ziggy29
Moderator Emeritus
Let's say you have $100,000 in equity in a margin account with a 50% margin requirement. This $100K is invested in, say, CMOs.I think I may have mis-interpreted "margin account".
That means you can "borrow" up to an additional $100,000 to purchase more CMOs, using the original securities as collateral. You retain 50% "equity" in the margin account, the minimum allowable.
Let's say they raise the margin requirements to 66 2/3% -- that is, your equity needs to be at least 2/3 as much as the security value in the account. That means that your $100K equity can only control a total of $150K in securities. Thus, you will be hit with a "margin call" to sell $50,000 of these CMOs in order to make the call. (The other alternative would be to inject another $100,000 in cash.)
But if you did this, a LOT of investors and institutions would be hit with the same margin calls. You'd have an obscene number of sellers and almost no buyers. The market value of the underlying securities would plummet as a result. Let's say that when you mark to market these securities lose 20% of value because of all the sellers, no buyers and little liquidity. Now even after you sold that $50K to meet the margin call, you now have $50,000 borrowed on a portfolio that is now worth $120,000 (20% less than the $150,000 these used to be worth). But with $120K of securities, suddenly you have only $70,000 in equity...and that means you can control only $105,000 in securities to meet the 66 2/3% margin requirements. Now you have to sell ANOTHER $15,000 of these securities into an already stressed market, as do many others -- which makes the buyer/seller imbalance even worse and causes the security value to fall more.
Rinse, lather, repeat. You have a potential death spiral. This is exactly the scenario the Fed is trying to avoid by accepting these securities as collateral in exchange for Treasury securities. The Fed doesn't have to sell into margin calls.