Margin calls are a dreaded word for individual and institutional investors, causing them to liquidate their portfolios at perhaps the very worst possible moment. A margin call happens when an investor borrows against his assets and then sees the value of those assets plummet. As a result, they are forced to sell off part of their holdings in order to settle their loans with banks.
The problem is that many of the investors doing the selling these days are institutional investors like hedge funds – and they are highly leveraged. In some cases, they can't meet their margin calls.
While federal regulations limit the amount of margin trading that individual investors can do, that is not the case with hedge funds. The hedge fund industry is essentially unregulated. This, in turn, enables hedge funds to borrow many times over the actual value of their assets.
As reported back in October 2008 by the New York Times, margin calls can affect more than simply large, institutional investors with outsize portfolios. By flooding the markets with sell orders, margin calls can send stock prices widely lower, creating financial havoc on ordinary investors, as well.
Earlier this month, margin calls were again in focus when, on May 6, the Dow Jones Industrial Average witnessed a 1,000-point drop. Rumors immediately began to circulate that the crash was caused by human error or market manipulation. Others say the fault stemmed to highly leveraged players such as hedge funds that faced margin calls. In a matter of minutes, those margin calls multiplied. The end result: Systemic financial chaos ensued as stock prices plunged quickly and mercilessly.
Aubrey K. McClendon, CEO of Chesapeake Energy, knows all too well the ramifications of margin calls. In 2008, he was forced to sell all of his 33.5 million shares – at a huge loss – in Chesapeake because of a margin call.
Similarly, Sumner M. Redstone, chairman of Viacom and CBS, revealed in 2008 that he would sell $400 million in shares in those companies to pay down a loan.
And, of course, who can forget Bear Stearns? Its meltdown was quick and swift after a number of trading partners started making margin calls.
Two years later, margin calls are once again front and center – and fully capable of taking a market downturn into a full-on global crash.
If you are an individual or institutional investor and have concerns or questions about margin calls, contact Mark Maddox. We can evaluate your situation to determine if you have a claim.