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The Crash of 1929 was followed by a decade of legislation designed to prevent the securities markets abuses thought to contribute to the Great Depression. Among the perceived abuses was the liberal and destabilizing extension of credit for the purpose of purchasing and carrying securities ("security loans"). Loans by brokers and dealers to their customers, commonly referred to as "margin loans" or "debit balances," received the most attention in the public debate, although hypothecation loans by banks and loans by nonbanks (currently called "G-loans") also came under scrutiny.1
Broker-dealers finance margin loans in several ways. Internal funds from the broker-dealer's own account and, more important, from the credit balances of broker-dealer customers provide about 70 percent of the money required to finance margin loans.2 Thus, customers with cash balances indirectly lend to customers who want to leverage their investments by borrowing to buy or hold securities. The remaining source of funds for margin loans is external financing from bank and nonbank lenders.
The Board of Governors adopted Regulation T, the first federal limit on margin loans, in 1934. These "margin requirements" were placed on loans made by brokers and dealers to their customers for the purpose of purchasing or carrying securities. Such loans are called "purpose loans" or "purpose credit." Extensive literature exists about the consequences of Regulation T for the performance of securities markets. This literature has been updated by recent studies in this Review; Fortune (2000) reviews the foundations and content of Regulation T; Fortune (2001) assesses the implications of margin lending for stock market volatility.
The present study focuses on security loans by banks and nonbanks and on the margin regulations adopted by the Board of Governors to limit purpose loans by banks and nonbanks to broker-dealers or other borrowers. Regulation U, adopted in 1936, imposes limits on commercial bank loans to purchase and carry margin stock. Regulation G, adopted in 1968 but merged into Regulation U in 1998, limited non-- bank purpose lending on margin stock. Regulation X, adopted in 1971, limits the ability of U.S. persons or their agents to borrow abroad to circumvent Regulations T and U.
Along with the previous studies just cited, this study can be seen as a revisitation of the territory covered in earlier Federal...