What If the Margin Called But Nobody Answered?

(Chart courtesy Doug Short, Advisor Perspectives)

All we’re missing now is a spark:

BTIG’s Dan Greenhaus has one message in his note to clients on Wednesday: Stop worrying about margin debt.

Here’s Greenhaus:

“Like the Fast and Furious movie franchise, worries over margin debt have become a frequent occurrence. A new post on Business Insider, which has nearly 40,000 views, is titled ‘Here’s some great news for those who want the stock market to crash.'”

That post, written by Business Insider’s Henry Blodget, highlighted that margin debt is at a record high and could be cause for concern over the stock market.

Blodget adds, “Even after adjusting for inflation, margin debt is now higher than it was at the peak of the great bull market in 2000 and the echo bull market in 2007.”

But back to Greenhaus:

Greenhaus argues that even though margin debt hit $507 billion in April, it’s really small as a percentage of the New York Stock Exchange’s market cap at around 2%.

Greenhaus adds: “And so, the high level of margin debt doesn’t mean this will cause a crash. It just means whenever stocks start to crash, the tumble would be faster as investors scramble to meet their margin calls.”

Think of margin calls as an accelerant for starting a fire. By itself it can’t start a fire, but once a spark is lit it causes the fire to spread too rapidly to be easily put out.

When you sell a falling share you bought with your own money, you’re only out the difference between your buying and selling prices. When you sell a falling share you bought with borrowed money, the lender will make that margin call to get his capital back. Odds are you’ll have to sell other shares to make good on that margin call — if you can. The more shareholders with margin debts, and the bigger the margin debts, the faster the accelerant works on the flames.

I saw a couple of acquaintances lose everything to margin calls when the last two bubbles popped, and their stories were hardly unique. Gambling — and the stock market is gambling — with other people’s money is a dangerous game.