A new study by the Federal Reserve Bank of New York has found that requiring higher margins, or down payments, for the purchase of stock may cool the volatility of an overheated market.
The study contradicts the view of Federal Reserve Chairman Alan Greenspan and sides with Securities and Exchange Commission Chairman David S. Ruder on a topic that has been hotly debated since the stock market crash.
As regulators and Wall Street have considered new ways of controlling volatility, some experts have argued for a more active use of margin requirements to reduce speculation and dampen price swings. Others, like Greenspan, have contended that margin requirements, which are set by the Fed, should be used only to guarantee that investors can pay for their purchases rather than to calm tempestuous markets.
In recent decades, the Fed has increasingly followed Greenspan’s view and has shifted initial margins little from their current level of 50%--meaning that an investor buying stock must pay at least 50% of the purchase price in cash and may borrow the rest.
In his study, economist Gikas Hardouvelis looked at the history of the Fed’s margin regulation since the 1930s and concluded that volatility has been lower during periods when margin requirements have been high. The study finds that higher initial margins have reduced both overall stock market volatility and “excess” volatility--that is, volatility caused by factors unrelated to underlying economic conditions.
The paper may lend significant support to those who have argued for more active use of margin limits, particularly since it is the first study directly to address the question, according to a spokesman for the New York Fed.
Hardouvelis’ study appears in the latest issue of the New York Federal Reserve Review, a quarterly journal that is widely respected and read by economists and policy-makers. Such articles are not considered policy position papers of the Fed but rather the fruits of independent research.
Still, some economists speculated Wednesday that the paper probably was in line with the views of E. Gerald Corrigan, who is president of the New York Fed and a longtime ally of former Fed Chairman Paul A. Volcker. Volcker favored the use of margin requirements for broader regulatory purposes, they noted.
“These articles are closely vetted by the leadership at the Fed, and if Gerry Corrigan had objected, you can bet it wouldn’t have been in there,” said Georges F. Rocourt, chief economist with Mercantile-Safe Deposit & Trust Co. in Baltimore.
Hardouvelis notes as a caveat to his study that margins have not been changed since 1974. There is thus no evidence on whether raising margins can still limit volatility at a time when markets are international and include heavy trading in such newer investments as stock index futures, he notes.
Changes in margin requirements have become less frequent over the years, in part because of objections that they represented too imprecise a tool for regulating market behavior. The Fed has also increasingly favored regulatory tools that affect all borrowers--such as manipulation of interest rates--rather than those that simply affect some classes of borrowers.