Wall Street Needs You to Borrow Against Your Stock
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This is Your Money Matters from The Wall Street Journal. Welcome to Your Money Matters. I'm Jennifer Strong in New York. A boom in securities-backed lending is bolstering bank profits, but critics say it doesn't always benefit clients. Here in the studio with the story is The Wall Street Journal's Michael Worsthorn. Michael, Wall Street brokerages are pushing customers to take out billions of dollars in loans backed by stocks and bonds, and you say regulators are keeping a close eye.
Yeah, since the financial crisis, there's been an incredible ramp up in this type of lending activity amongst brokerages. Basically, when the financial crisis hit, brokerages can no longer rely on the steady flow of commissions, of selling stocks and bonds to boost their profits. So they've turned to alternative types of revenue, and a big part of that is lending. Basically, brokers are being incentivized. They're being paid by their managers to convince their clients
What is securities-backed lending and why is it booming on Wall Street?
to leverage their investment portfolios. A big part of it is because we've had this second-longest bull market in the history of the United States. So you're seeing a lot of people flush with cash, and they're being told that instead of selling your securities and paying capital gains taxes to buy a house, buy a yacht, pay for graduation, or even pay for taxes, their financial advisor is instead telling them, Take it out against your securities and buy those things that you want. And the marketing materials are in some ways highlighting the benefits a lot more than the rest. And it sort of masks the bigger fear that a lot of regulators have is that once the markets do fall and they will at some point.
there's going to be margin calls and there are going to be some investors that are not going to have the cash to cover those. And that means they're going to sell securities. And those are permanent losses that they can't recoup anytime soon then at that point. But the longer term risks and people don't know where the markets are going to go day to day, you can't really always bank on that the next day the Dow is going to go up.
Right. A permanent bull market is not something anyone would advise you to count on. Now, these loans help brokers out in a few different ways. You've mentioned a couple. Can you unpack some of the others?
Yeah, sure. So basically, when a financial advisor talks to one of their clients about one of these loans, if a client were to take it on, so say they have a $100,000 portfolio of stocks and bonds, they'll talk to their client, they'll take out one of these loans. The loan could be, you know, for 70 percent of that value. Then the financial advisor doesn't get compensation right away in every one of those instances for that person taking out the loan. It usually only comes when the person starts to draw down that loan. And firms, you know, see time and time again that the longer the person has one of these loans, the more likely they are to use it.
How are brokerages incentivizing clients and advisors to use loans backed by stocks?
In fact, there was one statistic at Morgan Stanley that they found over an 18-month period, a client was 37% more likely to then start using the loan just because it's sitting there around. Once they start using that loan, the financial advisor immediately starts to get compensation for that loan. Also, at some of these firms like Morgan Stanley and Merrill Lynch, the overall balance of the loans that they are able to get clients to take out at the end of the year, that contributes to a year-end bonus as well. So there's a couple financial mechanisms that these firms have put in place to make sure that brokers are doing this business. And while it's not the bulk of an advisor's compensation, It can be several thousands of dollars.
And there are a few that do so much of this business that it is a big part of their compensation, not every broker's compensation. But for some of them individually, it's a big part of their compensation. So there are some real conflicts there that investors may not always be aware of, of why that brokers are initially calling them and saying, we got this great idea for you.
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