As the stock market coasts along at all-time highs, market observers are sensing that a big correction – a fall of at least 10% in the broad market – is on the horizon.
At a time when many observers say financial hazards are sharply increasing, Wall Street firms are pumping risk into their customers’ accounts with securities-backed loans.
“Securities-backed loans total at least $100 billion for the biggest brokerages—up exponentially since the financial crisis—with several billions of dollars of additional debt held at smaller brokerages, banking analysts estimate,” according to a recent Wall Street Journal page one story.
Such loans are big “revenue drivers” at firms like Merrill Lynch, Morgan Stanley, Fidelity and Goldman Sachs, according to InvestmentNews, an industry trade newspaper.
“The loans work a lot like margin loans. Brokerages lend against the value of an investor’s portfolio,” the Journal reports. “But unlike margin lending, customers don’t use the debt to buy more securities.”
These loans pose a great hazard to unsuspecting customers who could see their loans quickly called if their portfolios drop precipitously during a sharp market decline. If the margin call isn’t met, the securities backing the loans are sold and the borrower is responsible for the balance, according to the WSJ.
Critics worry that the surging stock market has made investors numb to the risks of borrowing against their investments. Sound familiar? It should. Investors binged on perilous margin debt in the run up to the dot.com bubble and the financial crisis of 2008.
There is no doubt the big banks are pushing such loans. Merrill Lynch alone opened more than 121,000 such loan accounts between 2010 and 2014 with more than $85 billion in credit extended. Morgan Stanley reached a $1 million settlement with Massachusetts this year after the state’s regulator accused the firm of developing a sales program that encouraged brokers to pitch loans regardless of whether clients needed them.
And brokers at Wall Street banks have been following orders, according to the Journal.
“We were dramatically pushed to put these on all of our client accounts,” said a former Merrill Lynch broker who left to manage his own investment-advisory firm since 2014. “Whenever you’re product-pushing, it’s not in the client’s best interests.”
In the case of Morgan Stanley, brokers were given scripts coaching them to offer the loans to clients who said they needed to pay for taxes or cover expenses for a wedding, graduation, car or a so called luxury item, like a car or yacht.
“Brokerage executives say the loans can help clients avoid selling assets,” according to the Journal. “The client can get cash without shifting their investments; they also avoid potentially locking in losses or incurring taxable gains, or missing out on future stock market gains. Clients are also able to borrow money at relatively low interest rates because the loans are secured.”
That strategy is nonsense, others warn. “If people need the money, they should sell securities,” said a professor of finance quoted in the Journal’s story. “It’s very risky to take a leveraged position in the market, and I don’t think people are thinking about it that way.”
The Journal article also notes that “the growth of securities-backed loans has drawn the attention of regulators, who have questioned the brokerages’ marketing and sales efforts as well as the suitability of the loans.
“It’s not healthy for the industry,” said William Galvin, Massachusetts’ top securities regulator, who has been investigating how firms motivate brokers to push these loans. Brokerages “should be more concerned about this,” he said, “but they’re in favor of competition and seeing who can get more loans.”
Expect brokerage clients to file more investment fraud cases linked to such loans when the market tanks.
The Wall Street sharks are circling again, offering the lure of securities-backed loans, which can add perilous amounts of risk to clients’ stock and bond portfolios. Customers beware!
Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.