In September 1987, just a month before the stock market crash, margin debt as a percentage of total stock assets stood at a then-record 1.37 percent. Last month, it was 1.44 percent.
Scary? You bet.
Margin debt is a tool used by stock speculators to increase their winnings. Investors borrow money from brokerages to buy more stock than they could otherwise afford on their own. If the stock rises, they end up making far more money than they would without borrowing; if the stock crashes, they lose their shirts.
In April, market volatility actually led to a comforting decline in margin loans, bringing down the stock debt-to-assets ratio from a peak of 1.54 percent in March. But this kind of dangerous speculation is still alarmingly high, and that’s just one of the recent trends giving economists the heebie jeebies.
Other kinds of debt are also at record highs, making it clear that a couple of years of good times have left consumers giddy. This mountain of debt, combined with continuing interest-rate hikes like last week’s half-point jump in the federal funds rate, mean a probable slowdown in the bustling economy. It also means a likely increase in bankruptcies, and could even presage an economic downturn if borrowers don’t get more cautious.
The upshot is that business people and consumers need to start getting more careful about the level of debt they’re shouldering. For those already highly leveraged, it’s a good time to start paying down loans.
A large amount of margin debt is dangerous because it makes the market extra volatile. If a drop in stocks causes nervousness for regular investors, it can cause panic among those who rely on stock gains to pay off high-interest loans. These loans are guaranteed by stock holdings, so when the market goes south, investors are forced to sell immediately to pay off their loans sometimes leading to mass pullouts, or crashes.
The rise in household debt is even more worrisome. Household debt recently surpassed total after-tax income for the first time in history. For most, this debt takes the form of home or car loans, or credit-card bills. Those who are barely able to make their monthly payments are facing a rude awakening in coming months when their credit-card issuers raise already-high interest rates even higher, and when the rates on their variable mortgages start inching upward. Even if this doesn’t force people into bankruptcy, it will force them to do something they haven’t thought about for awhile: economize.
Considering that consumer spending accounts for about 60 percent of the U.S. economy, the coming cutbacks don’t bode well for business. That in turn could make it harder for companies to pay off their own debts. Particularly vulnerable are homebuilders and home sellers, and companies that make and sell big-ticket consumer products.
There are already signs of trouble. Delinquencies are rising on sub-prime loans (mortgages for poor-credit households) and Federal Housing Administration loans. Twenty percent of American households with annual incomes of less than $50,000 had debt service burdens of over 40 percent, up from 15 percent between 1989 and 1995, according to a recent Federal Reserve Board survey. And the average credit-card debt load is rising even as the average credit-card interest rate increases.
None of these statistics are cause for panic considering that corporate fundamentals, like earnings, are still very strong. But they are sobering. They all point to a future that isn’t quite as rosy as the immediate past. And they are a clarion call to borrowers to tone down their exuberance and proceed with extra caution in the months ahead.
