Margin Calling

 A common feature of both the 1929 Crash and the unnameable financial crisis of 2008 is a high volume of margin calls on highly  leveraged securities portfolios.  This time it's hedge funds that have done the excessively leveraged buying.  As the prices of the securities the hedge funds bought at a high margin plummet, the hedge funds need put up more cash collateral to their lenders to replace the lost collateral represented by the plunge in value of the security bought on margin.  This forces the excessively leveraged hedge fund to sell shares, driving prices down.  Forced sales to meet ever increasing margin calls creates a vicious cycle that leads to a market plunge.  This is what has been repeatedly happening in the markets  lately and was a key factor in the 1929 collapse.   An important provision of the Securities and Exchange Act of 1934 allows the Federal Reserve to set margin limits on the amount of leverage used to purchase securities.   The Federal Reserve does this through Regulation T.  But Hedge Funds exploit an exception in the Investor's Company Act of 1940 that allow investment entities comprised of sophisticated investors (investors holding more assets than most people have, no Mom & Pop investors need apply) to avoid margin regulations.  The exception was not meant to apply on the scale it is being exploited by Hedge Funds today.  No one foresaw the hedge fund explosion and how it would introduce the same systematic risk caused by over leveraged equity purchasing that proved so fatal in the fall of 1929.  Yet here we are again.  Despite the earnest arguments that hedge funds should be unfettered in order to take risks that are net beneficial for the economy, it makes no sense to allow them to engage in the same unregulated margin purchasing that destabilized the financial system in 1929 and now again in 2008.  The systematic risk from over leveraged security purchasing has nothing to do with the sophistication of the investor, rather it arises from the aggregate actions of a number of risk taking investors.  It is naive a la Greenspan to think that because someone is a  sophisticated investor they won't take on risk that when aggregated with that taken on by other sophisticated investors  proves disastrous.  This notion has been proven false now twice.  The loophole that hedge funds exploit to escape margin requirements needs to be closed.  This would be one small step to restoring sanity to our markets.