Borrowing money to invest! What could go wrong?

0:01NPR.

0:06Hey, Ricky. Hey, Waylon. Tell me, what could you do if you wanted to invest$100 in Apple stock, but you only had$50? Oh, I know the answer. You are talking about margin trading, right? Absolutely. I could set up a margin account with my brokerage firm, put my$50 in there, and then they could lend me the other$50. of course at a very high interest rate, and then I could buy that stock. Let's rip some day trades. Absolutely right. Investors in the U.S. stock market are making a lot of these margin trades these days. The total amount of borrowing is at an all-time record level over$1.5 trillion. That's up by 50 % from a year ago.

0:51Woof, that is a lot of leverage. This is The Indicator from Planet Money. I'm Waylon Wong. And I'm Ricky Mulvey. Today on the show, when margin trading goes wrong, how these bets unwind, and why a debt-fueled stock market crash in South Korea could be a cautionary tale for the U.S. stock market.

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2:26The amount of margin debt at U.S. brokerages is now greater than the total amount of American credit card debt. More money is being borrowed to play with the stock market than we've racked up on our Amexes. And making profits with other people's money is great. The problem is when markets go down, you still have to cover that loan and the interest. If the price of the stock goes down too much, you have two choices. That's Heather Tuch's finance professor at Yale. You can either sell the stock to start to pay down that loan or post more margin to your account, that is, infuse more capital into your margin account.

3:05In other words, Heather says, put up more cash or be forced to sell investments to cover the loan. In the U.S., investors can use margin trading for pretty much any stock, but it's different in India. So Heather and her co-author decided to take a look at how margin trades play out there. In India, the regulators were in some ways kind to academics in that they designed rules that made studying this question a lot easier. Easier because there's a dividing line in India between stocks that can be bought with margin and others that can't. She says that made it a great place for a natural experiment on whether margin trades cause market instability.

3:43And what they found was, yes, margin mattered, especially during a financial crisis. It's during those downswings that we get this amplification. The margin basket of stocks went down significantly more than the basket of non-margin stocks during the crisis. Many margin sellers were forced to sell their investments to cover loans. This forced selling helped amplify overall losses. A similar phenomenon just happened in the South Korean stock market. Right. Investors there are excited about two companies, SK Hynix and Samsung. They make memory chips for AI data centers. And, you know, as you've covered on the show, lots of demand for these chips right now.

4:23SK Hynix and Samsung dominate South Korea's stock market. The value of both companies skyrocketed as more investors got excited about their chips. This thing is so big and it's moving so fast. That's Urien Timmer, director of Global Macro at Fidelity Investments. Semiconductor earnings have tripled in the last year. Like, it's crazy. Everything is sort of in fast forward and it's just multiple dimensions more of what we might typically see in a boom-bust cycle. Earlier this year, South Korea legalized single-stock leveraged ETFs. These look just like a normal ETF on the outside, except there's extra leverage, futures, and various other financial tricks on the inside to multiply your returns.

5:05What could possibly go wrong? Yeah, there's a downside. Is that if the ETF loses value, the losses are also magnified. Now, these investments have been legal in the U.S. since 2022. South Korea wanted to keep up, so investors cut money in its stock market. These ETFs became more popular in Korea as the value of those semiconductor companies grew, making up 20 % of trading on the South Korean exchange on some days. Yurion is not a fan of these tools. I call them weapons of self-destruction. I don't know why regulators approve these things. His pessimistic view seems to hold, in Korea at least. The value of its stock market plummeted 40 % at one point.

5:47The companies still estimate booming demand for their memory chips, but investors got a little less excited. The leverage bet started to unwind and margin traders had to sell their investments. More than 3 % of the South Korean adult population received a margin call, their broker saying, hey, you need to sell something or put up more cash to cover these loans. The sell-offs seem to have little to do with the future prospects of these companies. SK Hynek saw revenue more than triple over the past year, and it has plenty of demand for its chips. You look at the fundamentals of these companies, they're fabulous.

6:21So it's just a matter of you're in over your skis and when you use leverage, you can lose all your capital. Urien is essentially saying that many South Korean investors took on too much risk, which completely blew up their accounts. Goldman Sachs estimated that about 360 ,000 brokerage accounts were forced to sell all of their investments to cover their debts. The majority of these accounts belong to people under the age of 35, according to Bloomberg. Younger people felt confident taking on a lot of risk and maybe had less experience in financial markets. That's who got hurt. Now, is there a lesson for the United States?

6:57As we've discussed, we're seeing a record level of margin debt here. But here's the interesting thing. While there was limited interest in leveraged ETFs initially, in the last couple of years, it's spiked. And the Federal Reserve can do something about this, at least when it comes to margin debt. The bank has a little-known job. The bank essentially tells investors how much money do you need in your pocket to borrow a dollar. Right. So if we go back to that example we started with, if you have 50 bucks to invest in Apple and you want to invest$100 total, the Fed could say, OK, we should be more cautious.

7:32Your brokerage firm can loan you, say,$25, not$50. The Federal Reserve played around with this requirement in the years after the Great Depression. Interestingly, that crash came after soaring margin debt fueled a bubble. Should the Fed get involved today? This is more complicated. Yes, margin debt is at a historic level, but Urien says it's not growing as fast as it has in the past. And he says the size of the debt compared to the size of the overall stock market hasn't changed much over time. You know, the growth rate is about 53 percent, which is certainly a lot. But I compare to periods of very speculative fervor in the market.

8:16Of course, 2000 comes to mind. That was, of course, the internet bubble. And the rate of change of margin debt then was 81%. So considerably faster. Jürgen believes we are in a yellow zone, not a point of panic. That's why I'm saying that you've got to look, you know, not just at the sentiment, but something has to crack in the fundamental story. The Fed hasn't touched these investing loan requirements since 1974. Still, we wondered if now was a good time to revisit this requirement and break out a tool it hasn't used in decades. This would slow down the amount of new debt in the stock market.

8:52We reached out to the Fed's press office but could not get anyone to speak to us on the record. Urien Timmer believes the Fed may not want to get involved with margin trades for a simple reason. I think the Fed generally does not get into the stock market slash bubble business. They figure nobody can predict these things. Remember, Greenspan especially called the NASDAQ a bubble in 96 and it ran for four more years. So I think they at least are humble enough to know they can't time these things. Spotting a bubble forming is easy. Timing the pop is much more difficult. You don't want to shut down a party that could keep rocking for a while.

9:31Waylon. I feel really confident about the outcome of a UFC fight this weekend. Oh, no. However, I only have$20 in my pocket. So I was wondering. Can Polymarket lend you this money? I'm not lending it to you. How much money do you have in your wallet right now? The bank of Waylon. I don't carry cash, I'll have you know.

9:55This episode was produced by Corey Bridges with engineering by Travis Hagen. was fact-checked by Sierra Juarez. Kiki Cannon edits the show, and The Indicator is a production of NPR.

10:10This message comes from Capella University. That spark you feel? That's your drive for more. Capella University's FlexPath learning format lets you earn your degree at your pace without putting life on pause. Learn more at capella.edu. This message comes from Betterment. Their automated investing and saving tools give you the quiet confidence of someone who knows where to put their money with tax smart tools that help grow your after-tax returns year-round. Get started today at Betterment.com. That's B-E-T-T-E-R-M-E-N-T dot com. Investing involves risk, performance not guaranteed. Betterment is not a tax advisor, nor should any information herein be considered tax advice.

10:52Please consult a qualified tax professional.