Margin Debt Has Exploded by 49 Percent in One Year to $814 Billion. The Actual Figure May Be in the Trillions. Here’s Why.
When Jerome Powell, the Chairman of the Federal Reserve, appeared for an interview this past Sunday night on the CBS investigative program, 60 Minutes, he asserted complete ignorance of the amount of margin debt currently being used to inflate the stock market to one new historic high after another. The exchange between Powell and 60 Minutes host, Scott Pelley, went as follows:
Pelley: “The securities industry has reported that $814 billion has been borrowed by people investing in the stock market, borrowed against their portfolios. That’s a 49 percent increase over last year. “And the last time it grew that much was in 2007, before the Great Recession. And the time it grew that much before that was 1999, just before the dot com implosion. At what point does the Federal Reserve start to rein in this speculative bidding up of stock prices based on borrowed money?”
Powell: “That sounds like margin debt. I don’t know that statistic. I really can’t react to that statistic. I would say the main thing that we do is we make sure that the financial institutions that we regulate and supervise understand the risks that they’re running, manage them well, have lots of capital, lots of liquidity, and highly evolved risk management systems so that they do understand the risks they’re running and have plans to deal with them. And that way, when there are shocks, for example, if there were to be a big market correction, you will see financial institutions that are strong enough to stand up to that. Not just private financial institutions, but also markets and things like that, payment utilities and things like that. That’s really what we do.”
Pelley provided Powell with perfect examples of how excessive levels of leverage and unfettered risk-taking on Wall Street blow up markets and the U.S. economy, citing 2007 and 1999. Today, the Fed supervises some of the most highly leveraged financial institutions in the world – including Wall Street banks that are fueling not only their own internal leverage but also fueling obscene levels of leverage by loaning out hundreds of billions of dollars to hedge funds. For Powell to claim ignorance of one of the most important statistics used to monitor excess leverage in the financial system is an insult to the American people.
One good reason that Powell may have wanted to dodge this issue of margin debt is that he knows very well from his days as a Wall Street insider that the $814 billion margin debt figure cited by Pelley is just the tip of the iceberg.
The $814 billion margin debt is the latest amount reported by Wall Street’s self-regulator, FINRA, for February 28, 2021. Indeed, that figure stands 49 percent higher than the $545 billion reported at the end of February in 2020. But as Powell well knows, and the public is just learning through the recent implosion of the family office hedge fund, Archegos Capital Management, Wall Street’s largest banks are not actually reporting all margin debt that is fueling the sharp rise in stock prices.
According to FINRA’s Rule 4521, Wall Street firms are only required to report margin debt for “margin accounts for customers” held at “member firms.” By “member firms,” FINRA means the broker-dealers it supervises. FINRA does not supervise Wall Street banks that are also engaging in highly-leveraged trading — it supervises just the broker-dealers owned by those bank holding companies. For example, according to the most recent report from the Office of the Comptroller of the Currency (OCC), Goldman Sachs Bank USA, a federally-insured bank, has $271.65 billion in assets versus a notional (face amount) of $42.24 trillion in derivatives-see cap#2 and .pdf. On April 1, Financial Times reporter, Robert Armstrong, provided insight into how Wall Street banks are creating private derivative contracts known as swaps, to magically transform margin loans used for stock trading into simple collateralized loans for reporting purposes. This has enabled the Wall Street banks to secret these margin loans away from the eyes of regulators and, in doing so, ostensibly dramatically under report the amount of margin debt in the financial system.
This swap structure has not only enabled the amount of margin debt in the system as a whole to be dramatically underreported but it has also allowed hedge funds to obtain much higher initial margin debt than is allowed under the Federal Reserve’s Regulation T, which sets initial margin at 50 percent of the stock’s purchase price, not the six to one margin (and possibly higher) that was provided by the Wall Street banks to the Archegos family office hedge fund.