Calling You

When I was a young trader, there were two calls you wanted to avoid: one was from the risk department, which usually was more of a suggestion, than an order--“we’d like to see you trim that position a bit”. The other call was a direct request: “please deposit additional funds in your account or we will sell some of your positions so that your margin account complies with the rules.” I have never received a margin call in my life, but I have to imagine it does not feel too good.

We are discussing margin, the ability to trade your account using borrowed money, or leverage, because yesterday investors who may never have opened a margin account in their lives were affected by it. News emerged that two large investors, Carlyle Capital and Thornburg Mortgage had missed recent margin calls. The news triggered a chain reaction, as investors considered that other similar firms could be facing the same problem, which would mean a forced liquidation of already-depleted positions to meet margin obligations.

The numbers were ugly: the Dow plunged 214.60 points, or 1.8%, to end at 12,040.39; the S&P 500 fell 2.2%, or 29.36 points, to close at 1304.34, the lowest close for the broad market measure since Sept. 22, 2006--the S&P 500 is down 11% this year and is 17% below its record close last October; and the Nasdaq tumbled 2.3%, or 52.31 points, at 2220.50, down 16% for the year and is 22% below its October high–and officially in a bear market. What is occurring for some companies is similar to what may be happening to your neighbor who overreached on his real estate exposure when interest rates were low. The process is called “deleveraging” and it means that folks need to shake off one heck of a hangover!

When credit was easy, the punch bowl was full of delicious loans. Some used that cheap money to buy condos in Florida, while others, like hedge funds, used it to enhance their returns. As the punch bowl was drained, the aggressive real estate maven could not find a buyer in sight, while the hedgie had to deal with declining asset prices and margin departments who are not interested to wait and see whether markets correct back in the favor of the funds. Forced sales are now occurring on a daily basis.

I have seen the deleveraging process before and it is not pretty, but it is a necessary component to recovery—kind of like sleeping off that hangover. Hopefully you are in a well-diversified portfolio that can withstand the swirling winds. And if you are like me, you never partook in the party in the first place, which means that you did not get drunk last night, but you sure feel pretty good today.