What Is Forced Selling (Forced Liquidation)?
Forced selling or forced liquidation usually entails the involuntary sale of assets or securities to create liquidity in the event of an uncontrollable or unforeseen situation. Forced selling is normally carried out in reaction to an economic event, personal life change, company regulation, or legal order.
Key Takeaways
- Forced selling (forced liquidation) may refer to a number of situations where an individual's assets are required to be sold.
- Within the investing world, if a margin call is issued and the investor is unable to bring their investment up to the minimum requirements, the broker has the right to sell off the positions.
- In personal finance, an individual's assets may be liquidated for many reasons including: bankruptcy, divorce, or death.
Understanding Forced Selling (Forced Liquidation)
Forced Selling within a Margin Account
In the realm of security investments, forced selling can occur within an investor’s margin account if the investor fails to bring their account above the minimum requirements after being issued a margin call. Forced liquidations generally occur after warnings have been issued by the broker, regarding the under-margin status of an account. Should the account holder choose not to meet the margin requirements, or simply cannot pay them, the broker has the right to sell off the current positions.
The following two examples serve as illustrations of forced selling within a margin account:
- If Broker XYZ changes its minimum margin requirement from $1,000 to $2,000, Mary’s margin account with a stock value of $1,500 now falls below the new requirement. Broker XYZ would issue a margin call to Mary to either deposit additional funds or sell some of her open positions to bring her account value up to the required amount. If Mary fails to respond to the margin call, Broker XYZ has the right to sell $500 worth of her current investments.
- Mary’s margin account net value is $1,500, which is above her broker’s minimum requirement of $1,000. If her securities perform poorly, and her net value drops to $800, her broker would issue a margin call. If Mary fails to respond to the margin call by bringing her delinquent account up to good standing, the broker would force sell her shares in order to reduce leverage risk.
Forced Liquidation of Personal Assets
Forced selling of personal assets can occur when a family member passes away; an estate may be forced to sell the deceased’s assets and properties to pay off debts. In divorce proceedings, assets are also often sold and proceeds divided between both parties.
Creditors, under the authority of a court’s writ of execution, can usually force the sale of a debtor’s assets by auctioning them. The Forced Liquidation Value (FLV) or Forced Sale Value (FSV) is the proceeds received from the sale of these distressed assets, which are used to pay off the debt.
Forced Buy-In vs. Forced Selling
The opposite of forced selling in a margin account is a forced buy-in. This occurs in a short seller’s account when the original lender of the shares recalls them or when the broker is no longer able to borrow shares for the shorted position. When a forced buy-in is triggered, shares are bought back to close the short position. The account holder might not be given notice prior to the act.
Real World Example of Forced Selling
In the event of a crisis, portfolio managers might be forced to sell certain assets in order to mitigate their losses. For example, some hedge fund managers, who invested hundreds of millions in Valeant Pharmaceuticals, were forced to exittheir long positions in Valeantwhen the stock dove in value in 2016 and triggered redemptionsby investors.
