He left the bank without even stopping by my desk again.
Many of my trader friends told me they used their American Express cards to buy stock. With Amex, you don’t have a credit limit, as such, and if you pay in thirty days, you don’t pay interest. So, they would buy stock, and hold it for thirty days, sell it, and pay off the bill when it came in. But because of settlement rules, it was possible to hold the position for 33 or even 35 days.
Picture using a $10,000 cash advance on a charge card to buy $50,000 worth of stock, that you can’t afford to pay for, because you are hoping that it will go up in the next 34 days. I don’t know about you, but that would be a long sleepless 35 days for me. But for these guys, this was their normal routine, month in and month out.
I heard stories, although didn’t actually see it with my own eyes, of guys taking cash advances of tens of thousands of dollars, buying hundreds of thousands of dollars worth of stock they couldn’t afford, and holding it for thirty days.
In addition to being insane about trading stock and “leveraging” their position, one commonality between all of these educated, well-off men was that they sneered at the “jerks” who fell for the home-equity credit scams on TV.
“Can you imagine someone being that stupid and using their home equity to buy a stereo?” They would say.
The late 90’s and into about 2000, Wall Street was experiencing what financial experts call a bubble. It is a time when the market goes up and up. Prices and returns inflate until, eventually, like a bubble, they burst. And then you are left with a soggy, deflated balloon, and no house.
When Charles Edward Merrill, founder of Merrill Lynch, coined the phrase, “Bringing Wall Street to Main Street,” he didn’t mean that normal people should be leveraging their kid’s college fund, their retirement monies, or their home. He was trying to level out the playing field, and give the regular Joe a chance to participate in the stock market. But somehow, the concept became perverted and blown out of proportion on a scale that would probably have sent Merrill spinning.
Everyone was focused on “let your money work for your you.” But, as comedian Jerry Seinfeld pointed out, “What if my money gets fired?”
In addition to leveraging assets and salaries, people in New York, and elsewhere, decided that they, like big corporations, should hire accountants, who knew how to “work the system.”
“Why should the government be making money on your taxes?” was a common phrase that was thrown about, as people sat in Starbucks, drinking a $4 latte and swapping tax avoidance strategies.
A friend of mine, a Wall Street trader, earned $800,000 in one year. His accountant used aggressive, but legal strategies to postpone all of his tax payment until the following year. And why did my friend want to do this? So that he could use his tax money to buy stock.
His plan was brilliant. Use the $250,000 in his tax account to buy stock, fully leveraged, of course. And when the stock went up, he would sell it, and use the profits to pay last year’s taxes and this year’s taxes. Or, maybe he would look for another loophole to push the tax debt further one more year.
Since a technology mutual fund could gain 190% per year, my friend, and others like him, saw their debts as decreasing in value at a rate of 190% per year.
Unfortunately, for my friend and others like him, a basic rule of both physics and finance is, what goes up, must come down. The bubble burst.
If you use leverage in a stock account, the stock is essentially the collateral securing the loan. This method works great in an upward market. But now, let’s say that your stock drops in value by 10%. You no longer have enough collateral to secure the loan. The loan comes due in the form of a margin call. This basically means, you have to repay the loan, or put enough money into the account to make up the shortcoming in your collateral.
But money — cash — was the one thing none of these guys had. Cash was stupid. Cash was for losers. Cash prevented you from “leveraging,” from maximizing your returns.”
So, how did they make up the deficit in the face of a margin call? They sold stock. But they were now selling it for less than what they had paid for it. So, they had to sell more than what they lost. For some of these guys, the credit card bills, home-equity loans, or whatever crazy credit bills also came due, and now they were in serious trouble.
My friend, the trader, who postponed his $250,000 income tax payment, lost everything. On Wall Street, if you wind up in trouble with the IRS or have any personal credit issues, bankruptcy or foreclosure, you generally lose your license and your job.
The tax debt which my friend believed was decreasing at a rate of 190% wasn’t. Those gains in his portfolio were “paper gains,” not real. But his tax debt was real. Suddenly, he had no money, no job, and a $250,000 tax bill staring him in the face.
Like a recovering alcoholic who could never go near a bar again, my friend needed to find the simplest, most secure, quietest job he could. He started working at the post office. His new salary was $40,000 a year. And he will be paying off his tax debt for the rest of his life.
This would be a good place to end this article. We saw how crazy the bubble was and how stupidly people used credit in America. But sadly, it doesn’t end here.
When technology stock blew up, people went to small cap. When the stock market more or less imploded, people ran to real-estate.
“I can’t believe how stupid we all were with stocks before,” a friend of mine told me. “But I learned my lesson. Real estate is the way to go. It’s safe. You can see. You can touch it. And it always goes up in value.”
This particular friend used his house as collateral to invest in as many condominiums as he could. When last I checked with him, they were still unrented. And in the face of the current trend of foreclosures and lack of consumer credit, I don’t see how he could sell them.
If I had a chance to pull him aside at a cocktail party I would tell him, “I got a hot tip for you, the new, new thing.” Then I would look over both shoulders to make sure no one is listening and tell him the financial secret handed down to me by the film, “The Graduate.”