The Federal Reserve v. Wall Street

THOUGH Wall Street has long awaited and yearned for a cut in margin requirements, last week's move by the Federal Reserve Board set off a lively round of debate about the nature and function of one of the Street's most complicated safety valves. To many Wall Streeters, the cut from 90% to 70% seemed too little, too late. New York Stock Exchange President Keith Funston called it a "step in the right direction," but urged a bigger cut to "a more normal rate." Though most welcomed it, some brokers feared that the cut, coming when the market has been sliding, would only create doubts about the market's future.

The change means that investors need now put up only $700 instead of $900 to buy each $1,000 worth of stock. The other 30% of the price of the stock is bought on credit, covered by a loan made by the broker, on which the customer pays 4 1/2% to 5% interest. The Fed's move actually affects a small--but important--part of the market, since only some 20% of all shares traded on the New York Stock Exchange are on margin. With less "down payment" required, an investor is now able to increase his stock holdings immediately if he wishes. Brokers' phones were busy all day after the announcement, answering thousands of questioners who asked: "What is my buying power now?" The margin cut applies only to securities listed on national exchanges. Stocks on the more volatile and speculative over-the-counter markets cannot be bought on margin.

In juggling margins, the Fed tries to control speculative excesses by regulating the amount of credit flowing into the market. The Fed now believes that stock market credit is relatively stable at about $4.2 billion--and that a 70% margin is enough to keep it that way. Actually, this is only $165 million less credit than in October 1958, when the stock market and credit were soaring so high that the Fed raised the margin from 70% to 90%. And in April of last year, despite the increased margin, there was $550 million more credit outstanding on stocks than now. Thus, many Wall Streeters believe that when the Fed says that credit regulation is its only motive, it is telling only half the story. Says Luttrell Maclin, partner of Paine, Webber, Jackson & Curtis: "The Fed became worried about declining business and stock prices. Its action is no longer a function of stock market credit but a veiled effort to fiddle with prices."

Since the end of the 1946-47 period, when 100% margin was required (i.e., stock could not be bought on margin at all), the Fed has cut margins four times. Each time the margin changes had little effect on basic market trends except to stimulate short-term rallies and raise volume.

Many Wall Streeters feel that such "fiddling" causes an unnecessary guessing game about the Fed's intentions. They feel that 70% margin is too high in today's economy, and that with U.S. consumer credit at a record $52.8 billion, too tight a hold on stock credit is unfair. Says Isaac W. Burnham II, senior partner of Burnham & Co.: "To exact 90%, 80% or 70% margin on the world's most liquid collateral--listed securities--is outrageous. The Fed ought to set margins at 50% and leave them there; 50% is adequate protection for customer and broker."

Few brokers argue for lowering the margin below 50%. They, too, remember 1929. And they recognize that to many investors, low-margin buying symbolizes not a welcome increase in purchasing power but the psychological threat of being liquidated in case of a market shakeout. Before the crash of 1929 and the Securities Exchange Act of 1934, customers could put up as little as 5% margin on stocks, and few put up more than 25%. The excesses were aptly described by Eddie Cantor: "They told me to buy this stock for my old age. It worked wonderfully. Within a week I was an old man." But things have changed. At the height of the 1929 speculative fury, there were 1.5 million stockholders v. 12.5 million today. Investors then owned shares worth $89.7 billion on the New York Stock Exchange--an estimated $10 billion to $15 billion on credit. Today, N.Y.S.E. shares total 6.3 billion, worth $298 billion; but only $4.2 billion is on credit.

Though margin changes may have little effect on the course of market prices, they are both a guardian against credit excesses and an important part of the Fed's whole system of monetary checks and balances. Taking a broad view of market movements and the state of the economy, the Fed is able to stimulate or check overall business activity by interplaying margin changes with its open-market operations and with its power to change member banks' reserve requirements and the discount rate (which it recently lowered). Like all economic measures, margins must be used flexibly, would be less effective if they were set at the fixed 50% requirement sought by Wall Street. Wall Street will continue to debate just how flexible margins should be--but the Fed is not apt to pay much heed. Its view extends far beyond the world of Wall Street.

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