The Securities Exchange Act of 1934 empowers the Federal Reserve to regulate credit (money loaned from broker-dealer to the investor) associated with the purchase of securities, also known as margin.The Act’s intent is to manage the amount of speculative activity that can be applied to securities transactions and to manage the supply of money in the credit markets.
The Fed responded to its new powers by enacting Regulation T,which places credit restrictions on broker-dealers by establishing initial margin requirements and prescribing how a margin transaction must be maintained. This regulation was soon followed with Regulation U,which imposes credit restrictions on other lenders that would finance margin transactions, such as banks. Regulation U forbids banks from extending more credit than the “maximum loan value” for margin securities, which it identifies as 50% of the stock’s current market value.
As a tool of monetary policy, the Fed has historically used Regulations T and U to raise and lower margin requirements, with the idea of slowing or increasing speculative activity in the credit markets. Increased margin requirements mean reduced lending, which means a reduction in the size of the money supply. However, the Fed has recently come to believe that regulating margin has a negligible impact as a monetary tool, and it has left initial margin requirements unchanged at 50% since 1974.
