One story told about Joseph Kennedy, the family patriarch, was how he made his decision to get out of the stock market before the crash. The fellow shining his shoes told Kennedy about the success he had had in the market and then predicted how the market would behave over the next week. Kennedy concluded the guy was right, but, he reasoned, if a lowly shoeshine boy could predict the market, there was a fundamental flaw in the market itself. Hence, it was time to get out. Are we reaching the same time as the use of leverage becomes a tool of Joe Investor?
Part of the problem can be traced to the hedge funds, which seem to be springing up all over the place. They’re borrowing a heck of a lot of money, and there is very little oversight by the government or the investment community nor is there a lot of collateral as exotic transactions are being used which allow them to borrow with very little down. Things have reached a state where the NY Fed, SEC and European regulators have started meeting to take a measure of the risk.
We’re talking big numbers here. Hedge funds borrowed $1.46 trillion last year; five years ago they borrowed $177 billion. Margin debt of individual investors set a new record, $293.2 billion, in March. Five years ago, margin debt was $134.58 billion.
Even such conservative organizations as the Pennsylvania State Employees Retirement System are part of the crowd. Are they the shoeshine boy of 2007?
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