Regulation T - Reg T

Imposed by the Federal Reserve, this nugget regulates how margin can be extended by broker-dealers as well as the limits on how much margin can be made available to investors. According to this rule, brokers can offer up to 50% margin.

So you probably remember all those horror stories of clueless investors borrowing more than the usual 50% maximum margin to either buy more securities or just, um…stuff. Not shockingly, this was a big problem in the unregulated world, before the various securities acts went into power in the 30s and 40s.

Reg T basically covers the form and manner in which brokers, or brokerages, can extend credit to their customers. That is, in most cases, for normal retail investors, the maximum amount they can borrow, courtesy of the kindly, loving, care-taking people at Reg T, and think of that T as “training wheels” is 50%.

So who hates this law? Who loves this law?

Well, if you think about the dynamics of a brokerage, they are the casino. The house. The matron. They don’t like to take a lot of risk. But, undoubtedly, they have clients who do. So think about the situation where Joe RollsBigDice borrows right up to the limit of 50% margin, and things go well, and he borrows more and more, continuing his practice of being right up to the limit of a 50% limit structure.

From a margin account, Joe is allowed to buy anything legal. He can buy more securities, or he can buy that shiny red convertible Porsche with the awooga horn. So in his margin account of $300k, he’s borrowed a hundred grand to buy more stocks, and since his margin limit at 50% leaves him head room for only 50 grand more when he just had to have that Porsche, he was limited to buying the 9-year-old one with a dent in it, and that fish smell that will never go away.

So Joe is now all in, just kissing his maximum margin borrowing capacity of 150 grand, against the 300,000 dollars in equity value in his account. Then, one day, North Korea gets moody, and nuclear things...happen.

And the market takes a huge Dr. Strangelove-ending kind of dive. So now Joe RBD’s broker, with whom he has become friends-ish over the last few years, has to have the unpleasant phone call that Joe must present money to make his 50% margin maximum work.

Joe has to sell shares, producing cash, until the total amount he has borrowed against his investment portfolio is 50% or lower. So this is bad enough. It’s an unpleasant conversation. Joe will probably blame the broker for not preventing him from making whatever stupid bets he made, and Joe might switch and go to eTrade, or somewhere else.

So yes. That’s bad. But in the era before the 50% margin, where there were essentially no training wheels, investors could borrow whatever they were allowed to borrow. So then, instead of having a 50% cap, investors would have to not only sell essentially all of their stock portfolio, but they might suffer incremental debts beyond it, where sadly, the brokerage has to bring the sheriff, kick the wife and kids out of their home, and repossess their icebox, their horse named Betsy, and their brand new, state-of-the-art electric toaster.

And now, instead of being less wealthy, Joe and his entire family are flat broke, and living on a horse down by the river. So while Reg T drew a lot of mumbling about overly active government intervention at the time it was released, it in fact made for a dramatically smoother transition when times got tough.

Maybe that's what the T stands for…