[LiveTheDream]

> I am also against the ability to trade by borrwing money from brokers (margin trading or leveraged trading). If an individual trader screws up, they wipe themselves out. If they borrowed money, then the consequences of their bad trades starts to seep out to others. If more than a handful of traders, trading on margin, go belly up, the lender could be in trouble as well...you can see how this could ripple across a system.

In theory, shouldn't those giving the loans account for the risk and thus be protected from wiping out themselves?

[bd_at_rivenhill]

This is exactly what happened during the stock market crash of 1929, and regulations were put into place in the 1930s to prevent excessive margin leverage that might result in liquidity problems at brokerages (and in the banks that lend to them). These regulations have been in place since then and probably mitigated the effects of the dot com crash in 2000. See http://en.wikipedia.org/wiki/Regulation_T as a good starting point for research.

Interestingly, I read somewhere that there were similar regulations regarding residential mortgage loans that were repealed during the 1980s, does anybody have a reference to this? I think that requiring a 20% equity/debt ration when originating or refinancing a mortgage loan probably would have made the 2008 real-estate crash look a lot more like the dot com bust and would have saved a lot of economic pain.

[Retric]

This is one of those cases where in theory you could be correct. Unfortunately, historical evidence does not support your viewpoint.

[rayiner]

Even theoretically there are agency problems in many situations re: evaluating credit risk. And as we have learned in practice, people are just bad at gauging credit risk. Finally, the traditional theory doesn't incorporate behavioral economics, which IMHO turns a lot of the traditional precepts on their head.