Borrowing Money Against Your Investments

I woke up this morning and turn on TV. I found out on CNBC,  a cable financial channel that the Dow Jones Averages was down 250 points. That got me up real quick. I had to find out what was going on.

 

It did not take long for me to find out that China decided to deny investors the right to place Corporate Bonds with a Standard and Poor's credit rating of BBB and below as collateral for borrowing money.  That meant that many tens of millions of dollars in loans came due immediately.  In the business, we call that a "margin call." ( Do not get that mixed up with a booty call!)

 

DEFINITION of 'Margin Call'

 

A broker's demand on an investor using margin to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin. Margin calls occur when your account value decreases to a value calculated by the broker, exchange, or government's  particular formula.

 

This is sometimes called a "fed call" or "maintenance call."

 

You would receive a margin call from a broker if one or more of the securities you had bought (with borrowed money) decreased in value past a certain point. You would be forced either to deposit more money in the account or to sell off some of your assets.

 

DEFINITION of 'Margin Account'

 

A brokerage account in which the broker lends the customer cash to purchase securities, cash, goods, or services. The loan in the account is collateralized by the securities and cash. If the value of the stock drops sufficiently, the account holder will be required to deposit more cash or sell a portion of the securities.

 

In a margin account, you are investing with your broker's money. By using leverage in such a way, you magnify both gains and losses.

 

Here is the Problem!

 

The price of oil is going down. Some of these companies and countries floated junk bonds like Venezuela's oil financing bonds.  Due to falling oil prices, China does not want to be caught with worthless bonds, collateralizing portfolios.

 

Venezuela’s state-controlled oil company will sell dollar bonds for the first time in six months as the government seeks foreign currency to end shortages of imported goods.  If these bonds default it would be like receiving goods from the store and not paying for them because your credit card is no good.

This action against such bonds especially bonds to finance oil operations around the world caused tens of millions of dollars to come due. People and governments had to sell off portfolios to bring in enough cash to satisfy the margin call.  The reaction, stock and bond prices around the world went down quickly.

 

Don't Snicker

Many people bought cars and homes with this borrowed margin money. Governments financed activities for the people like water and sewer projects. Yet corporation financed everyday activities in the business like stop gap payroll and benefits such as healthcare for employees.  For many, this was the start of layoffs in some businesses.