Oh, the folly..
I have a number of criticisms of the current economic system, as many of you know. I pretty much hate money, and think everyone should have access to unlimited resources. Haven’t figured out how to implement that one yet.. 😉
Anyway, one of my criticisms of the stock market is of margin accounts. I have a margin account – I don’t remember what feature I needed that the regular account didn’t offer, but there was something having nothing to do with what I’d normally think of as margin that I couldn’t do unless I switched to a margin account. I’ve purchased on margin a few times, and I’ve had to answer a margin call once. I was able to.. but I’m not criticizing it because of me.
Instead, I’m criticizing it because of the people who can’t make their margin call. Not, as you might think, because I feel sorry for them – although I do – but because I feel sorry for the whole system. It’s *got* to be dynamically unstable.
Here’s the problem. If you can’t answer a margin call, your broker sells off your assets to pay back your margin debt. Now, if this were a isolated system and you were the only user of it, this would work fine. However, you’re *not* the only user – and selling off your assets lowers the price of those assets for everyone else. Maybe only fractions of a penny for each individual margin call – but multiply that by 10,000 or 100,000, and you’re starting to talk about some pretty serious wampum. Now, one side effect of lowering the price of those assets is that it makes other people’s margin ceiling *lower*, because your margin purchasing power is based on the value of the assets you hold. So, it can result in other people getting margin calls – which some of them will be unable to pay – and the result is kind of a domino effect which only starts to be really apparent in a prolonged bear market.
Who would design such a thing? I nominate Bloody Stupid Johnson, from Discworld. It has his flavor to it.
I should mention that I’m not in fact a financial guru, and there might be some really well designed effect that counteracts what I’ve just described. Feel free to comment.