Matt Levine on Margin Calls
In times of market volatility, potential clients may call complaining about unfair margin calls. For a quick overview, I recommend today's "Money Calls" column on Bloomberg, by Matt Levine:
For the article, go here: https://bloom.bg/34lVUJb
Margin calls (1)
"As I have said before, my instinct, when banks and their customers are fighting over margin calls, is to side with the bank. The deal with margin lending is that you buy stocks using the bank’s money, and then when the stocks go up you keep all of the profits. That is a good deal for you, if there are profits. It is not such a great deal for the bank. They’re putting up much of the money for your investment, but they are not a co-venturer with you; they don’t share in your gains. They earn the same interest on their money no matter how well you do. The only way this makes sense for them is if they earn the same interest on their money no matter how poorly you do. You don’t treat the bank like a partner when things go well and you make money, so you should not expect the bank to treat you like a partner when things go poorly and you lose money. When your stocks go down and the bank calls you for more margin, you can say 'no no this is a temporary drop in a sound long-term investment, let’s ride it out,' but they can and should ignore you; it’s not their long-term investment. Instead, as soon as anything goes wrong, your bank is going to be demanding more money, and if you don’t get them the money fast enough they will seize your collateral, blow out your position, protect themselves and leave you with the loss.
"This all tends to be very clearly spelled out in the legal documents, not only because it is the proper allocation of the risk (you mean to take risk and the bank doesn’t), but also because the bank is probably bigger than you are and so can write the documents to favor itself. And so to exaggerate slightly your margin loan contract probably says something like 'if the bank gets nervous about anything for any reason it can sell all your collateral and seize your money and there’s nothing at all you can do about it ever.'
"And yet when there are widespread margin calls, there is often litigation; despite that clear allocation of the risks, margin borrowers always seem surprised and angry when they get margin calls, and sue their banks to stop them, and sometimes even win. There are various reasons why—sometimes banks can be overly rapacious in their margin calls, or sell collateral to themselves for too cheap, etc.—but here’s a fascinating one:
Investment contracts give banks clear rights to liquidate positions. But lawyers say there still can be scope for making claims if banks act too quickly or mishandle a liquidation and impose bigger losses than would otherwise have been crystallised.
They say there are risks that, in the often-heated conversations that come with a disputed margin call, things might be said which contradict the contract wording and create opening for legal claims.
Mike Hawthorne, legal director at Pinsent Masons, said: “The danger for banks and brokers is that, in the course of the potentially confrontational discussions around the margin call, something might be said which the customer could misinterpret as an agreement to allow more time to provide the margin or before closing out the account.”
"Basically the lawyers write a contract saying 'we can do whatever we want,' and the traders and risk managers say 'let’s do everything we can to protect ourselves,' but then the salespeople and relationship managers get on a recorded phone line with the customer and say 'obviously we want to work with you here, we are reasonable people, you are a valued customer,' and the signals become a bit mixed. No salesperson ever wants to tell the customer 'nope, we can do nothing to help you, we’re standing on our contractual rights and we don’t care how it affects you,' even though that may be exactly the bank’s position. And so the salesperson says something vague and conciliatory and it ends up being used as a reason to sue.
See the article for more, or....