Investors’ Use of Brokerage Credit Declines in August

Investors in August further reduced their use of brokerage credit to buy stocks, a sign that caution about the market was rising even before the Sept. 11 terrorist attacks.

But some big investors--including the Bass family of Texas--still were heavy users of brokerage loans as of the attacks. The Basses were forced to sell $2 billion of their Walt Disney Co. shares last Thursday, in part to pay off brokerage credit.

Margin debt--the total sum borrowed against stock accounts--slipped to $161.1 billion at the end of August, down 2.5% from the end of July, the New York Stock Exchange said Tuesday.

The August total was the lowest since March 1999.

Use of margin credit to buy stocks is considered a barometer of investor sentiment. Heavy borrowing to buy shares indicates that investors’ outlook is bullish. Declining margin use usually reflects growing skittishness about the market’s direction.

Under Federal Reserve rules, investors can borrow up to 50% of the purchase price of a stock.

Use of margin can magnify an investor’s profit in a rising market. Likewise, in a falling market, use of margin magnifies losses.

Say an investor buys $10,000 worth of XYZ stock, at $100 a share, using $5,000 cash and $5,000 borrowed. If the market value of XYZ stock then rises from $100 to $150 a share, the investor’s account rises accordingly, up 50% to $15,000.

But the investor actually has a 100% gain on his original $5,000 cash investment, less the interest cost of the margin loan.

If XYZ stock falls to $75, however, the total account in the example above would be worth $7,500, a decline of 25%. But the investor would have lost 50% of his original $5,000 cash investment.

Margin use boomed with the surge in technology stocks in 1999 and early 2000. Total margin credit reported by NYSE brokerages peaked at $278.5 billion in March 2000.

Some investors have paid off loans voluntarily. Others, such as the Basses, have been forced to do so as nervous brokerages have called in loans as share prices have tumbled over the last 18 months.

Last week’s near-record drop in the stock market triggered a flurry of such “margin calls.” However, many brokerages say the volume of margin calls was smaller than in past market sell-offs because outstanding margin debt has fallen.

In a margin call, a brokerage typically tells investors with heavy stock losses to put up more cash to cover their borrowings--or face liquidation of their stocks.