Financial History 139 (Fall 2021) - Page 14

Inflation cartoon titled “ Coming Down to Earth ,” 1921 .
Collection of the Museum of American Finance borrowed money is called the initial margin requirement . The requirement sets a minimum for the amount of collateral a buyer must provide to get a loan to buy stock . The Federal Reserve is charged with controlling this requirement ; it did so actively in the 1920s and also from 1929 to 1974 .
In the 1920s , the Fed progressively raised the requirement from 10 % to 50 %. Between 1929 and 1974 , it changed the initial margin requirement 23 times , from a low of 40 % during the Great Depression to encourage people to buy stock , to a high of 100 % during World War II , effectively prohibiting buying stock with borrowed money .
If Federal Reserve Chairman Jerome Powell were to raise the requirement tomorrow , this leg of the stool would break . But the requirement has not budged from the 50 % level set in 1974 , and the reluctance of the Fed to make any further adjustments has made its use the capital markets ’ equivalent of the nuclear option . This tool is effectively off the table for now . Therefore , troubling signs of excess borrowing remain , leaving this leg of the stool cracked .
3 . Interest Rates
A lax monetary policy accompanies financial bubbles , but it ’ s not just absolute interest rate levels that matter — it ’ s the direction in which those rates are moving . The Fed ’ s primary means of setting interest rates is the federal funds rate , the interest rate at which banks provide overnight loans to each other . In the big picture of the markets , the federal funds rate is the captain of the team , the lead violin . All fixed income markets look to the federal funds rate before they move in a direction .
When the Federal Reserve was trying to arrest hyperinflation in the early 1980s , the federal funds rate peaked at nearly 20 %, its all-time high . Last March , during the worst days of the pandemic stock market , the Federal Reserve slashed the rate to its lowest level in history , where it remains today — 0.25 %.
In comparison , between 1927 and 1929 the Fed raised the discount rate ( a much more draconian move than adjusting the federal funds rate ) three times from 3.5 % to 5.0 %. Early in 2020 , in response to the pandemic , the Fed lowered the discount rate from 2.25 % to 0.25 %, a huge stimulus signal for the markets . And that is where the discount rate remains today .
The Federal Reserve is taking more stimulative measures today than at any point in its nearly 110-year existence . Chairman Powell stated that low rates are here to stay for the foreseeable future , and “ it will be measured in years ” before the Fed considers raising interest rates .
But what about the long end of the
12 FINANCIAL HISTORY | Fall 2021 | www . MoAF . org