The Great Cra$h 1929 is a book by J.K. Galbraith, written more than half a century ago in 1954. I read it to get some information about the decline of the stock market in 1929, which is the focus of this little book. Hopefully, nothing would remind me of today’s financial crisis. But there is something about margin calls in the book which sounds familar. The following takes place on Wednesday, October 23rd 1929 (ch. VI, end of 4):
That afternoon and evening thousands of speculators decided to get out while – as they mistakenly supposed – the getting was good. Other thousands were told they had no choice but to get out unless they posted more collateral, for as the day’s business came to an end an unprecedented volume of margin calls went out.
Margin calls played a role in the Great Depression. Speculators used leverage to play the market. They borrowed money, bought stocks, and put the stocks up as collateral. This only works when the stocks do not lose in value, so their price should better go up. If it goes down, the value of the collateral will eventually fall below that of the loan. This is when the bank gets worried and sends you a margin call so that you close the gap.
However, in today’s financial crisis it wasn’t human investors who got margin calls from their banks, but hedge funds and other financial institutions. Reuters reported:
Wall Street banks are facing a “systemic margin call” that may deplete banks of $325 billion of capital due to deteriorating subprime U.S. mortgages, JPMorgan Chase & Co (JPM.N: Quote, Profile, Research), said in a report late on Friday.
JPMorgan, which sent a default notice to Thornburg Mortgage Inc. (TMA.N: Quote, Profile, Research) after the lender missed a $28 million margin call, said more default notices and margin calls were likely. The Carlyle Group’s mortgage fund also failed to meet $37 million in margin calls this week.
The big difference is that today’s Fed has aggressively pursued a policy of ensuring liquidity while in 1929 the Fed did not react to the market turmoils. Margin calls are a tool of potential negative feedback loops, and in 1929 they worked to drive stock market prices down very quickly. Did our time’s Fed save the day this time? It is probably to soon to call.
P.S.: I edited some crappy English and unclear wording. Still fighting with the flu.
econoblog101 
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