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Where does credit card debt and margin debt come from?

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May 21, 2013 – Comments (25)

So when a bank creates a loan, the new bank credit is created on the spot....it is "created out of thin air". What about margin debt and credit card debt though? The credit card company has to pay the merchant with actual cash , and the broker lending margin has to pay off the seller of the stock with cash

 

when I see articles like "margin debt hits all time highs, signaling danger in the market", I don't get it. Wouldn't any increase in margin debt mean there has to be a lot of cash with brokers?

 

or for credit card debt expanding signaling an over leveraged economy...doesn't that just mean that credit card companies were flush with cash? How could one increase without a decrease in another, etc? Aren't margin and credit card debt more like "full reserve bankingL in the sense that they cannot create new credit? 

25 Comments – Post Your Own

#1) On May 21, 2013 at 7:15 PM, awallejr (78.92) wrote:

Credit card debt is an amortized unsecured loan.  As long as you make at least the minimum payments all is well.  And should the credit card company change the terms on your credit card it does not impact old debt, only new purchases.

Margin credit is a secured debt, should the value of the security fall below a certain percentage required to be maintain you are obligated to payoff a certain amount.  This can have a cascading effect.  So when they say "margin debt hits all time highs, signaling danger in the market" it is a warning that should the market correct, margin calls could go out causing a cascading market.

2008-2009 crash was a classic example.  CEO of CHK got wiped out because of margin calls and crashing stock price.

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#2) On May 21, 2013 at 8:20 PM, Valyooo (99.39) wrote:

No, but what I mean is this:

 

consumer A wants to take out a loan. Bank creates loan as an asset and checking account as a liability. Now if this consumer defaults the bank has less reserves and can create a cascading effect because this new thing was created out of nowhere

 

with a credit card, the credit card company has cash, the retail store has an item, and the consumer has an open credit line. After the purchase, te store has the cash, the consumer has good, and credit card company has less outstanding credit available to lend. How can there be a cascading effect? Nothing new has been created so there is not any extra leverage in the system.  

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#3) On May 21, 2013 at 8:26 PM, Valyooo (99.39) wrote:

So how can the level of margin debt change over time? It its not created out of thin air like bank credit, where is the extra money being lent coming from? With a bank loan, debt can change over time because loans can expand and contract over time. If margin is full reserve, then when brokers are lending margin they are decreasing their cash giving it to sellers of stock. So isn't it just a simple transfer of payments? Like if I had $100 in cash and you had $0, and you borrowed $100 from me, there would still be exactly $100 in the system (friends cant use fractuonal reseve lending) so why does it matter that now there is cash and a loan? How's that any more risky? Same amount of cash

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#4) On May 21, 2013 at 8:36 PM, Mega (99.96) wrote:

"Like if I had $100 in cash and you had $0, and you borrowed $100 from me, there would still be exactly $100 in the system"

There would be $100 cash, and a $100 loan, which one friend records as an asset and the other as a liability. The system went from 100% assets and 0% debt, to 50% assets and 50% debt.

The difference between traditional banking and credit card banking is just that it's sped up, assets and liabilities turn over a lot faster. Other than that (and the higher interest rates to compensate for credit risk and convenience) the mechanics are the same. Bank loans aren't created out of thin air.

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#5) On May 21, 2013 at 8:48 PM, Mega (99.96) wrote:

Or rather it's 50% currency and 50% loans. Or 67% assets and 33% debt

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#6) On May 21, 2013 at 9:10 PM, HarryCaraysGhost (99.61) wrote:

with a credit card, the credit card company has cash, the retail store has an item, and the consumer has an open credit line. After the purchase, te store has the cash, the consumer has good, and credit card company has less outstanding credit available to lend.

Ok let me take a crack at this, but I'm not sure I'm answering your question properly-

With credit card companies such as V and MasterCard there is no loan, they just control the infrastructure to facilitate your transaction.(collecting a swipe fee from the merchant every time a card is used) 

The loan is always through the bank issuer, so it's just like any other loan they would issue. Collateral on a CC could  be the amount in a savings account up to card limit.

Whether the bank uses margin or just operating income I have no clue. Note- Card issuer American express does originate loans, but they also charge a $50 membership fee so I would assume that would offset any defaults.

Hope this was somewhat helpful, that's just my rudimentory knowledge of the banking world by owning Visa all these years.

Cheers

 

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#7) On May 21, 2013 at 9:32 PM, Valyooo (99.39) wrote:

Megashort,

 

That makes sense, but what is risky about that?  There is no less stuff in the world nor less incentive to work in the economy...I see the main issue with FRB that it distorts prices and interest rates leading to bad use of capital...what is the inherent risk of a loan? (this is a side note) The capacity to create new stuff is unchanged 

 

Seems like the risk is that the producer thinks he has an asset so he produces less, if the consumer does not make up the consumption society loses 

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#8) On May 21, 2013 at 10:28 PM, Mega (99.96) wrote:

A certain percent of people who take out loans are not going to pay them back - that's human nature.

Now depending on the terms of the loan, default might be more or less risky. Credit cards are unsecured debt, the bank gets nothing if you default, and has to write down their asset to $0. This is credit destruction / deleveraging, and it's bad if you own equity in a bank, or if you want to borrow from a bank and they won't lend because of their capital position.

An aircraft loan is much less risky, the lender can just repossess the plane and loan it to someone else.

Margin debt is also not very risky (for the lender), because it's callable - not a fixed amount/term. Brokers will liquidate your positions in order to keep portfolio margin below 200%. But, the fact that it's callable makes it very risky for the borrower.

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#9) On May 21, 2013 at 10:56 PM, Valyooo (99.39) wrote:

200%? I use IB...they only require I post 15% for portfolio margin

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#10) On May 21, 2013 at 10:58 PM, Valyooo (99.39) wrote:

Sometimes its hard to see how economies work when you take money out of the equation....sometimes I can't see why something can negatively effect society, and the amount of real goods and services, only the nominal dollar amount, which is not a real good but rather a media of exchange

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#11) On May 21, 2013 at 11:06 PM, Mega (99.96) wrote:

Yeah, I meant Reg-T margin. http://en.wikipedia.org/wiki/Portfolio_margin

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#12) On May 21, 2013 at 11:33 PM, Valyooo (99.39) wrote:

But how can investors AS A WHOLE be more margined up? Wouldn't this mean that sometimes brokers have a ton of cash sitting aroun doing nothing, and at other times they're lending that money to investors? Why would brokers have so much cash laying around?

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#13) On May 22, 2013 at 1:18 AM, jiltin (30.77) wrote:

Only one party or group can make or print money, that is FED.

When bank creates a loan, it is funded by sponsor . Sponsor gets from someone else (like Fannie Mae or Funds) or group of sponsors. We do not how many links are going like this. It is pretty difficult to trace as it spawns many to many thread.

If loan is defaulted or bankruptcy filed, someone gets the loss or group of people share the loss.

The issue of too much margin or too much credit leads to bankruptcy when system explodes. This has domino effect rippling across the country.

If you want really know how this is working. Open an investor account in lendingclub.com with $100. You can sponsor max 4 person ($25 per note) for loan. Play with it, you will come to know everything.

Lendingclub.com is very simple logic,but a sample of lending industry. Or Read enough before opening the account. You can finally sell your notes and get some money (You will lose some commission). However, the real world credit industry is too complex to understand. 

 

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#14) On May 22, 2013 at 1:23 AM, awallejr (78.92) wrote:

Ok I give up, you keep throwing out terms like credit card debt, checking account debt, margin debt and mixing them up.  Each instrument is different. Someone else run with it.

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#15) On May 22, 2013 at 1:35 AM, awallejr (78.92) wrote:

Actually this will be my last attempt.

A credit card is an unsecured loan by a lender to you when you make a purchase.  The lender gives the merchant cash and you pay that loan off over time at a generally ridiculous interest rate.  The lender can't force you to pay sooner.  It is what the then current agreement terms are.

A margin account is where a lender will give you a loan to buy securities but you must put up collateral (securities).  Different brokerage houses have different terms but the gist is that if the collateral's value declines too much you have to put up more cash, hence a potential cascading effect since you may have to sell stock to cover.

A checking account has nothing to do with debt.  It is an instrument  comparable to cash.  You write a check that is covered by your cash.  If you don't have the cash to back it, it bounces.

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#16) On May 22, 2013 at 1:47 AM, Valyooo (99.39) wrote:

I never once said "checking account debt", not sure why you think i did.

 

I understand what a credit card is and what margin is and how they work...I have used both and used to sell credit cards.

 

What I am saying is, lets say I have 1000 in a brokerage account, and I want to buy 2000 worth of stock.  In order to do this, I must borrow 1000 from my broker.  Unlike a bank, a broker cannot use fractional reserves.  So, he must have that extra 1000 laying around to pay the guy I am buying the stock from.  So if on average individual investors are super leveraged that means brokers must have had record levels of cash laying around before the leveraging started...so either the broker has a ton of cash, or he uses a ton of cash to pay off sellers...the amount of money in the system does not change, like it does when a bank creates a loan, correct? 

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#17) On May 22, 2013 at 2:04 AM, jiltin (30.77) wrote:

Lendingclub is Simple concept, a peer to peer lending market place.

Borrowers will apply for a loan say $1000. He/she will be given a chance to choose interest rate Class A (low interest 12%),B,C,D,E (high interest 26%) depending on their credit scores, debt ration and other factors.

Assume 5 borrowers are there requesting $1000,$2000,$3000,$4000 and $5000.

Investors (like you and me) will move the fund from their local account to lendingclub account. Say 200 investors are there with each $500. 

Each of the investor can lend $25 to these five borrowers. They can lend $25 or multiple of $25 and each is considered as a note.

Once all the people are funded, the borrower gets the loan and pay monthly PMI to lending club. The system divides the amount to each note holder principal and interest portion.

The equation now comes to one borrower can be funded by many investors and one investor can lend many borrowers. 

This is simplest example of complex financial/lending world. 

Now gets the tough part. One borrower defaults and files bankruptcy, it is spread across those investors funded him !

One borrower affects many investors. If many defauls, the impact to investors are high as single investor may be hit by multiple borrowers.

When high margin or high credit circulation occurs, the same thing (multiple or mass borrowers defaults) occurs with complex financial world. This is the core domino issue during every economic down turn.

 

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#18) On May 22, 2013 at 2:14 AM, awallejr (78.92) wrote:

consumer A wants to take out a loan. Bank creates loan as an asset and checking account as a liability

As I said you are mixing different instruments.  Stick with one otherwise this blog gets chaotic.  You want to talk margin, fine.  You want to talk credit card, fine. But they aren't the same insturments.

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#19) On May 22, 2013 at 3:19 AM, somrh (75.46) wrote:

I believe the credit card debt would be like other bank loans in that it would expand the money supply (M2). The money in the purchase is credited to the seller's account but no funds are deducted from anyone else's account. 

I believe margin loans are funded by money markets, no? If that's the case it really depends on whether or not you choose to count money market funds as money.

IIRC, money market funds aren't counted in M2 but are in M3. So M2 would remain constant and M3 would expand (assuming I'm correct in my assumption that margin loans are funded via money market funds.)

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#20) On May 22, 2013 at 3:31 AM, Valyooo (99.39) wrote:

awallejr, I was just simply comparing how a bank loan differes from a margin loan in the fact that one expands money supply and one does not.

 

somrh, Oh, maybe you are right...I was unsure if margin loans were funded by each broker or if the broker borrows money market money  and lends it to buyers..that makes a lot more sense 

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#21) On May 22, 2013 at 11:14 AM, jiltin (30.77) wrote:

somrh,

"The money in the purchase is credited to the seller's account but no funds are deducted from anyone else's account". This can not be true. Funds must be deducted from other party, sponsor.  I am firm on this. Or before issuing credit card, say $10000 limit, someone else acccount is deducted $10000 as a sponsor.

Only FED is allowed to create money, no one else.

Regarding, credit card or margin or any lending account, both are borrowing at high level, but different instruments.

When someone defaults other party,sponsor, suffer.

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#22) On May 22, 2013 at 4:17 PM, somrh (75.46) wrote:

jiltin,

Only FED is allowed to create money, no one else.

This isn't true. The Fed only controls M0 which is only a small fraction of the overall money supply. The bulk of it is determined by the private banking sector via credit extension.

This is not to say that there are no losses in the event of the default. When a commercial bank extends credit they create an asset (the loan) and a liability (deposit seller's bank account).

Then end result is that M1 (or at least M2) increases in the enitre system. If the loan is defaulted on (and written to $0), that doesn't alter the fact that the liability still exists. 

About the closest thing I can think of with regard to credit cards is their securitization. In those cases, there may not be an expansion of M1 or M2. But banks hold a pretty good chunk of loans on their balance sheets so they are all part of the credit creation process.  (FWIW, I glanced at the annual reports of BAC and JPM. BAC had just under $100B in credit card loans, JMP was well over $100B.)

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#23) On May 22, 2013 at 4:26 PM, Valyooo (99.39) wrote:

Then end result is that M1 (or at least M2) increases in the enitre system. If the loan is defaulted on (and written to $0), that doesn't alter the fact that the liability still exists.

 

Can you explain this a little more?  I don't think I fully get what you mean. 

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#24) On May 22, 2013 at 5:09 PM, somrh (75.46) wrote:

@Valyooo

Here's a bit of a cop-out but likely a better explanation than I can offer:

Steve Keen The Myth of the Money Multiplier

If you're asking about the liability, if I swipe my credit card at Walmart for $100, $100 is added to one of Walmart's bank accounts.

That deposit ends up as a liability on the bank's balance sheet since all deposits are the bank's liabilities. That liability doesn't go away if I default on my credit card debt. Walmart still wants its money. 

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#25) On May 24, 2013 at 9:28 PM, jiltin (30.77) wrote:

Somrh, Thank you, I read about this in wsj article today.

 The Fed Squeezes the Shadow-Banking System 

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