Nobody sets out to borrow $188 billion. It happens one tax bill at a time. Charles Schwab (SCHW) said Thursday, Oct. 15 that margin loans on its books nearly doubled in a year, to roughly $188 billion. A big reason is a strategy that promises to beat the market and cut your capital-gains taxes at the same time. About $61 billion of Schwab's margin book sits inside it.
Hannah Erin Lang and Miriam Gottfried of the Journal lay out how it works. The account tracks an index and tries to beat it. Then it borrows against the portfolio to add two side positions. One owns extra stocks. The other sells borrowed shares, a short position that gains when those stocks fall. More positions means more losses to harvest, and harvested losses shrink the tax bill. Hedge-fund firms such as AQR and Quantinno now run nearly $190 billion this way, up from just over $1 billion five years ago, by one industry estimate. Morgan Stanley (MS), Bank of America (BAC) and Goldman Sachs (GS) all reported double-digit margin growth this week, and the paper names this strategy as a key reason. We hold those three banks at weight in 16, 11 and 19 books. Nothing added.
When the custodians flinch
Fidelity helped the boom by letting smaller accounts in. It got so popular that Fidelity paused new accounts in February. The money ran to Schwab, and Schwab has now pulled up the ladder too. Last month it raised the minimum for some new accounts to $10 million from $1 million. It stopped enrolling new clients in portfolio margin accounts. Chief Executive Rick Wurster told analysts, “It was important to us to throttle growth for a period of time.” People familiar with the matter told the paper the leverage carries significant balance-sheet risk. Schwab's own shares fell 2.7% Thursday, Oct. 15, on rate worries, even after beating estimates.
The bigger number sits underneath. U.S. margin debt hit $1.45 trillion in August, near the summer's record of $1.5 trillion. Part of that is mechanical. When stocks climb, a short seller has to put up more collateral, and that cash can come straight out of a margin loan, automatically. Leveraged funds passed $180 billion in assets in the second quarter. Borrowing is everywhere in this market, and it wears a lot of different costumes.
Our read
This is a Tax story that belongs under Investments/Risk IN04. Tax-loss harvesting is real and useful. Borrowing to manufacture more losses is a different animal. It adds a margin loan, a short book and a lender who can change the terms. The tax benefit only matters if the strategy survives the next bad year, and that's the year a margin call shows up. When the two biggest custodians in the country say they can't support it operationally, we read that as a warning. For most households we'd put the leveraged version in the avoid column and keep the plain version. Any tax plan belongs on paper with a CPA before it touches an account.
The line in your own plan this touches is the margin feature on your brokerage account. Many accounts have it switched on from day one, whether or not you ever meant to borrow. This week, log in and find the margin balance line on your statement. If it's anything other than zero, find out what you're paying and what would trigger a call. Then look at any tax-loss program you're in and ask whether it borrows, and get the answer in writing. Rain doesn't check whether you packed the umbrella. If you'd like us to read the statement with you, that's a short call.