Minyan Mailbag: Margin Debt
Editor's Note: Minyanville is a community of people who share an interest in fiscal literacy. As perspective is an important aspect of our daily routine, we share this exchange with hopes that it adds balance to your process.
Just a dumb question from this novice: To what extent does margin debt/cash balance in brokerage accounts matter if individuals have a mountain of debt overall? I mean, what if I took out another mortgage on my house (or borrow from credit card issuers for that matter) and poured that cash into my brokerage account to trade stocks? The margin stats would suggest I'm liquid and/or unlevered when from a 'big picture' standpoint nothing might be further from the truth.
In situations where overall debt levels are high, focusing on changes in margin debt seems myopic.
What am I missing?
Professor Scott Reamer replies:
Your hypothetical brings into full relief the weakness of implying causal effects from this particular data series. Perhaps more to the point, however, I would argue that WHY you taking on debt or hoarding cash in your brokerage account is an essential part of trying to understand what we can reasonably conclude from those human actions (Rothbardian reference quite on purpose there).
And my reply:
Your point illustrates the significant weakness in looking at any one data series by itself: each little picture has to be viewed within the context of the big picture.
It is very likely that investors with large amounts of debt, as we know they carry, have some common sense and are choosing not to "margin" that debt up even more when they buy stocks. But the fact remains that consumer debt is at a high relative to GDP.
Consequently, the premise that low margin debt suggests those that own stocks will not have to sell into a decline, may then be false since the correlation between all asset prices is rising due to high liquidity: falling stock prices would likely mean falling housing prices. Liquidity is a function of debt; liquidity is introduced into the system through debt.
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