Investors Return to Risky Margin Buying - AP

Oct 09, 2003

By RACHEL BECK, AP Business Writer

NEW YORK -- Such short memories these investors have. They got burned before by borrowing cash to buy stocks. And now they are right back doing that again.

Buying on margin, as it's called, is going on at a pace not seen in some parts of the market since the height of the last bull market. And individual investors seem to be behind much of these gains.

Margin buying can result in big returns if stocks go up, but losses can be magnified and holdings wiped out if prices tumble.

"This creates an illusion that people think that they can buy things that they really can't afford," said Brian Orol, president of Strategic Financial Planning Group in Raleigh, N.C.

Margin buying isn't new to Wall Street. Back in 1929, so many investors had bought on margin that it added to the panic when stock prices tumbled during that year's crash.

In the late 1990s, investors, eager to participate in Wall Street's dramatic rally, saw it as a way to finance their stock buys if they didn't have the cash. Unfortunately, when the market collapsed in 2000, many were left with nothing or even owing money.

But it seems they haven't learned from their past mistakes.

No sooner did the market resume its climb last spring with the most risky and volatile stocks -- including technology, Internet and semiconductor shares -- once again leading the way, than investors increased their margin buying.

Margin loans through brokerage firms registered with the National Association of Securities Dealers have quadrupled this year to $26 billion in July, the latest data available. That tops the $21.4 billion borrowed at the top of the bull market in March 2000.

Margin debt has climbed 10 percent this year to $148.5 billion in July for firms regulated by the New York Stock Exchange, trailing what was reached at the market's last peak.

It's the sharp rise seen at online trading sites that indicates average investors, not just professionals, are doing big buying on credit. At Ameritrade, for instance, margin activity jumped 46 percent to $1.9 billion from April to June, the most recent data available.

This upsurge even spurred the NASD, the brokerage industry's self-policing group, to issue a warning last month reminding investors of the risks of margin buying.

Under Federal Reserve rules, investors can borrow up to 50 percent of the purchase price of a stock.

Brokerage firms don't extend these loans just out of the goodness of their hearts. There is big money to be made on margin accounts, all at investors' expense.

For starters, they charge interest, so investors typically pay around 5 percent on the money they borrow. And that is owed no matter if the stocks rise or fall.

Should a stock bought on margin decline, brokerage firms can issue a "margin call." That comes when investors' accounts fall below certain required levels allowing the brokerage firm to demand payment of part of the loan with cash, a deposit of securities from outside the account or by selling some shares in the account.

Consider this scenario...
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