Ross Aldridge in Las Vegas Nevada reviewed the proposed tax revision that was presented by presidential frontrunner Donald Trump on 60 minutes. If this plan is implemented would the plan stop the imminent stock market correction that is current at the beginning? Evidence has been mounting for months that an economic bubble is building in the U.S.
That's not a happy prospect. In the financial markets, bubbles never go away quietly. As contributor Michae Hilzik summarized:
The most disquieting indication is a ferocious run-up in borrowings against stock and bond holdings. We're not talking about margin loans, which are used to buy securities and are limited to 50% of the value of one's stock and bond holdings.
Consumers are feeling pretty good, and they are starting to spend money again, and they're starting to do dumb things.- Morgan Stanley's Mike Wilson
The real increase has been in "non-purpose" or securities-based loans, which are used for other needs or, well, for fun - a second house, a boat, a vacation, etc. They're collateralized by the same securities but can amount to as much as 95% of a portfolio.
At a press briefing last week reported by Business Insider, Mike Wilson, an executive of Morgan Stanley's wealth management arm, cautioned that "Consumers are feeling pretty good, and they are starting to spend money again, and they're starting to do dumb things. They're starting to borrow money, they're starting to maybe buy that house they shouldn't or that car they shouldn't."
That's amusing, because Morgan Stanley has been aggressively hawking non-purpose loans: its total securities-based loans totaled $38 billion at the end of 2014, a 70% increase over two years earlier according to an analysis by Paul Meyer of the Securities Litigation and Consulting Group.
The firm's pitch to clients is entitled "Invest in Your Dreams." Among those dreams it puts in its clients' heads: "The restaurant you've always wanted to open. That advanced degree you finally have time for. The perfect house that won't be on the market long. A 1963 Ferrari GTO, just because."
Wall Street types are always on the lookout for can't-miss, slam-dunk, win-win investments that they can either load into their own portfolios or stuff into their clients' accounts. These are often known as "story plays" because they come complete with a yarn explaining why they're can't-miss,...
Wall Street types are always on the lookout for can't-miss, slam-dunk, win-win investments that they can either load into their own portfolios or stuff into their clients' accounts. These are often known as "story plays" because they come complete with a yarn explaining why they're can't-miss,... ( Michael Hiltzik )
Some of those are certainly going to be "dumb things," in Wilson's words. Adds Josh Brown of Ritholtz Wealth Management and The Reformed Broker website: "Consumers really are doing dumb things. And they have plenty of help."
Meyer observes that securities-based lending is especially risky - for the borrower. (For the broker, it's great.) This lending "creates serious conflicts of interest, saddling the customer with risks and potential long-term consequences he or she may not fully understand until the next bear market arrives."
Borrowers typically aren't judged by their ability to repay - their credit rating, income, or expenses - but chiefly by the size of their portfolio. As the Morgan Stanley spiel shows, customers are encouraged to borrow for the purpose of consuming, rather than investing. Brokers are incentivized to put clients in these loans through higher commissions and cash bonuses.
It's one thing to buy securities on margin; the strategy isn't risk-free but the margin loans have a cushion of 50% of the value of the underlying security, which limits the risk except in a severe downturn. Non-purpose borrowing against a portfolio can have a smaller cushion, and in the case of a downturn that prompts brokers to call in the loan, the money is gone - spent on that restaurant, house, GTO or vacation.
The idea that investment advisors owe a higher duty to their clients than to their own pocketbooks is an old one, often detested by Wall Street.
The idea that investment advisors owe a higher duty to their clients than to their own pocketbooks is an old one, often detested by Wall Street. ( Michael Hiltzik )
The prudent way to use securities to fund such dreams, of course, is to sell them and spend the proceeds. Borrowing against them instead could magnify the pain of a downturn for customers, and for the markets. Excessive leverage, remember, is what really drove the housing crash a few years ago - homeowners had borrowed against their equity and spent the money, leaving no refuge when home prices began to turn down.
The rapid growth in securities loans prompted the Financial Industry Regulatory Authority, the industry self-regulatory arm known as Finra, to put the practice on watch earlier this year. "Any time you see leverage increase in a variety of ways," Finra Chief Executive Richard Ketchum said, "that increases risk for investors."
But so far, Finra hasn't taken action to rein in the lending. As Meyer observes, the size of the portfolios in brokerage accounts may create an irresistible temptation for brokers with clients looking to fund their "dreams." With $16 trillion in client holdings sitting in accounts at brokerage houses, Meyer writes, "there is still a lot of potential collateral waiting to be encumbered."
Ross Aldridge Consultants located in Las Vegas Nevada sees a lot of downside that has yet to be disclosed with negative financial and automotive potholes along the flash crash paths of the cyber highways. We will continue to stay away from these stocks: XOM, CAT, GS, BOA, JD, and HD. We have liquidated our 40% holding in SKF as or $54.25 target mark has been realized. The roller coaster market will continue to make three head and shoulders before the end of the 4th quarter 2015. We advise to buy SKF back at $49.25 and sell at $59.10 at the end of the 1st quarter 2016.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in SKF over the next 72 hours.