When I worked for one of the most famous private banks in the world, the thing that shocked me the most was how much money rich people borrowed. You see, I grew up in the middle of the middle class, and their goal was to live “free and clear.” That is, to pay off all their debts and, most importantly, their mortgages.

After all, if you’ve got all this money, why on earth would you want to borrow more and owe someone?

That’s a naive question the young and uninitiated ask because they don’t realize that capitalism isn’t an economic system; it’s a goddamn superpower.

Don’t get me wrong: I’m still not big on debt. But there are far-reaching economic implications even if you’re not indebted. That’s because rich folk taking out loans using their shares as collateral drive up asset prices. The point of this piece is to demonstrate how they can have their cake and eat it, too.

When I came across a Bloomberg article titled “Morgan Stanley Said to Offer SpaceX Staff Loans as Value Soars,” I thought it would be the perfect opportunity to show you how shareholders use their stock to borrow money, leveraging it to get even richer than they would with plain capital gains (the cake). And they can do this without selling their shares (eating it, too).

I used to see this frequently with high-net-worth individuals (HNWIs), but it’s even more common with star employees and owners of fast-growing companies.

Bloomberg’s article opened with this (bolds mine):

As SpaceX’s valuation hits a record of about $350 billion, propelling Elon Musk’s own net worth to new heights, Morgan Stanley also stands to benefit. The bank has opened its specialized lending program to SpaceX employees who want to cash in on soaring shares in Musk’s rocket and satellite maker but not lose their equity stake, people with knowledge of the matter said. To participate, employees needed at least $500,000 worth of vested SpaceX stock, some of the people said.

First, let’s decode this “specialized lending program.” In the United States, it’s called a “margin loan.” In Europe, it’s commonly called a “Lombard loan,” after its inventors, the Italian bankers of Lombardia, the province where Milan, Italy’s banking hub, is located.

The easiest way to define a margin loan is to call it a “collateralized loan.” That is, the borrower gives the bank collateral in exchange for the loaned funds. For example, a mortgage is a collateralized loan. The house is the collateral for the loan the bank gives the owner. (We took the name “mortgage” from the French, where it literally translates to “dead pledge.”)

In this case, Morgan Stanley, one of Wall Street’s biggest investment banks, will loan cash to SpaceX employees against their SpaceX stock (the collateral). This stock must be “vested,” which means it must be stock the employee already owns, not stock that he has been promised later in the form of options.

Let’s get into the structure so you can see precisely how these deals work. The article continued:

The loan structure includes an advanced rate of 15% on the value of pledged shares, with a loan maintenance of 40%, some of the people said. The interest rate on offer is roughly SOFR plus 4.5%, equating to around 9% at Monday’s rate.

What does that even mean? Let’s break down the numbers simply.

The Numbers

Remember, this loan is designed for SpaceX employees who own vested stock and want liquidity (cash) without selling their equity.

Advanced Rate of 15%

If an employee pledges their SpaceX stock as collateral for a loan, they can borrow up to 15% of the stock's value. For example, if an employee has $1 million in SpaceX stock, they can borrow 15% of that, or $150,000.

Loan Maintenance of 40%

The loan must always be backed by collateral (the SpaceX shares) worth at least 40% more than the loan itself. This means if the value of SpaceX shares drops and the collateral value falls below this threshold, the employee will need to provide additional collateral (more shares) or repay part of the loan to maintain the required 40% cushion.

Interest Rate: SOFR + 4.5%

What’s SOFR? That’s LIBOR’s replacement. If you haven’t heard of LIBOR, that’s ok. LIBOR was the London Interbank Offered Rate, the rate at which international banks loaned money to each other. It was the benchmark rate before SOFR was invented.

SOFR stands for Secured Overnight Financing Rate. It’s a widely used benchmark interest rate for loans, currently around 4.60% (as of yesterday).

SOFR plus 4.5% means the loan’s interest rate is around 9.10% annually at current rates. Employees will pay this interest on the loan amount they borrow.

For reference, when interest rates were near zero, my old bank charged its HNWI clients less than 1% on margin loans. By comparison, these loans for SpaceX are costly.

Why Take Out These Loans?

Employees get access to cash without giving up ownership of their SpaceX equity, allowing them to benefit from future increases in the share price.

Since SpaceX shares appreciate quickly, albeit on the private market, it's wise to hold onto them. The last thing you’d want to do is sell.

What Are the Risks?

There are three significant risks to be aware of.

First, if the value of SpaceX shares declines, employees might face a "margin call," which would require them to add more collateral or repay part of the loan.

Next, at 9%, the loan is expensive compared to typical loans like mortgages or personal loans. As SOFR fluctuates, if rates go up (admittedly unlikely over the medium term since the Fed is cutting interest rates), the loan gets more expensive to pay back. This is similar to an adjustable-rate mortgage (ARM).

Finally, employees who rely heavily on their SpaceX stock (both as investment and loan collateral) will face financial risks if the company’s valuation falls unexpectedly. The risk is similar to, but not exactly like, Enron shareholders mortgaging their houses to buy more Enron shares. Once those shares crashed, those shareholders lost their shares and their homes. If SpaceX shares fall, for instance, in the event of a crash, the borrower will be on the hook for the margin call and whatever he used the loaned funds to finance.

How Does This Drive Up Prices?

In short, because the employees don’t sell shares and Morgan Stanley will dole out cash, SpaceX shareholders will take that money and buy stuff, which will become more expensive with every purchase. Later, when regular folks want to buy the same stuff, they’ll find it more expensive. That’s why it’s important to be early when buying stuff.

This phenomenon is called The Cantillon Effect.

Wrap Up

These transactions happen all the time. They're more inflationary at very low interest rates because they multiply the money in circulation without a commiserate amount of selling. But even with rates at this level, things around the SpaceX launch facility in Texas are about to get more expensive.

Have a great day!