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Fears of market collapse amid record margin debt

NEW YORK – Borrowing money from stock brokers to buy stocks has now hit an all-time high, triggering fears of a downward market adjustment and a collapse of the brokerage-made loan market investors typically use to fuel continued bull market growth.

Data published by the New York Stock Exchange at the end of March shows margin debt – the loans made by stock brokers to permit investor clients to buy stocks on credit – has reached a record high of $466 billion, approaching for the first time a half-trillion dollars.

Analysis of NYSE margin debt shows previous peaks have foreshadowed severe market corrections.

It happened in the summer of 2000 just before the dot.com stock market crash and in the summer of 2007, preceding the bursting of the housing bubble that caused the dramatic economic downturn that began in 2008.

Stock market technical analysts have recently drawn attention to the rising level of margin debt. They note that when, as now, the margin debt drops below its 12-month moving average a strong signal is being given to investors to get out of the stock market because “investors are using less of the rocket fuel (i.e., margin debt) needed to keep stock prices artificially high.”

The fundamental problem with using margin debt to buy stocks on credit is that borrowing to buy stocks works only as long as the stock market is going up in value. When the stock market levels off or begins to drop significantly in value, investors buying stocks on credit run the risk of having borrowed money on a losing proposition.

In the extreme, when an investor’s account begins to lose value in a stock market adjusting downward, a brokerage firm can initiate a “margin call,” forcing the investor either to liquidate stocks or to add money to the account to maintain the ratios demanded by federal regulators between the amount of money borrowed on margin and the underlying value of the stocks purchased.

On Monday, stocks declined for a third session in a row, pulling the S&P index into the red for the year The decline raised investor fears the Internet, social media and biotechnology stocks that have fueled the current bull market may be losing momentum.

Fed ‘tapering’

At the end of March, Federal Reserve Chairwoman Janet Yellen indicated that the Federal Reserve has not yet done enough to combat unemployment even after holding interest rates near zero for more than five years and engaging in a policy of “Quantitative Easing,” or QE. The QE policy has pumped the Federal Reserve’s balance sheet to $4.23 trillion with purchases of U.S. Treasuries and other federal government bonds.

Yellen’s remarks were widely interpreted by investors as indicating the Federal Reserve would continuing buying U.S. debt for the foreseeable future.

Under Yellen’s direction, the Fed has engaged in a policy of “tapering” the amount of QE, reducing by $10 billion a month the amount of U.S. debt the Fed purchases. The Fed’s aim is to reduce the $85 billion/month amount of QE under former Federal Reserve Chairman Ben Bernanke to zero before the end of the year.

In January, WND reported fears that tapering QE to zero could cause interest rates to rise, risking the possibility a severe market correction.

Recent concerns about margin debt nearing $500 billion have added to concerns that the Federal Reserve’s ability to continue boosting the U.S. stock markets by buying U.S. debt may be coming to an end, with a downward market adjustment becoming more likely in the next few months.