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Margin calls hurt markets
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April 4, 2000: 5:41 p.m. ET
Tumultuous late trading due partly to flood of margin calls for leveraged investors
By Staff Writer Martha Slud
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NEW YORK (CNNfn) - For many investors who finance their holdings on margin, the dreaded calls have been flooding in.
Wall Street's late afternoon nosedive Tuesday was tied in part to heavy volume of brokerages calling in the margins extended to leveraged traders. For investors, buying on margin allows them to buy securities without having to put up all of the money themselves. But when stocks take a dive and brokers call in this borrowed money, or margin, investors are required to pony up extra money or sell some of their stock to cover the losses.
No one factor was attributed to Tuesday's wild selling, but experts said that margin calls helped build on the market's downward momentum.
"Margin calls tend to precipitate a sell-off, and you've got to figure that part of this action today was due to the initial thrust of the margin calls' feeding the selling," said Vince Farrell, chief investment officer at Spears Benzak Salomon & Farrell.
At one point Tuesday, the Dow Jones industrial average fell nearly 500 points before recovering to narrow the loss to about 46 points, while the technology-heavy Nasdaq composite index clawed back from a loss of more than 570 points to finish the day down 73 points. Experts said that as people received margin calls throughout the day, some panic selling ensued.
"There are a lot of people who are tremendously overextended and we're now getting down to a level to where these margin calls are massive," William Sullivan, a senior vice president and economist with Morgan Stanley Dean Witter, said at the height of Tuesday's sell-off. "The calls are going out right now."
Depending on the brokerage, investors may be able to borrow an amount equal to the value of the securities they hold. Each brokerage sets a minimum equity requirement, below which an investor's account cannot drop. If the equity level does dip beneath a certain point, the brokerage can place a margin call.
Regulators at the Securities and Exchange Commission have expressed concern about the practice of buying on margin, saying it can create a bubble in the market.
Several brokerages said Tuesday they were seeing an increase in margin calls to their leveraged clients.
 "When the market goes down dramatically, you're going to have more margin calls, and this is definitely one of the higher days," said Mike Dunn, a spokesman for Datek Online Holdings Corp.
He said "well under a quarter" of the firm's nearly half-million customers have margin accounts. "Some days are in the hundreds; others in the thousands," he said of the number of calls that go out.
Another discount brokerage, DLJ Direct (DLJ: Research, Estimates), also said it was seeing an increase in margin calls. Firm spokeswoman Linda Finnerty said that like other brokerages DLJ Direct has a list of stocks that cannot be purchased on margin because they are highly volatile. Such stocks include some Internet shares or recent initial public offerings.
"We have a very conservative margin policy," she said.
A spokeswoman for Merrill Lynch, Susan Thomson, said that over the past few trading days, "we've seen a slight increase in margin activity."
But "the vast majority of Merrill Lynch clients are capitalized well beyond their margin requirements," she said.
The firm has not made any adjustments to its margin requirements. "We're comfortable in our position and we're going to have to see what tomorrow brings," she said.
 Meanwhile, shares of brokerage firms including Charles Schwab (SCH: Research, Estimates), the leading online broker, slipped 7-5/16 to 49-5/8 on the day, and E*Trade Group Inc. (EGRP: Research, Estimates) lost 3-1/16 to 24-3/8 amid investor jitters that brokerages could be saddled with losses from investors who fail to repay their loans.
For some investors who buy on margin, especially inexperienced traders, this wild trading may mark the first time they've seen the downside of leveraged buying, experts said.
"The margin debt situation speaks to the effect of where people who bought in on margin expected stocks to go only one way - up," said Joe Battipaglia, chief market strategist at Gruntal & Co. "When the market starts to sell off, those are the people that are affected the most." 
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