Some market truisms seem positively antique they’re so deeply woven into the fabric of Wall Street. For example, “Don’t fight the tape.” They haven’t used actual tape for decades – the market ticker has long been a digital display. But everyone knows what “don’t fight the tape” means. (It means that if a stock or the market is going up, even if you think it “shouldn’t,” don’t bet against it. And, conversely, if it’s going down, steer clear.)

Don’t fight the Fed” is only a bit more modern. (If the Fed is trying to damp down inflation or speculation, don’t bet against it by buying stocks or long-term bonds.)

Ah, but what do you do if the tape says one thing and the Fed another?

Once upon a time, when the Dow hit the incredible level of 6,000, it got Fed Chairman Alan Greenspan thinking – and talking – about “irrational exuberance.”

What must he be thinking now that, 18 months later, it’s 9,000?

Back in February, 1997, I wrote in this space:

With Alan Greenspan leery of our overheating as the Japanese market did a decade ago (rich at 20,000 on the Nikkei Dow it nonetheless doubled – 40,000 – before dropping back to 14,000), I wouldn’t be surprised to hear him one of these days float the possibility of raising margin requirements from 50% to 55% or 60%. “The economy is sound,” he might say. “Stock market values reflect that. But one does worry whether some of the ‘irrational exuberance’ I speculated on a few months ago might not at some point warrant our considering the possibility of nudging the marginal market participant toward more prudence, perhaps by a small adjustment to the margin requirements.” Of course, it would be a much longer sentence than that, nestled into the middle of an answer to the New Delhi Times on the topic of agrarian reform. Never want to be too straightforward at the Fed.

Well, so far no such thing has happened. But if anything, with the market up another 50%, it makes even more sense.

Normally, one thinks of the Fed pulling the levers of interest rates and money supply, tightening or loosening credit. Those are its main tools. But tightening credit now to damp down an exuberant stock market would be a blunderbuss approach that could hurt our humming economy and very likely worsen today’s main economic problem: Asia.

But there’s this other little tool the Fed has, unused for decades, which is its control over margin levels.

Clearly, if the Fed announced today that, effective immediately, the margin requirement (the down payment required when you buy a stock) was being raised from 50% to 100%, it would be a disaster. The market would plunge, as huge volumes of stock owned on margin had to be sold. But merely to suggest that it might be raised in small increments if the market kept rising at an unsustainable pace might, all by itself, apply a useful damper. Then, later, if need be, those incremental notchings-up of the margin requirement could be applied – or not – as circumstances required.

In the meantime, may I offer my own margin guideline? It is this: If you’re buying stocks on margin, don’t. Or at least be very sure you appreciate the risks and know exactly what you’re doing.



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