It was reported on CNBC this morning that margin debt in the stock market hit $270 Billion in 2006. A number very close to record levels. Despite this the SEC has proposed lowering margin requirements for institutions on stocks, options, and futures. Now ranging from 25% to 50%, the proposal is to drop them to 15%. This would increase margin debt to nose bleed levels.
At the same time as the equities markets are expanding credit, consumers have been borrowing themselves into debt levels not seen since the great depression. When was the last time we saw leverage like this in equity markets and consumer debt? It was the last time the Republicans ran everything: 1929.
A normal cyclical correction right now in the equity markets, the housing market or a recession could trigger a catastrophic chain reaction because of the mountain of debt permeating every corner of the US economy. A 20% correction in stocks in the near future would be in line with historic norms, but if it caught over-leveraged hedge funds and investors by surprise they could be forced to liquidate their investments setting off a chain of panic selling. Foreclosures on home owners who obtained 100% financing expecting rising asset prices are skyrocketing. Consumers are as unprepared for an economic downturn as over leveraged investors are.
Arthur Laffer the father of supply side economics thinks stocks are undervalued by 67.2% and further that we should'nt worry about the inverted yield curve because it's "different this time". Based on his track record one can be fairly certain that reality will play out the opposite of Laffer's predictions. If that is the case the reckless fiscal policies and unprecedented credit expansion of the Bush administration is about to put us in a world of economic hurt.