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Federal Reserve Margin Requirements and the Stock Market**

Published online by Cambridge University Press:  19 October 2009

Jacob Cohen
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Extract

The boom stock market is a well known phenomenon of our time. The investor (and public) interest in the market, however, does not seem to be shared by the monetary policy makers. Certainly, if we use the 1920's as the benchmark, the Federal Reserveexhibits considerably less anxiety over the present boom market than it did then.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 1 , Issue 3 , September 1966 , pp. 30 - 54
Copyright
Copyright © School of Business Administration, University of Washington 1966

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References

1 In a June 1, 1965 speech Wm. McChesney Martin, Chairman of the Board of Governors of the Federal Reserve System, spoke of “disquieting similarities between our present prosperity and the fabulous twenties.” Offsetting these similarities, however, in his only reference to the stock market, the increase in stock market credit was said to be smaller now than at that time. (New York Times, June 2, pp. 1, 69.) Despite overall fears, the Chairman evidently felt no concern about the stock market.

2 For a discussion of this earlier period see Harris, Robert E., Federal Margin Requirements: A Selective Instrument of Monetary Policy, (University of Pennsylvania, Ph.D. dissertation, 1958), pp. 107, 117.Google Scholar

3 Bogen, Jules I. and Krooss, Herman E., Security Credit (Englewood Cliffs, N. J.: Prentice Hall, 1960), pp. 110–111Google Scholar.

4 Annual Reports of the Board of Governors of the Federal Reserve System, 1960, p. 82; 1962, p.114.

5 Harris, op. cit., pp. 395–96.

6 While the criterion variables may not be independent of each other, the effect of the use of first differences is to virtually eliminate the intercorrelation of the independent variables.

7 The values of the beta coefficients are not given in the tables.

8 One would have to assume that banks respond to the higher absolute return on business loans (as well as to possible related advantages of business lending) when business demand increases, rather than to higher relative returns, since over the period considered the call loan rate (based on average December figures) has risen slightly as compared with the business loan rate. (Data on call loan rates secured from the Federal Reserve Bank of Cleveland.)

9 Federal Reserve Bank of Minneapolis, “Margin Requirements,” Monthly Review (October 1963), pp. 10–11Google Scholar; Federal Reserve Bank of Cleveland, “Call Loans,” Economic Review (October 1964) pp. 7–9Google Scholar; for similar results see Harris, op. cit., chapter XII.

10 Although margin requirements in the various regressions play the role of both dependent and independent variable, the equations escape inconsistency because of the varying lags in the relationships. Changes in margin requirements (as dependent variables) have their closest relationship with security credit with a two quarter lag and with security prices when the latter are lagged one quarter. Changes in security credit and prices (as dependent variables) are most closely linked with changes in margin requirements of the same quarter (now the independent variable). In this way the various relationships involving margin requirements are consistent with each other.

11 Sprinkel, op. cit., chapter VII.

12 See also Friedman, Milton and Melselman, David in “The Relative Stability of Monetary Velocity and the Investment Multiplier in the United States, 1897–1958,” Commission on Money and Credit, Stabilization Policies (Englewood Cliffs, N.J.: Prentice-Hall, 1963), pp. 217ff.Google Scholar

13 The money stock is defined as demand deposits adjusted plus currency—presumably currency outside banks. Ibid., pp. 179–80.

14 In the equations shown, stock market purchases, nonfinancial expenditures and current receipts after deductions (the flow of funds equivalent of disposable personal income) are expressed in their actual flow form. We have also tested the effects of expressing them in first difference so that all the variables are uniformly expressed in first differences. The effect is to strengthen the conclusions reached below. That is, the effect of bank security credit on financial flows becomes weaker (significance levels decline although the negative relation remains) at the same time that the relation with nonfinancial expenditures becomes more significant (and remains positive).

We also note some effects from these adjustments on the significance of the “outside” explanatory variables—income and financial dissaving. The latter variable loses its significance in all of the equations with this being true of the disposable income variable in the financial flow equations.

15 It should be pointed out that in earlier work using flow of funds data 1939–56, we did find a significant impact of bank security credit on net increases in financial assets. Other variables used in the same equation were gross increases in consumer credit, net increase in “other”: security credit, net increase in mortgage credit, and the flow of funds equivalent of disposable personal income.

16 See Hazard, John W. and Christie, Milton, The Investment Business, A Condensation of the SEC Report (New York: Harper & Row Co., 1964), pp. 320ffGoogle Scholar. On the problems of interpreting bank loan classifications see this author's article “What do Bank Loans Really Finance?”: in Carson, Deane, ed., Banking and Monetary Studies (Homewood, Ill.: Irwin 1963), pp. 387ff.Google Scholar In particular, the use of net bank security credit (the only data available) may obscure a possible relationship between gross security credit (before netting of security credit repayments) and stock market activity.

17 The possibly grave consequences of a break in equity prices has been emphasized in the writings of Hyman P. Minsky. See “Can ‘It’ Happen Again?” Banking and Monetary Studies, op. cit., pp. lOlff.; Commission on Money and Credit, “:Financial Crisis, Financial Systems and the Performance of the Economy.”: Private Capital Markets (Englewood Cliffs, N.J.: Prentice-Hall, 1964), pp. 173ff.Google Scholar It is a theme also found in Galbraith's, J. K.The Great Crash (Boston, Mass.: Houghton, Mifflin, 1961), pp. 198–199.Google Scholar

18 New York Stock Exchange, The Stock Market Under Stress (New York, 1963), pp. 58–6O.Google ScholarPubMed

19 Balance of payments data are based on U. S. Department of Commerce, Business Statistics, 1963, p. 13; Treasury Bulletin, tables on purchases and sales of long-term securities by foreigners and net purchases and sales of U. S. stocks by foreigners

20 Federal Reserve Bank of Chicago, Business Conditions (November 1963), p. 10.

21 Federal Reserve Bank of Philadelphia, Business Review (February 1961), p. 19; Friedman, Milton and Schwartz, Anna Jacobson, A Monetary History of the United States, 1867–1960 (Princeton, N. J.: Princeton University Press, 1963), pp. 306–307.Google Scholar

22 Minsky, “Can ‘It’ Happen Again?” Op. cit., pp. 110–11.