Video: What Are Margin Calls?

What are margin calls? The term has been bandied about lately as being one of the reasons for the steep declines in the market. Basically, it’s when depositor’s margin account at a brokerage falls below minimum levels and the brokerage tells the depositor to either deposit more money or they have to sell off some of their holdings. And a spate of selling drives down stock prices because as supply increases, prices drop. But why are there margin accounts and why are brokerages making margin calls in the first place? Marketplace’s ever-salubrious Paddy Hirsch explains with girl scouts, girl scout cookies, a whiteboard, dry-erase markers, and stick figures, in the video inside…

Margin calls and the financial market’s decline [Marketplace]

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  1. BeeBoo says:

    Just want to point out that if you don’t thoroughly understand margin and the fact that you can lose more money than you have in your account, you shouldn’t be using it.

    • 12-Inch Idongivafuck Sandwich says:

      @BeeBoo: I agree, and I would go so far as to say that even if you do thoroughly understand it, you still probably shouldn’t use it…

    • pirate_panda says:

      @BeeBoo: As I understand it (from a year or so of college history/economics) margin calls were a big part of the 1929 stock market crash as well. Even for people who don’t play the stock market it’s a good thing to teach them.

      • Canino says:

        @pirate_panda: margin calls were a big part of the 1929 stock market crash as well

        Kind of true, but margins at the time didn’t work the same way. Part of the reason there hasn’t been a monster crash like in 1929 is because of the reforms of the margin system.

        Margins at the time were much lower, weren’t necessarily backed, and could even be backed by the security itself.

  2. squablow says:

    I like this guy and his little videos. The first one, with shorting stocks, I knew what that was before the video, but I was less familiar with how a margin call works, and it couldn’t have been explained more simply or clearly.

    • Anonymous says:

      @squablow: As much as I appreciate this guy’s effort, it’s the little details like going from $100 thin mints and $25 dolls to claiming one of those dolls as collateral for a $0.25 drop in cookie prices that makes me think if this is the level of detail and effort an expert places in a layman’s explanation, then it’s no wonder Amy and Jill and the stock market have gone into this spiral thing. Ugh, thinking about one of his earlier videos on CDOs (an investor filling a champagne bottle with mortgages and creating a capital structure out of wine glasses) still makes me groan. Maybe the economy really isn’t broken and it’s just that economists haven’t found the mixed metaphor to optimally explain it.

      • Agent Cow3.14 says:

        @ShubhaAtalanta: I think of CDOs as a pyramid scheme with insurance as the product. I’m just happy that my 401k hasn’t dropped 50%.

      • Trai_Dep says:

        @ShubhaAtalanta: If your eyes are rolling over how simplified Paddy’s analogies are, you’re probably not the audience he’s trying to educate. :)

      • Grive says:

        @ShubhaAtalanta: Uh, he does mention that the packets at 2 dollars each would net one dollar gain, with the implication being that Jill purchased 100 of them.

        So a $.25 drop in cookie prices is a $25 drop in the total value of the investment – so it’s an increase of $25 in collateral for $25 in devaluation.

        That, and the video isn’t trying to prep people up to become stockbrokers. It’s a simple, illustrated way to let people know what a “margin call” is. Something like telling people that the engine in their car turns because the pistons move the crankshaft when gas burns. It’s not an attempt to make everyone an automotive engineer – just giving some general culture.

  3. sebadoh128 says:

    “Everything I needed to know about the stock market I learned from Trading Places.”

    -Robert Willumstad

  4. SOhp101 says:

    He doesn’t really answer why there are margin calls, other than that quick bit about how the other girl is irresponsible and needs to borrow money to buy more cookies.

    I forgot who said it, but one of the biggest reasons for such large stock market gains (and losses) are due to the fact that there is such a large gap in wealth inequality and those who aren’t already wealthy have no choice but to borrow money to make a decent amount in the stock market. Pretty soon when you have the majority of people who are trading in the stock market borrowing money, and a crash is inevitable.

    • Agent Cow3.14 says:

      @SOhp101: I figure some investors just don’t have the liquidity on hand to make the purchase, so they put some of their own stock as collateral to borrow another stock they think will do well. Just because you’re Donald Trump doesn’t mean you walk around with a million in cash, you ‘margin’ in credit cards.

  5. m4ximusprim3 says:

    I like paddy because every video ends with him throwing the pen and everyone needing a drink.

    I alwyas imagine that to be how the markets work. At some point, all of the margin call people throw their phones in the air and go have a gin and tonic.

  6. artki says:

    Amy’s hardcore

  7. SayAhh says:

    Also, say EVERYONE starts daytrading and quit their dayjobs (from, say GM). No wonder the stocks are worthless since nobody’s making the goods, because those who were hired to make those goods are untrained and underpaid…

    Derived this from an example of a wiser Buddhist monk educating a younger, idealist Buddhist monk: if everybody becomes Buddhist, and everybody becomes so devout that they become monks and nuns, then the human race will become extinct within 100 years! So, even in religion, moderation is the key :)

    Anyway, my stock trading example is overly simplified, but it gets the message across: stop daydreaming and start working! Or else the next financial fad will be Lotto jackpots! Will we bail out those who “invested” in lottery tickets, too, with taxpayer money? It’s too big to fail! LOL

  8. Trai_Dep says:

    It’s great that in this age of animated 400MB PowerPoint stacks, teleconferencing and holographic reporters, a thoughtful, Irish guy armed only with a dry-eraser and a black marker can explain so compellingly in an entertaining way.
    Although it helps that he calls for drinks on the house after every presentation. :)