Stocks: a margin of safety
VISITORS to the United States in the early years of the Republic -- de Tocqueville, for example -- often noted the tendency of Americans to forget the lessons of the past in their haste to reach a more progressive future. Optimism is fine. At the same time it is important for a nation to recall the mistakes that have been made along the way, precisely to avoid their repetition.
We mention all this because of news reports that the Federal Reserve Board and Treasury Secretary Donald Regan are now calling for an end to federally mandated credit curbs on stock market transactions -- ``margin requirements.'' In a new report, the Fed recommends that the various securities and commodities exchanges be allowed to set their own credit requirements. Mr. Regan, meanwhile, would totally end margin requirements.
Perhaps the Fed and Mr. Regan are right, but at the same time, we admit to feeling a tad uneasy about scuttling the margin requirements. With the enactment of the Securities and Exchange Act in 1934 the Fed was empowered to set limits on the amount of credit that can be used in stock trading. In recent years the limit has been set at 50 percent, which means that persons who buy or trade in stocks and convertible bonds have to muster up an amount in cash equal to 50 percent of the value of the total transaction. Back in the 1920s, it might be recalled, when dreams of great wealth achieved through flirting with Wall Street dazzled many an unsophisticated investor, a person was required to put up cash equal to only some 10 percent or so of the amount of the transaction -- a shortfall that figured in the financial ruin of many investors in the market crash of 1929.
Congress should carefully study the Fed's reasons for ending the curbs. Granted, financial conditions today are far different from the economic conditions of the late 1920s. For example, credit purchases of stocks don't necessarily divert money from commerce today, as they did in the 1920s when speculation was the primary objective of the investment game.
Still, who can really say that such credit curbs are not needed to protect unsophisticated investors today, despite the fact that a large part of the trading now occurring on Wall Street involves large institutional investors? The credit curbs grew out of direct experience with a wrenching financial disaster that rocked the United States to its very foundations. For that reason, Congress should examine proposals to end the curbs with very special care. ------30------ {et
