Some have asserted that the Federal Reserve can deflate a stock-price bubble--rather painlessly--by boosting margin requirements. The evidence suggests otherwise. First, the amount of margin debt is small, having never amounted to more than about 1-3/4 percent of the market value of equities; moreover, even this figure overstates the amount of margin debt used to purchase stock, as such debt also finances short sales of equity and transactions in non-equity securities. Second, investors need not rely on margin debt to take a leveraged position in equities. They can borrow from other sources to buy stock. Or, they can purchase options, which will affect stock prices given the linkages across markets.
Thus, not surprisingly, the preponderance of research suggests that changes in margins are not an effective tool for reducing stock market volatility. It is possible that margin requirements inhibit very small investors whose access to other forms of credit is limited. If so, the only effect of increasing margin requirements is to price out of the market the very small investor without addressing the broader issue of stock price bubbles.
If a change in margin requirements were taken by investors as a signal that the central bank would soon tighten monetary policy enough to burst a bubble, then there might be the appearance of a causal effect. But it is the prospect of monetary policy action, not the margin increase, that should be viewed as the trigger. In a similar manner, history tells us that "jawboning" asset markets will be ineffective unless backed by action.