Regulation T’s margin limits undercut the arbitrage that Modigliani-Miller assumed

Evidence

For example, investors could not buy stock entirely on credit: to do so was prohibited by the Federal Reserve’s famous “Regulation T,” introduced after the credit-fueled stock-market excesses of the 1920s. Regulation T restricted the extent to which brokers could lend investors money to buy stock. From time to time the Federal Reserve altered the percentage of the cost of a stock purchase that could be borrowed, but in the period discussed here it was typically no more than 50 percent, and sometimes much less. The “arbitrage” operation of switching between investments that Modigliani and Miller invoked might therefore not be available to most investors, and was not free of risk: price fluctuations might lead stocks bought on credit no longer to be worth enough to serve as collateral for the loan, leading an investor’s broker forcibly to sell such stock. — Donald MacKenzie, An Engine, Not a Camera, 194

Categorization

• XREF: Concrete institutional detail showing how regulatory rules shape which market mechanisms can actually operate — central to the performativity-vs-description debate. — connects to: The M-M debate hinged on whether arbitrage could overcome institutional restrictions — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 193; Tax-adjusted Modigliani-Miller implied postwar corporate debt levels were too low — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1141; Modigliani-Miller made market-value maximization the test of corporate investment — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1171