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Rise in Margin Buying Leads to NASD Alert

The industry group warns investors of the pitfalls of using credit to purchase stock.

September 16, 2003|Tom Petruno | Times Staff Writer

Another sign that speculation is alive and well again on Wall Street: More investors are buying stocks on credit.

The rise in such margin account use brought a warning Monday from NASD, the brokerage industry's self-regulatory group.

"In the first seven months of this year, the amount of debt used to purchase securities has risen 25%," said Mary L. Schapiro, NASD's regulation chief. "Due to this dramatic increase, NASD wants to alert investors to the potential risks involved with the use of margin -- and the consequences that can result from its use."

Under Federal Reserve rules, investors can borrow up to 50% of the purchase price of a stock. Brokerage firms normally lend for such purchases at low rates.

Buying stocks on credit can generate big returns in a rising market. But in a falling market, an investor's losses also can be magnified by the use of debt.

As stocks sink in value, investors who bought shares on credit can face margin calls -- demands by the brokerage lender to put up more cash as collateral. Investors who can't come up with the necessary funds may find that their stocks will unilaterally be sold by the brokerage, NASD warned Monday.

The agency also reminded investors that margin account holders aren't entitled to choose which securities or other assets can be sold in a margin call and that a brokerage can increase its margin requirements anytime without notifying clients.

Margin borrowing soared in the final year of the 1990s bull market, according to data from the New York Stock Exchange and NASD. The outstanding balance of margin debt jumped from $162 billion in January 1999 to a record high of $299 billion in March 2000, when major stock market indexes peaked.

As stocks plunged in 2000, 2001 and 2002, many investors were forced to liquidate their margin accounts, often at substantial losses.

Total margin debt stood at $174.4 billion in July, the latest data available. Though that was far below the 2000 peak, it was up sharply from $143 billion at the end of April.

The stocks that have led the market rally since mid-March have included many volatile technology issues -- some of the same issues in which investors lost hundreds of billions of dollars during the bear market.

The tech-heavy Nasdaq composite index has rocketed 45% since March 11. The blue-chip Dow industrials are up 26% in the same period.

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