Finance: What is Reg T?

Reg T, or Regulation T, is a federal regulation that covers the form and manner in which brokers, or brokerages, can extend credit to customers.

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Transcript

00:22

the unregulated world before the various securities acts went into

00:26

power in the nineteen thirties in nineteen forties will rig

00:29

he basically covers the foreman manner in which brokers or

00:33

brokerages can extend credit to their customers Credit that's where

00:37

the tea's coming from or how you remember it That

00:40

is in most cases for normal retail investors the maximum

00:44

amount they can borrow courtesy of the kindly loving caretaking

00:48

people at wreg tea and think of that t is

00:50

you know training wheels How about that to remember Well

00:52

that maximum margin fifty percent So who hates this law

00:56

Who loves this law Well if you think about the

00:58

dynamics of a brokerage they are the casino the house

01:02

the matron They don't like to take a lot of

01:04

risk and they don't like having clients go bankrupt playing

01:08

in their casino but undoubtedly they have clients who dio

01:11

so think about situation where joe roles big dice borrows

01:15

right up to the limit of fifty percent margin And

01:18

things go well any borrows more And then he borrows

01:20

more continuing his practice of being right up to the

01:23

limit of fifty per cent limit all the time Things

01:26

were good for a while from a margin account Joe's

01:28

allowed to buy anything legal that he can buy like

01:31

mohr securities are taken by that shiny new convertible portia

01:35

Well let's look at his account here Shows in his

01:37

margin County has three hundred grand He's borrowed one hundred

01:40

grand to buy more stocks And since his margin limit

01:44

at fifty percent leaves him head room for well only

01:47

fifty grand mohr Who Well he just had to have

01:51

that portia But unfortunately with only fifty grand to spend

01:54

he was limited to buying the nine year old one

01:57

with a dent in it And that you know that

01:59

fish smell that will never go away But it was

02:01

fifty grand Joe bought it So joe is all in

02:03

now Just kissing his maximum margin Borrowing capacity of one

02:08

hundred fifty grand against three hundred thousand dollars in equity

02:11

Value in his account Well guess what As things tend

02:14

to do in shmoop video one day north korea gets

02:17

moody And while nuclear things happen and the market takes

02:20

a huge dr strangelove ending kind of dive So now

02:23

joe are beedies broker with whom he has become friends

02:27

ish over the last few years Well has tohave the

02:31

unpleasant phone call that joe must present money to make

02:35

his fifty percent margin maximum work Because he's over that

02:39

fifty percent number Why Because the three hundred grand is

02:42

now i'll say two hundred grand was only allowed to

02:45

borrow one hundred grand Fifty spent two hundred That would

02:47

be the hundred yet He's borrowed one hundred fifty So

02:49

he needs fifty thousand bucks right now to make himself

02:52

hole or else And the else's that the brokerage just

02:55

goes and sells stocks at whatever price they're trading at

02:58

until his margin max is hit So joe or the

03:00

brokerage has to sell shares producing that cash and it's

03:04

tough to do in a market that's down big Thank

03:07

you kim jeong eun So this is bad enough it's

03:10

an unpleasant conversation Joe will probably blame the broker for

03:14

not preventing him from making whatever stupid bets he made

03:17

and joe might switch and move on to e trade

03:20

or somewhere else His friendships probably over so yes that's

03:24

bad but in the era before the fifty percent wreg

03:27

team margin limits there were essentially no training wheels on

03:31

retail investors Uneducated investors could borrow whatever they were allowed

03:36

to borrow by the brokerage So then instead of having

03:39

a fifty percent cab well investors would not have toe

03:42

on ly cell essentially all of their stock portfolio to

03:45

pay for their margin when things went down But they

03:48

might suffer incremental debts beyond it where sadly the brokerage

03:52

has to bring the sheriff kicked the wife and kids

03:54

out of the home repossess the icebox there horse named

03:58

betsy and their brand new state of the art electric

04:00

toaster What it was like back then and now instead

04:03

of being less wealthy well joe and his entire family

04:06

are flat broke and living on a horse down by

04:10

the river So while wreg t drew a lot of

04:12

mumbling about overly active government intervention at the time that

04:16

it was released it in fact made for a dramatically

04:19

Smoother transition When times got tough as they always do

04:22

in the stock market and as retail investors seemed always

04:25

forget What goes up usually comes down and you know 00:04:29.314 --> [endTime] tough maybe maybe that's What the t stands for