[Song Seungseop's Financial Light] The Scariest Call in the World: 'Margin Call'

"Dear Customer, Please Replenish Your Margin by Tomorrow"
The Power of Margin Calls That Can Lead to Forced Liquidation and Debt if Not Properly Handled
Even Hedge Funds Have Gone Bankrupt Due to Margin Calls

A securities firm's margin call notification text recently posted by an investor on an online internet community.

What is the phone call that investors fear the most in the financial market? It is probably a "Margin call." If you fail to properly respond to a margin call, not only can your assets be forcibly liquidated, but you may also end up in debt. Recently, even the U.S. Treasury Secretary has expressed concerns about margin calls.

In the financial market, "Margin" means collateral. Although it sounds complicated, it is essentially a type of deposit. The deposit system exists to prepare for potential losses. If a tenant fails to pay rent properly, the landlord deducts from the deposit held in advance, and if the borrowed item is not returned, the deposit can be disposed of at will. The margin (collateral) in the financial market works the same way. It is the minimum deposit that financial companies require to prepare for future losses.

Suppose you want to buy 100 million KRW worth of stock A. You only have 10 million KRW on hand. You need to gather an additional 90 million KRW or borrow it from someone. At this point, a securities company proposes: "Deposit 10 million KRW as collateral and buy 100 million KRW worth of stock A. Our company will provide the money." You accept the offer, and the stock price rises to 110 million KRW. You return 90 million KRW to the securities company and keep 20 million KRW, achieving a 100% return.

It's good if you make money... but what if the stock price falls?

A poster of the movie 'Margin Call' featuring a graph depicting a stock market crash.

The problem arises when the stock price falls. The stock that was worth 100 million KRW drops to 90 million KRW. The investor must use all their collateral to barely avoid a loss. Then, the contract becomes difficult to maintain because there is essentially no collateral left. The securities company will think, "We spent 90 million KRW, but can we get the money back in full?" To maintain the contract with the investor, the securities company contacts them to demand more collateral. This is the margin call.

When you receive a margin call, you typically have 1 to 3 days to provide the required collateral. If you fail to do so, the financial company initiates a "forced sale." This means selling the investor's stock A without their consent. Of course, even forced sales may not cover the losses. A margin call means the asset's price has dropped significantly. For quick liquidation, the price is set low. The remaining loss must be covered by the investor, meaning they incur debt.

In Korea, securities companies usually offer "unpaid transactions" and "credit transactions." Unpaid transactions allow you to buy stocks on credit, usually requiring only 40% of the desired purchase amount as a deposit. If you fail to repay within 3 days, forced sales occur. Credit transactions are similar in that you borrow money to buy stocks, but the repayment period is 90 days. If the evaluated value of the purchased stock falls below 140% of the collateral ratio, forced sales are implemented. Before forced sales, margin call requests are made, but it is difficult to provide additional collateral. Since you used unpaid and credit transactions because you lacked funds, it is naturally hard to raise money.

If you fail to respond to a margin call, you may face forced liquidation and become a debtor

Korean-American investor Bill Hwang (Korean name Hwang Sung-guk), known as the main figure behind the "Archegos incident," is seen leaving the U.S. District Court in Manhattan, New York, on April 27 last year (local time). [Image source=Yonhap News]

There have been financial firms that went bankrupt because they failed to prevent margin calls. One example is the hedge fund "Archegos," founded by a Korean-American. When the stocks they invested in plummeted, they faced margin call pressure and were forcibly liquidated, causing a vicious cycle of further stock price crashes. At the time, Archegos's investment was estimated at 5 to 10 billion USD, with losses reportedly reaching 30 billion USD (about 34 trillion KRW). Investment banks absorbed damages amounting to 10 billion USD.

A similar incident occurred in Korea with the Soci?t? G?n?rale (SG) Securities stock crash. Recently, there have been massive forced sales in the domestic financial market. On the 3rd of this month alone, forced sales worth 59.719 billion KRW occurred in one day. This is the highest record since the 58.878 billion KRW forced sales on April 17, 2006. The current monthly average forced sales amount is about 52.257 billion KRW (as of the 16th), more than three times higher than last month. If this trend continues, the monthly average forced sales record is likely to be broken.

On the 16th, U.S. Treasury Secretary Janet Yellen warned that if the federal government's debt ceiling is not raised, a default procedure will be inevitable, and margin calls may increase. She emphasized, "Global panic could trigger numerous financial market collapses caused by margin calls, asset market flight, and fire sales," adding, "Such a financial crisis will deepen the severity of the recession."

Editor's NoteFinance is difficult. Confusing terms and complex backstories are intertwined. Sometimes, you need to learn dozens of concepts just to understand one word. Yet finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial issue each week and explains it in very simple terms. Even if you know nothing about finance, you can immediately understand these "light" stories that illuminate your understanding of finance.