10 October 2008

Margin Call, Gentlemen?

This is something going around the trading desks. Suddenly tightening margin credit is a precipitant to artificially steep market declines as those students of the Crash of 1929 will well remember. That is something one does on the upside of a potential asset bubble, not in the decline.

If this is true, then there is an obvious need for the Fed to step in and provide credit relief even if on high rates, moreso than propping up a few banks by buying their worthless assets at above market prices.

Forced margin selling because of arbitrary private bank policies is going to create a major problem in the financial markets, leading to a greater concentration of wealth, and the ultimate descent into a loss of freedoms.

The selling has reached historic proportions. There literally is a "run on the market," as investors worldwide are dumping stocks.

It seems that the major catalyst for this selling is the fact that the newest large banks primarily J. P. Morgan, Goldman Sachs, and possibly Morgan Stanley as well -- have issued massive margin calls to hedge funds and other professional traders who use these banks as prime brokers.

These calls were not issued because of market losses, but more because the banks arbitrarily decided that they wanted their customers to use less leverage. Margin rates as low as 15% for broker dealers were raised to 35%; hedge funds who had been used to operating on high leverage were told that they had to bring accounts up to a much larger percentage of equity.

In this illiquid environment, where all manor of exotic securities literally have no bids, the only place to raise the cash to meet margin calls was to sell stock. That is what really set this market over the edge -- as the first notice of these calls were issued on October 2nd and 3rd.

There was something of a grace period to meet the calls, but funds realized they weren't going to be able to meet them other than by selling stock. There are rumors that the most massive of the calls are due Monday (October 13th). If so, this market could continue to decline through then.