Rumours, disasters and ‘re-hypothecation”.

[Marc]

Wow - check out this post on Re-hypothecation - I never heard of it until about 24 hours ago - but reading about it makes me sick. How can businesses get away with doing this shit? The regulators should be sacked.

Quote:

Here is a good description of it from the Reuter’s article,

…hypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is “hypothetically” controlled by the creditor, who has a right to seize possession if the borrower defaults.

Why do this? It’s in part about who gets to show what assets as still being on their books while others get to use said assets as collateral for their own loans. Which brings us to ‘re-hypothecation“. Who says an asset that has been “hypothecated” once can’t be “re-hypothecated”? Well actually no one. The UK and the US authorities have spent a decade removing any restraint of Hypothecation to bring us to where we are now.

So, Bank 1 has an asset. It badly needs cash because it’s nearly broke. It hypothecates its asset to bank 2. Bank 2 also needs/wants a loan.So it turns to bank 3 and says, I happen to have a lovely asset which I hypothetically control, would you like it? Bank 3 says great. So bank 2 gets its loan which it probably uses to make other loans, while the asset it got from bank 1 is re-hypothecated to bank 3. Now bank 3 hypothetically controls the asset. Bank 3 turns to bank 4 and does the same. We now have 4 banks three of whom hypothetically control the original asset which is in fact still where it started, in bank 1 – a bank which was in such trouble it had to hypothecate its assets. Along the way, however, three banks have used the asset to get themselves loans and all of those loans rest on hypothetical control of the original asset. A pyramid of loans and obligations rest on a single asset whose control is now not at all clear should any one along the chain need to assert their control or need it bank to pay off their debts – should anything go wrong in the the ventures into which they put the money they borrowed on the strength of the ‘asset’. And THAT my fellow citizens is why the bankers insist they get paid so much.

http://www.golemxiv.co.uk/2011/12/rumours-disasters-and-re-hypothecation/

And on a trading forum members are reading their broker contracts and some are discovering clauses that allow their assets to be Re-hypothecated!

http://www.elitetrader.com/vb/showthread.php?threadid=232268&perpage=6&pagenumber=23

[One]

Am I right that "hypothecation is when a borrower pledges collateral to secure a debt" is another way of saying "secures the debt against some asset, eg their house"?

That's fair enough.

This re-hypothecation business - that's downright criminal!

[spaceman]

Soooooo....Marc asks Spaceman for a loan of $100 and offers his $1,000 Rolex as security.... a bit later Spaceman finds himself a bit short so asks One for $100 telling One that he doesn't have any cash or security right now but Marc owes him $150 (interest added) and if Marc doesn't come up with the cash Spaceman will take Marc's $1,000 Rolex and give it to One

Spaceman has re-hypothecated and it's some insidiously evil plot?????

Careful you don't find yourself drinking the money-masters kool-aid...... the next step after that is David Icke and his lizard men

Cheers
Spaceman

[Marc]

Soooooo....Marc asks Spaceman for a loan of $100 and offers his $1,000 Rolex as security.... a bit later Spaceman finds himself a bit short so asks One for $100 telling One that he doesn't have any cash or security right now but Marc owes him $150 (interest added) and if Marc doesn't come up with the cash Spaceman will take Marc's $1,000 Rolex and give it to One

Spaceman has re-hypothecated and it's some insidiously evil plot?????

Careful you don't find yourself drinking the money-masters kool-aid...... the next step after that is David Icke and his lizard men

Cheers
Spaceman

Hey Spaceman - read it again - the asset, in this case the Rolex is used as security on other deals that you (personally) do again and again. So if you promise my Rolex as security on deals and one of those deals breaks the person/business loaning you the $$ can claim my Rolex even though I am keeping up with payments.

So if you use my Rolex as security say 45 times (45 separate deals) and half of those deals collapse you need to find 45 Rolex watches or the equivalent in other security to pay. Your business fails - and in the liquidation process someone claims my Rolex watch. I am not 100% sure on this bit but its why MF Global and AIG failed with massive debt.
Sounds like fractional receive system but using your security as the asset - and it gets re-used as security many many times.

Still reading about it so my interpretation may not be 100% correct.

[spaceman]

Hey Hey

That's not the way I read it.....(though I didn't follow the links, I just read what was posted on this page).......if you're right about the " again and again " thing, then I would agree with you that this is wrong...very naughty up to the point of fraud in fact.

But I don't see how that could happen except in a clear case of fraud.....going back to my "Rolex" example.

Sooooo now I have money from One..... but I want more more more so I ask Bob for a loan....if I offer Bob the same deal as One without telling Bob about the deal with One this is clearly fraud..... If I do tell Bob that One has a claim to the cash/rolex why oh why would Bob lend me any further money knowing that he has no real security???

So me using the loan/rolex as security 45 times is clearly fraud unless each loan is for 1/45 of the value (or the sum of the 45 loans doesn't exceed the total of the original).....if a chain of people form (ie: One borrows from Bob, Bob borrows from Jim...out to 45) this would be fine as long as all the other links in the chain are made clear to each additional new link in the chain....... If Bob tries to represent to Jim that Bob holds the first level of security (as Spaceman really does) then this is also clearly fraud

As for a third party having claim to your cash/rolex even though you were keeping up your payments to me.......well that would depend exactly what was written in the fine print wouldn't it??.... If the loan contract between Marc and Spaceman is clear that I have no claim on the Rolex as long as the payments are being made and have no way of demanding early repayment then I would have no claim on the security/rolex and if I have no claim/rights to it how can anybody demand something from me that I don't have???

Cheers
Spaceman

[Marc]

Nuts right?

From my understanding this is exactly what happens. Its a bit rough on my novice brain but after reading several posts a few times it does seem to be the case - its just not called fraud as most contracts state they can do this with your assets.

Also this post is a good one "Why The UK Trail Of The MF Global Collapse May Have "Apocalyptic" Consequences For The Eurozone, Canadian Banks, Jefferies And Everyone Else'

http://www.zerohedge.com/news/why-uk-trail-mf-global-collapse-may-have-apocalyptic-consequences-eurozone-canadian-banks-jeffe

[h]ypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is “hypothetically” controlled by the creditor, who has a right to seize possession if the borrower defaults.

In the U.S., this legal right takes the form of a lien and in the UK generally in the form of a legal charge. A simple example of a hypothecation is a mortgage, in which a borrower legally owns the home, but the bank holds a right to take possession of the property if the borrower should default.

In investment banking, assets deposited with a broker will be hypothecated such that a broker may sell securities if an investor fails to keep up credit payments or if the securities drop in value and the investor fails to respond to a margin call (a request for more capital).

Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations much to the chagrin of hedge funds.

And...

Under the U.S. Federal Reserve Board's Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140% of the client's liability to the prime broker. For example, assume a customer has deposited $500 in securities and has a debt deficit of $200, resulting in net equity of $300. The broker-dealer can re-hypothecate up to $280 (140 per cent. x $200) of these assets.

But in the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated. In fact, brokers are free to re-hypothecate all and even more than the assets deposited by clients. Instead it is up to clients to negotiate a limit or prohibition on re-hypothecation. On the above example a UK broker could, and frequently would, re-hypothecate 100% of the pledged securities ($500).

This asymmetry of rules makes exploiting the more lax UK regime incredibly attractive to international brokerage firms such as MF Global or Lehman Brothers which can use European subsidiaries to create pools of funding for their U.S. operations, without the bother of complying with U.S. restrictions.

So with Re-hypothecation they use your assets in their own trades (primary brokers) even if you don't default. Thats one example of the use with Primary brokers.

Would be good if someone a bit more knowledgable can help out here and educate us dummies.

[spaceman]

If you're going to call me a dummy I'm going to call you smelly

that link doesn't say you can do it over and over again...it says in the US 140% of liability or in UK 100% of security....so back to my Rolex example

In the US the max would be 140% * $150 (Loan + int) = $210
In the UK max would be the Rolex = $1,000

Anybody lending $210 against a possible max payout of $150 if it goes wrong is taking a punt and good luck to them....in my example that would be One lending me $210 all the risk is with One as you only owe me $150 and if you pay that back and I can't pay the extra $60 to One, then It's not like One can still come at you or the Rolex.

Same goes for the UK only more so.....if One wanted to lend me $1,000 against the Rolex again all the risk is with One as what happens when you pay back the $150 and our business is at an end....can One come asking you for more money or the Rolex???

If people want to make those kind of bets who are we to stop them....in both cases One would be taking a big risk and as long as everything was out in the open and One is aware of the risks who is anybody else to say nay nay??

Cheers
Spaceman

[Marc]

I will do some more research but I don't think it is as simple as your rolex example.

It was one of the core reasons (so I have read) that MF Global and AIG crashed the way they did. I suppose its a concern to the rest of us when the Govt bails them out or people lose all of the investments through no regulation or that a bank has a bank holiday because its investment arm did this stuff.

Plus from how I read the article there is no limit for the UK

But in the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated.

Latter.

[One]

I read a few posts from that elitetrader forum - in great confusion and concluding there's a whole weird world out there - and got the impression it's more like this:

Marc gives Spaceman $1000 to invest. Spaceman takes a liking to a can't-possibly-fail investment that costs $2000. Spaceman doesn't have any cash to invest, so he asks One to loan him $1000 and re-hypothecates Marc's $1000 to guarantee that loan.

Then the whole thing goes pearshaped and the investment ends up only worth $1000. So One takes Marc's $1000 as repayment of her loan to Spaceman. Spaceman isn't out of pocket at all but Marc loses all his capital.

Any ideas whether I'm right?

[spaceman]

@ Marc...it might not be that simple indeed....but my example is of one way of doing it without any dodgy sleight of hand....so the actual rehypothecation isn't the problem IMHO ....it's just a term/tool.... undoubtedly that tool has the potential to be misused......and perhaps it was......but like the old saw......guns don't kill people, people kill people.

@ One..........You may well be right.... I don't know..........he he I'm an evil genius in your example.....none of my own money on the line, I get 50% of any profits with zero downside as I have no skin in the game.......sweet!!!....as long as it's all done above board what's the problem????.... I've talked the two of you into taking all of the risk in return for giving me some of the profits, if I can sell that deal then I deserve what I get......If I lie/withhold information to sell that deal then that's a whole different kettle of fish.

One thing is certain.........it's a complex area and there is lot of opinions out there on the interwebz.......... unfortunately some of them are really really stupid, and some people get sucked in by the stupid stuff because it appears to be easier to understand than the truth. But just because you can understand the stupid stuff doesn't make it any less stupid.

Even when you show some people the truth some still prefer to believe the lie ...... check out this vid from Eddy Current http://www.youtube.com/watch?v=k8VAsoVuShM ..... he admits to faking the clip and even to inserting a UFO .....somebody claimed that lots of other 9/11 videos have UFO's in them too......some men you just can't reach

Cheers
Spaceman

[Marc]

Hi One - that sounds like a good understanding

Just like Spaceman said - bloody complex with loads of opinion.

I remember someone saying (maybe in the 'Too Big to Fail' book) that only 4-5 people in the world truly understood CDO up to CDO Squared/Cubed and CDS.

What is really stuffed are the regulators and Fed who took these demons off the leash - stand up and take a bow Alan Greenspan...