies like My Track that advertise heavily also invest on their own on margin. Baruch Israel Hertz, who appears in the ads, owns the firm, and he did just that. When the market dropped, he reportedly ended up owing $45 million to four brokerage houses.
BARUCH ISRAEL HERTZ: What can I say? I'm fast.
SPENCER MICHELS: Hertz has declined interviews. Much advertised online trading, together with low trading fees, have made stock trading easier and cheaper today than ever before, luring more people into the market. And brokerage houses like Fidelity Investments now offer margin trading, which can be achieved with a click of the mouse on its Web site. Most reputable firms like Fidelity will loan a customer less money to buy stocks they consider risky than they do for blue chips. Tracey Curvey, who is in charge of online trading at Fidelity, says the requirements that margin buyers can only borrow up to 50% of a stock's value protect customers and the brokerage.
TRACEY CURVEY, Fidelity Online Investments: I think all of the industry is looking closely at their margin balances and portfolios because of the market volatility. But I do think the industry has been very responsible in looking at the margin requirements and in trying to educate their customers about how it works, and how it can be a positive and not a negative.
SPENCER MICHELS: In good times, buying on margin can be a positive-- people make money. But in the late 1920s, buying on margin became a grave danger, inflating the values of stocks. A speculator could put up just 10% of a stock's value, and borrow the rest. Margin debt was ten times greater than now, relative to the total amount of money invested. The stock market crashed, and that was followed by the Great Depression. Most historians put part of the blame for the crash on margin buying. In those days, the lenders of money kept on lending at a furious pace, despite admonitions from the Federal Reserve Bank, according to economist Bradford Delong.
BRADFORD DELONG, University of California: The Federal Reserve up to a year before the crash began telling banks that it did not want them making any more loans on stocks, that it did not want them taking stock for collateral for any loans at all. But of course back in 1929, the banks thought about this and told the Fed, "go away."
SPENCER MICHELS: Delong teaches economic history at the University of California at Berkeley. He says at first no one, including President Herbert Hoover, knew what to do.
BRADFORD DELONG: Throughout the 1929-1932 presidential term, throughout the Hoover term, very little happened in Washington. They just kind of stand like stunned deer and watch the Depression unfold. But starting in March of 1933, with his inauguration, Roosevelt kind of tried everything, and one thing was the Securities and Exchange Commission and expansion of the powers of the Federal Reserve as well. So that today no bank dares do what the National City Bank and the others did in 1928 and 1929, which is to ignore the Federal Reserve.
SPENCER MICHELS: Today, 71 years after the crash, the controls enacted during Franklin Roosevelt's administration, including the limits on the amount a stock investor can borrow, are supposed to protect the economy. Still, individuals can lose money. Alan Kelly works as a water in several restaurants, and buys stocks on margin.
ALAN KELLY, Waiter/Investor: There's a lot of people playing the market out there. Absolutely.
SPENCER MICHELS: On margin?
ALAN KELLY: Probably a lot of them are probably playing margin, sure. With the bull market of the last few years, everybody seems to think, you know, people are taking a chance.
SPENCER MICHELS: When the market plummeted, Kelly got hurt.
ALAN KELLY: Oh, that was pretty bad.
SPENCER MICHELS: Was it?
ALAN KELLY: Yeah.
SPENCER MICHELS: Did you get any margin calls?
ALAN KELLY: Ah, I got a couple.
SPENCER MICHELS: What happens when you get a margin call?
ALAN KELLY: Well, you pay up the money, or you sell out.
SPENCER MICHELS: So what happened with you?
ALAN KELLY: I paid up.
SPENCER MICHELS: There were winners as well. Larry Bill, a day trader who buys and sells stocks for a living, didn't happen to have any outstanding margin loans.
LARRY BILL, Day Trader: It was great, because I was in cash. I was buying, then I was selling two hours later, and it was wonderfully profitable for me.
SPENCER MICHELS: So in other words, you didn't have any money on margin at that point, you're saying?
LARRY BILL: Not when it was going down. But once it had reached the bottom, yes, I did buy on margin to pick up the bargains. Most were not that lucky. Most are in a lot of pain.
SPENCER MICHELS: When millions of investors are forced by margin calls to sell off the stocks they bought high-- even the solid ones-- prices drop, and the whole market can go into a tail spin.
BRADFORD DELONG: And that's the stuff of which great crashes are made.
SPENCER MICHELS: But Delong says today's stricter rules mean less risk. What makes the risk uncertain is that some money is borrowed not on margin, but elsewhere, and is used to buy stocks.
BRADFORD DELONG: People will find a way to speculate with borrowed money. And when you close down one possible channel, people are inventive enough to think up others.
SPENCER MICHELS: The Securities and Exchange Commission doesn't know how much stock is bought on borrowed money outside of margin, and can't do much about it. But for securities bought on margin, the SEC has asked the stock exchanges to examine their practices. And several states have issued warnings that some traders, like Mike Pavlik, endorse.
MIKE PAVLIK, Stock Trader: I think the problem with margin and the normal trading public is that they're undisciplined. They don't cut their losses.
SPOKESMAN: Hey, there's news on Vertel. Oh, that's a good increase!
SPENCER MICHELS: Discipline is what this company-- Electronic Trading Group-- is all about. These young traders buy and sell stocks all day long, using the company's money. They take home 50% to 70% of their profits. The company gets the rest. They are watched carefully by manager Clem Wohlreich, who has taught them rules and practices.
CLEM WOHLREICH, Electronic Trading Group: I think you may be over- trading a little bit. Make sure you don't go down for the day, because you've got a good day going on. It's a trader's crime to lose money after they've been up on the day, okay?
SPENCER MICHELS: While these company traders don't buy, as customers do, on margin, and are subject to a different body of federal rules, Wohlreich says the discipline they live by could be a model for margin buyers.
CLEM WOHLREICH: They're kids mostly. They're in their early 20's, and they think, "well, just let me do it one more time, and I get all the money back." That's not the way we trade. We trade with discipline. If... If you can show me that you can apply the disciplines that we suggest, I suggest I can probably make you a successful trader.
SPENCER MICHELS: Each trader has a dollar limit that he can lose. If he loses that, he stops trading for the day.
CLEM WOHLREICH: 80% to 85% of our traders are successful this month, and over 85% are successful for the year. Probably 70% to 80% of the people who walk in off the street are unsuccessful, and they, in fact, lose all their money.
SPENCER MICHELS: So, for somebody to trade on margin, borrowing money to trade, without the training you have?
CLEM WOHLREICH: Or without the discipline, you might as well take a loaded .38.
SPENCER MICHELS: Several brokerages report that in the past few weeks the amount of margin debt has declined somewhat, possibly because the April market drop forced some margin players out of action.