Risky Margin Accounts More Popular Investors Crave More Leverage, Brokers Want Extra Income From Lending

One of these days, margin accounts are going to get a bad reputation.

Some people still think that it was the overuse of margin accounts that brought down the stock market in October 1929 and triggered the Great Depression.

Something was bound to happen, some market buffs contend, when it was possible to buy $100 worth of stock by paying just $10 and borrowing the rest.

The lure of margin accounts in those days was that investors could make a lot of money by putting up a little when the price of a stock went up.

The catch, of course, was that if the price of the stock went down, the brokerage house could call for more money through a “margin call.” And if the buyer didn’t have the money, the broker had the right to sell the shares - and the investor took the loss.

In 1995, the risks of margin accounts are not nearly so great because the requirement is now 50 percent. In other words, an investor must put up $50 to buy $100 of stock on the margin.

But that small amount is only an example. Margin accounts are designed for speculators and other high-rollers, not typical investors. Not many prudent investors borrow money to invest.

They earn it first and invest later.

Still, some people have done very well by using margin accounts. Hillary Rodham Clinton, you may recall, parlayed a $1,000 commodities investment into a $100,000 profit back in the late 1970s - before she knew what she was doing. There are some analysts who say she never did know.

It was later reported that she traded with “insufficient margin,” although most of us don’t get that lucky.

Most people pay a pretty stiff interest rate on money borrowed from their brokerage houses plus a half or three-quarter percent for profit and, of course, brokerage fees.

Margin trading also came in for some criticism in October 1987, when the stock market took a precipitous tumble and investors lost billions of dollars.

It was later discovered that the losses of some players were bigger than others because their portfolios had been improperly tied into margin accounts as well as high-risk options.

Those investors who couldn’t come up with the money to make margin calls are still smarting from the experience. In the jargon of yesteryear, it was often said that coming up with more money to meet a margin call on a falling stock was “like riding a dead horse.”

Just a year ago, margin loans to investors reached a record $62 billion.

Buying on the margin always rises with the euphoria of a rising market, and the Dow Jones industrial average is now hitting weekly highs.

Obviously, there is as much - or more - enthusiasm for borrowing money to invest now as there was in 1929. But there also is more interest in lending money on the margin. Sometimes, interest earnings can be more profitable to brokerage houses than stock commissions are.

The nation’s brokerage firms are pushing to lower the margin requirement so speculators who have a taste for betting with borrowed money can go at it with everything they’ve got - and a lot more.

So far, however, they have not made it clear just how low they would like the requirement to go.

The more recent flap about margin accounts is that 5 million investors have a class-action suit against 16 brokerage houses, alleging that the brokerage houses earn millions of dollars each year by lending out shares owned in margin accounts - without sharing the profits with those who own the shares.

One good thing to come out of the 2-year-old suit is that brokerages are now required to improve disclosure in their clients’ statements.

Margin accounts and games being played with them should be closely regulated and monitored to ensure that proper disclosure is made and that all parties understand the situation.

It is hard to imagine that all 5 million investors could be wrong.