The latest in a long line of stock market bubbles is being fueled by record amounts of debt according to the New York Stock Exchange. This debt is called “buying on margin” (BOM). Notice the acronym of BOM, which is pretty close to bomb, and this current bubble is going to explode. Total BOM hit a record high of $528.2 billion in February 2017.
That’s more than half a trillion dollars being used to purchase corporate shares. That’s not a big problem when the market is going up, but it’s now late in the ball game. Our economic expansion is 94 months old, making it the third longest in US history. Statistical indications suggest that it isn’t going to challenge for the number two spot, and that it should peak within the next few months, and then we’ll hit a recession, which will be really bad.
February’s total BOM was $40 billion more than in December 2016. This increase is a sign of optimism or foolishness. People and institutions like hedge funds want to get in on the action while the stock markets are rising. This is probably a good thing to do early in a business expansion, but it’s extremely dangerous to investors and the economy to do this on this scale so late in an expansion.
Suppose you have have $10,000 to invest, so you purchase 100 shares of Home Depot at $100 per share. The market crashes, and the share price drops to $40. Now your investment is worth $4,000. That is not a good result, but your investment is still worth something, and can potentially recover if you hang on to it in the long run.
On the other hand, let’s say you borrow an additional $20,000 to buy another 200 Home Depot shares at $100 for a total of 300 shares and at a total cost of $30,000. The market crashes and the share price quickly drops to $40. Now your shares are worth $12,000 — but you owe your broker $20,000 (plus interest) for borrowing money to buy the stock. That broker calls in his loan. You are forced to sell your shares to get the funds, but at the lower price. You lose $18,000 on your investment. But your broker wants the rest of his $20,000 plus interest. That’s more than $8,000.
So your original $10,000 is wiped out, and you need to put up extra money to pay back your broker.
During most recessions, it’s much more difficult to get credit to pay your broker back, so you may both be out of luck, although you’ll likely be in court defending against him, her or it.
On a massive scale, that’s a recipe for absolute disaster for the whole economy.