Marginal Interest and a Fed Tool

Dave C. writes: "Re margin interest — or is it marginal interest? — is it DEDUCTIBLE interest? THAT is my question???? If one should make purchase of securities (aka stock), using money borrowed on margin, can one deduct the interest thereto from any capital gains realized when the securities so purchased are sold?? Gadzooks!"

I like a man who says Gadzooks. My older brother is actually alleged to have said it at age six or so, spontaneously, from something he’d read — which is when my parents knew he was bound for Harvard. ("Gadzooks," his competitive little brother would exclaim years later upon learning that his older brother had just graduated Harvard summa cum laude.)

In any event, the answer is, first, that, yes, it’s called "margin" interest, paid when you buy stocks "on margin," which currently can’t be for more than 50% of their purchase price, but I have a hunch — no one else seems to think this — that one day if the market keeps climbing briskly, Alan Greenspan will bump that requirement up to, say, 55% or 60%. It’s an all-but-forgotten Fed tool, but it could be a good one, as it wouldn’t raise interest rates and directly stunt the economy (no need: inflation is in check) . . . yet it could help provide a "soft landing" to the rocketing stock market.

"We are not suggesting that stock prices are irrationally exuberant," Greenspan could obfuscate. (It is his job to obfuscate, to nudge psychology ever so slightly through obfuscation, not send it over a cliff with clear, bold talk. We should be happy we’re not sure what he means.) "No, we have taken this modest action simply because we see quite a few investors coming into the market for the first time, and feel that for them to do so too heavily on margin could, in certain circumstances, prove, or perhaps not prove, depending on events not yet foreseen or discounted, possibly less than optimally prudent."

In other words, he could tap the brakes lightly a couple of times, slowing the market without necessarily sending it into a skid.

Anyway, it’s margin interest. And while it is not deductible directly against your capital gain, it is deductible — if you itemize your deductions — against ordinary income, so long as you meet certain conditions, which it sounds as if you do. (I’m not your tax adviser, but the main condition is that you not deduct more in investment interest paid than you have earned in investment income.)

But please let’s not lose sight of the real question here: what are you doing buying stocks on margin in the first place? With the market at these levels, that’s awfully dangerous unless you really know what you’re doing — and I would respectfully submit that you don’t, since you don’t know whether margin interest is deductible. Are you sure this is wise? Have you checked your local white pages for Gamblers Anonymous?