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Old 4th January 2018, 02:20 AM   #1391
Craig B
Penultimate Amazing
 
Join Date: May 2011
Posts: 22,841
Originally Posted by psionl0 View Post
I would have thought that "just the word of the borrower" covered that.
One of the inflationary mechanisms that causes bubbles to swell is that loans to enable speculation may be covered by the value of the speculated object. They are self financing, during the boom phase. In 1929 lenders lent on the security of the price of the shares to be purchased by the borrower.

A borrower might put down $10, borrow $100, thus multiplying his or her available funds tenfold. No problem on condition that prices keep going up; her or his collateral is secure. But if they stop going up ownership becomes a burden as there is current interest on the loan, and no dividend from the asset to offset it. And if the price falls the creditor wants more money to restore the collateral, and sends out a "margin call". If this is not heeded, the speculator is "sold out". That reduces prices even more and so a positive feedback cycle is established, with the explosive results normal for these processes.

As described by JK Galbraith
Prices as they fell ... kept crossing a large volume of stop-loss orders — orders calling for sales whenever a specified price was reached. Brokers had placed many of these orders for their own protection on the securities of customers who had not responded to calls for additional margin. Each of these stop-loss orders tripped more securities into the market and drove prices down farther. Each spasm of liquidation thus insured that another would follow.

Last edited by Craig B; 4th January 2018 at 02:53 AM.
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