The Fed, MFG and Reg. T

Bruce Krasting's picture

I think there is sufficient evidence today to conclude that Re-Hypothecation is at the root of the customer losses at MFG. This Reuters story started the discussion on re-hypothecation. There have been several additional articles on this at Zero Hedge,  (link, link) and FTAlphaville (link, link).  Let me add one additional bit of info.

The Canadian customers of MFG got their money back within 10 days of the MFG bankruptcy. The accounts that have lost money are either USA or UK based. In Canada, re-hypothecation is not permitted. I got these comments from a Canadian MFG account holder:

The trustee where segregated MF Global Canada customers' funds were held was RBC Dominion Securities. I don't think any of these funds ever left the trustee in Canada. Likelihood is if they left, the Canadian government would have made the parent Royal Bank of Canada eat up the losses and make full restitution.

We shall see in the coming weeks if, in fact, re-hypothecation is the cause of the problems. I’m convinced it is.

The rules on broker's ability to A) Hypothecate and B) Re-hypothecate in the USA are spelled out in Reg T. This set of rules has been established by our good friends at the Federal Reserve Bank. Let me provide some telling words on this re Reg. T rule 15c3-3: (emphasis mine/Link)


• Except as otherwise agreed in writing by the OTC derivatives dealer and the counterparty, the dealer may repledge or otherwise use the collateral in its business;

• In the event of the OTC derivatives dealer's failure, the counterparty will likely be considered an unsecured creditor of the dealer as to that collateral;

The Securities Investor Protection Act of 1970 (15 U.S.C. 78aaa et seq.) does not protect the counterparty.

Well there you have it. Reg. T does permit the broker to “repledge” (AKA re-hypothecate). In the event of default by the broker, the counterparty will be considered an unsecured creditor. (AKA customers lose money). And SIPC provides zero protection to account holders in the event of a broker default.

For me, there is sufficient information to conclude that Reg. T is flawed and must be changed. I have to believe there is any army of lawyers over at the Federal Reserve looking into this as I write and they are struggling with what they can do to “fix” the problem.

For sure a fix is required. MFG has not, as yet, morphed into a systemic problem. But we are getting closer by the day. The Fed is aware of this. The risk is that customers start to withdraw funds and assets from other brokers. The deleveraging this would cause would be catastrophic. A significant chunk of the shadow banking system (about $10 trillion) is dependent on the liquidity that is created by hypothecation. (The situation is bigger and more problematic in the UK)


A month ago Fed governor James Bullard stated on CNBC that the issues with MFG did not constitute a systemic problem. I wrote about this at the time Bullard made those comments. I made a public bet with Bullard (a six pack of beer) that he would be forced to eat his words. I never did hear from him.

I’m re-doubling the bet this AM. If Reg. T is confirmed to be the source of customer losses at MFG then Reg. T will have to be gutted. The changes will have to take place fairly quickly. The consequences across all markets of these changes could prove to be a devastating blow.

The nice folks at the FRB are having a big meeting this week. Reg. T and MFG will almost certainly be on the agenda. I have to believe all those smart folks at the Fed have figured out that we have a problem. We may well get some announcement on this topic by Friday.

Any changes to Reg. T will have profound effects on global markets. Not only the exchanges/asset prices will be affected, this has the potential to derail the global economy. We are already in a very dangerous liquidity situation. If the Fed is forced to change margin rules, liquidity will dry up for an extended period of time. Forced changes in Reg. T will prove to be a Black Swan event.



Should we get a confirmation of the foregoing discussion and the Fed is forced to react and make regulatory changes, there will be significant long term implications for the Fed. The Fed will have to shoulder the blame for the flaws in Reg. T. They will also have to take responsibility for the broader economic consequences that will surely follow those changes.

The possibility exits for the Fed to lose any credibility they may still have in the US and abroad. The completely unregulated Federal Reserve may lose its independence as a result.

There are big downsides to significant revisions to margin rules. The upside is that the Fed’s supreme power over the global economy would be finally checked.



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Miss America's picture

Hello Bruce,

Hyp/Re-hyp is the market.  While we're at it, why not say that Leverage and fractional reserve banking can't be done either? 

Look, I get where you're coming from, but the truth is Hyp/re-hyp is something people have on their resume's.  It's not some obscure thing or concept.  It just needs strict, straightforward (and punishable) regulation. 

Elimination would collapse the market.  plain and simple.  (there are like 30+ working financial mechanisms, if stopped, would collapse the market.)  The market, being a living thing, needs all it's current parts to survive.  Like a body, it wouldn't function without the lungs.  ...or heart.  ...or bones.  ...nervous system.  ...or skin.  etc.

I've long railed against so many bad parts of our market, but not the market as a whole.  Abuses are what needs to stop.  Regulations need to be strict and punishable. 

All the best, MA/RH

Miles Kendig's picture

Bruce, quick questions.

I'm wondering if re-hypo is limited to "vanilla" brokerage accounts or if things like trusts encompassing not only wealth management for estates, but for businesses & pensions are also governed by Federal reserve Rule T?  Are there exclusions or are potentially every account managed by, or through a prime broker subject to Rule T treatment?

Bruce Krasting's picture

My inbox is flooded with question like this. I don't have an answer to this question.

That is the problem. No one seems to understand what the implication of this are and if they are potentially at risk.

I answer these questions the same way. I suggest that folks look at the docs they signed when opening an account (or updates). If you have a doubt what you signed then ask. Period.

I have gotten several versions of brokerage language that I find troubling. If you signed off on something like this (regardless of what type of account it is) then I think there is an issue you should look into. Some samples of what not to sign:


8-Within the limits of applicable law and regulations, you hereby authorize us to lend either to ourselves or to others any securities or other property held by us in your margin account together with all attendant rights of ownership and to use all such property as collateral for our general loans. Any such property, together with all attendant rights of ownership, may be [pledged, repledged, hypothecated or rehypothecated either separately or in common with other such property for any amounts due to us thereon or for a greater sum and we shall have no obligation to retain a like amount of similar property in our possession and control.


Consent To Loan Or PledgeYou hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, repledge, transfer, hypothecate, rehypothecate,loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements [repos] or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control.”

Miles Kendig's picture

I'm sure there are some in house research departments on the pension side looking at this....

Another fab year of terrific reads Bruce.  Thank you.

mezurak's picture

So if these people have been using investors collateral as collateral for themselves, who's to say that they haven't been doing the same thing with our mortgage deeds ownership? If the mortgage collateral is never transferred to the MBS investor pool... then it's an asset for the holder... Right?

Roger Knights's picture

Couldn't the Fed announce that it'll change the rule, but only six months down the road? That would provide time for a gradual unwinding--in theory, anyway.

Donutwarrior's picture

Does the etomology of the word "re-hypothecating" involve theorizing and defecation? 

As in, "I believe, or now theororize that your property has been taken and what is left is the product of defecation?"

hbjork1's picture

"I think the definition is "Stealing from Peter to pay your friend, Paul.

Matt's picture

So, if I understand correctly:

Hypothecation: the bank pledges your assets as collateral when you buy additional assets on margin

re-hypothecation: the bank pledges your collateral when the bank buys assets on margin

hyper-hypothecation: your assets are pledged multiple times to cover margin for you and/or the bank

according to this article, re-hypothecation is not allowed in Canada. In a previous article, it was mentioned that two Canadian banks were in the top 10 list for re-hypothecation. Is this re-hypothecation only applicable to their American subsidiaries, or are they in violation of Canadian regulations?

11b40's picture

Legality yet to be detirmined, but the implication was that the Canadian banks routed funds to London, which were then re-hypothecated.

This internet thingy is really peeling back the layers.  All you have to do is look, and the corruption just stares right back at you.

hbjork1's picture

Yes!  And, at long last, an interresting article in Bloomburg (pg 70) detailing Paulson's july 21-08 Eaton Park meeting presenting bailout planw to a collection of bankers and hedge fund managers.

Very jucy.  Worth a read.  If Hank had not been a government official "seeking advice" he could probably be prosicuted.  

non_anon's picture

Houston, we do have a problem

lamont cranston's picture

I received 60% of my MF ccount $$$ via transfer to RJ O'Brien and have to file within 60 days to get the remainder, whatever that might be.

That's the wonderful world of rehypothecation in real $$$.

Tunga's picture

12 packs are the new 6 packs.

swani's picture

How is NOT changing Reg T, NOT going to cause a liquidity crisis?

My bet is that they will find 'a way' for the SIPC to 'cover' broker default instead of changing a 'regulation' that legally sanctions theft, adding to the moral hazard and screwing of the tax payer. Of course, it makes no sense, we know the US can't afford to pay for this 'insurance', but the government and the Fed seem to be doubling down on everything at the moment with no care in the world to what the voters think, why stop now?  

Joebloinvestor's picture

Well the CME had no problem changing margin requirements at the drop of a hat.

This should be able to be fixed in an afternoon.

(Sarcasm on)

toadold's picture

I'm wondering. Give the shaft to a Joe Six-Pack trader, no worry, shaft the owner of a family farm, no worry, shaft the owner of a flour mill, no problem. Rip off ADM.......maybe you better have somebody start your car for you? 

WTF_247's picture

Reg T hypothecation rules are for margin accounts only.  Cash accounts are not governed by Reg T, other than for an initial transaction (payment in full for purchase of securities), unless they have managed to weasel some new changes in.


Also,  I believe SIPC only covers brokerage accounts, NOT futures or forex accounts - those do not afford SIPC protection.

There has never been a case yet where SIPC did not make investors whole, up to the limits of coverage.  Now where it gets dicey is the cash component.  If its truly cash, and not invested in anything, then you can lose on coverage.  Most people with significant amounts of cash in an account invest them in money market funds (security), short term CD (security) or tbills - security - these would all be covered up to the 500k mark.

Most broker dealers have significant additional insurance to cover account balances above 500k, usually up to 10 or 100 million in value.  Now whether this would actually pay is another matter - if someone like GS goes under MFG style, there might be 50bil in assets at risk or more because of the assets their accounts hold.  I am not sure many insurance companies could cover that value if it were all cash.  Investments in securities (stocks) I doubt would ever "disappear" regardless of what happens.  The transfer agents have account holders on record for X number of shares - if a brokerage blows up, they still know that you own the shares regardless of whether those idiots repledged or stole them.

patience...'s picture

Not being familiar with MF Global, what type of collateral was being given, maybe cash only.

If so, MF Re-Hypothecating the asset is only another form of factional reserve all other banks enjoy?


SeanJKerrigan's picture

Sorry if this is a bit off topic, but I wanted to get some informed input.  We created an excel document which tracks the expansion of the debt, interest on the debt and what would have happened if the Super Committee had been successful.  I think you'll like this.

Our conclusions make a few assumptions, namely that economic growth will stay weak, but positive and that interest rates will remain at the levels they are now.  This is a big assumption of course, but its necessary to make any kind of estimate.  Just consider this the best case scenario!

In 2020, at a rate of $1.6 trillion new debt a year, the national debt will nearly double at $29.5 trillion.  Others generally agree with this, so nothing controversial here.

Over the next 10 years, at current growth rates and current interest rates, we will end up paying the banks $6.2 TRILLION in interest alone, not counting whatever they recieve indirectly through bailouts or other stimulus efforts.

Informed people know that the Super Committee was a joke, but lets go over how much of a joke it really was. They wanted to cut $120 billion a year or $1.2 trillion over 10 years and couldn't do it.  Even if they had succeeded, we still would have had $13 trillion in new debt between now and 2020 (9 years).  Since they failed, it will be $15 trillion.  In short, congressional efforts to get the debt under control are farscial.

Of course, there's good reason to think things will fall apart before this, but it just cements how screwed up things will get.  When you examine all of the various unsustainable elements of our society together, we can't imagine a scenario in which things "work out."

We have a medium length paper on this and other unsustainable issues issues here: The Unsustainability of Nearly Everything.  Suggestions for improvements are welcome.

WTF_247's picture

29.5 T x .035 = 1.0325T in interest payments.

We are only taking in a little over 2.5T now (guess from memory, could be off) in taxes.  so in 8 years, that is 50% of the taxes collected currently going to debt payments.

The basic flawed assumptions Washington uses for the debt is that it can grow forever as long as its matched with population/gdp/wage growth.

But this also assumes that people will continually make more and more money, paying more and more in taxes, and the economy will always grow at X%.  When this fails and wages and the economy stagnate for a period of time, it throws the whole crap theory out the window.

What these idiots fail to see is that every penny in interest is a penny NOT spent to help the American people.  Hell, the ENTIRE massive bailout was 780bil - and that was spent over several years.  We are going to pay 30% more than that EACH YEAR in interest in just a few years - none of which will go to anything productive at all.


This is what happens when you repeatedly pull forward demand for decades and decades.  I would gather that when this charade ends, world wide GDP will contract 40% or more as there will be massive haircuts to ALL sovereign debt around the world.  This will effectively pull the plug on almost all borrowing for decades to come - countries will be forced to live within the means the taxes collected can provide.

SeanJKerrigan's picture

All good points.  Thanks.

My figures were actually understated.  I assumed a steady 3.0 percent interest rate.  If we assume 3.5, then the total amount spent over the next 9 years on interest alone is actually a bit over $7 trillion.

Georgesblog's picture

Reg T is legalized embezzlement. If it is not lawful for and individual to aid anyone in the commission of a crime, So too does this apply to public officials. According to the Supreme Court decision in Screws vs. United States, the majority opinion stated that public officials are held to a higher standard, being presumed to know the law. This regulation makes public officials accessories before, to and after the fact, in the crime of embezzlement.

Spigot's picture

Bruce, this is exactly what I was thinking happened: that the weasels arranged the account fine print to allow that in a bancrupcy the account holder was an unsecured creditor. Sometimes this is done by claiming the funds go into a pool, either entirely or part of the day.

If ANYONE trading using these crack dens thinks their accounts are safe, its going to be a painful lesson in humility, as Celente has learned.

the grateful unemployed's picture

this is exactly the point, we assumed the law was writtent his way for the purpose of dispersing funds in a bankruptcy proceeding (the rule of pooled assets) but Corzine was guilty of reaching into the till preemptively. but preemptive actions, whether military or economic have been standard policy since Bush anyway. 2008 was a preemptive move to forestall collapse using taxpayer money, the biggest fucking re-hypthecation of all time. this is really small potatoes.

Spigot's picture

IMO no the fine print in every way only supports the legal right of the brokerage to do whatever in hell they want to, when they want to, how they want to...and anyone who agrees to that is basicly agreeing to getting screwed.

For example: Mutual Funds have a standard contract clause that states that at their discretion if you make a request for a partial or full liquidation of your account they can demand this be done in writing, with a 6 weeks delay to respond on their part, and then at their discretion they can issue you stock paper, rather than actual cash.

An additional example: the US Treasury, at its discretion, can convert any or all obligations of the US government into 30 yr paper.

And in this case I'm sure that the standard account contract language, if anyone ever read it, would make the Mafia look like genuine nice guys with odd fashion tastes.

While the game lasted it was fun and all good with the occational screwing. Now its nothing but the second part, and the "Law" is no where to be found. Gang rape without recourse.

SillySalesmanQuestion's picture

Thank You very much Bruce for clarifying this "fine" point about Reg.T and re-hypothecation. You and T.D. have greatly educated us the past few days and have done mountains of research and work...This site at Zero Hedge and its contributors (Bruce, Reggie, and W.B.7) have saved my sanity as well as my sense of humor. It is gratifying to see their are still educated, well-read, and logical individuals here at Zero Hedge. The sarcasm and wit expressed here in the comments section have made me wash my computer screen almost daily :) Keep up the great work all...

NotApplicable's picture

Boy, this oughta get the race for the exits going.

Just a month ago, I never considered, let alone knew about the concept of the velocity of collateral. This is like a Ponzi on steroids, meth and Everclear.

Paper wealth is about to demonstrate its inherent oxymoron condition, unless the Central Banks can suddenly shit new & improved paper to replace it all.

ex VRWC's picture

How to explain 're-hypothecation' to Joe Six Pack?  Is this about right?:

You set up a futures trading account at the broker.  To prove you are good, you put $1000 collateral in a safe deposit box.  The broker says "only you and us have the key.  We will only use it if you lose money and cannot pay".  Then, while doing other business with another party, the broker needs some collateral.  It doesn't have it, but it is allowed to pledge your collateral because of flawed securities rules.  But, the broker has to make another key and share it in order to make its collateral good.  So now the broker, its other party, and you all have the key to your box.  Then TSHTF, and the broker goes down.  Its other party has set itself up to get to the box and get the money first, and you are left holding the bag. So, the MF Global money disappeared because MF Global shared the key to it's client's money with other banks. And this is a huge, systemic problem.

onebir's picture

Does Reg T apply directly to the retail investor-broker relationship? I have the impression that the *retail brokers* are the counterparties of the OTC derivative dealers. The brokers are allowed to rehypothecate client (retail investor) funds/assets, but don't seem to be allowed to transfer it as collateral, which means there's nothing for the OTC derivative dealers to repledge/use under Reg T.

Maybe I'm missing something here...

I actually *don't* think the FED is on top of the potential for systemic problems any more. If they were, how could they have supported shifting BoA derivatives into the retail banking unit?

Perhaps Bernanke thinks the real economy needs further QE but feels so politically constrained that he needs clear evidence of systemic problems to justify it.

GMadScientist's picture

Perhaps if they say, "We will have the right to rob you, suckah", on paper, people will pay heed?


Hot Apple Pie's picture

The FRB is stuck between a rock and a hard place on the issue given the current state of the market. If they disallow or cust back on re-hypothecation, that would mean a lot of big dealers having to unwind a lot of "investments", which would shrink the market quite a bit right when they're struggling so much to keep it afloat. Of course they could just offer guarantees, but that would involve other agencies and Congress being willing to write a blank check for the future which seems unlikely at best.

StychoKiller's picture

Given what's been going on, I believe we can count on The Bernank to do the wrong thing.

QQQBall's picture


Corzine has to be able to read an income statement and balance sheet. Spinning this into another "WHOCUDDANODE" excuse is retarded. Billions and billions of positions and where did the money come from? "Ahhh, I have no idea".  


Sinclair has been telling people to take physical possession of stock certs for years; banksters have been levering up and juicing profits and bonuses for years and years literally with OPM.  Cut the bullshit with "No one knew." 

Absinthe Minded's picture

OT but I noticed this morning on the Yahoo Finance blogs that they no longer have any comments section. I guess TPTB didn't like the sheeple to be reading about such unhappy citizens in the US. It really is scary how they are are systemically silencing and controlling what we see and hear. Newt and Mitt, are you shitting me? We are so fucked if that's the best we can hope for. Unless Dr. Paul can pull off a miracle.

jayman21's picture

Disney bought yahoo not to long ago.  The math is simple and it does not surprise me.

TheMerryPrankster's picture

Disney = CIA

Managing the world one child like mind at a time.

jayman21's picture

Bruce - what are the chances cool heads will prevail and real change just might come from the FED that dare I say it, is constructive for the little guy?

Bruce Krasting's picture

Say I'm right and the root of the problem is how your assets get commingled. The Fed could fix this to create a better/truer segregation of customer assets.

So you, as a little guy, might end up better protected as a result.

But if the consequence is (as I suspect) a real hit to liquidity and a knock on recession then you, that little guy, will get hit on the head from another direction.

Little guys always get hurt the worst.

disabledvet's picture

Bu why is the Fed involved at all? The regulator is the CME and according to the WSJ this stuff is strictly "verboten" since unlike say the rigged casino called the NYSE the CME is in actuality a free market. I will be watching very closely the merger of the NYSE and the German Bourse.

the grateful unemployed's picture

it's in the Fed charter to regulate the banks, how is MF global a bank? how does Goldman get FDIC protection? which by the way would have solved all this. in the end Joe Six Pack trader will get more protection, but Joe Six Pack taxpayer will foot the bill.

QQQBall's picture

"Better segregation of funds". Taking someone else's money and pledging it as collateral on your trades is in no way, shape or form "segregation." Funds need to be safe, period... Liquidity or any other tangent is just bullshit.



The Big Ching-aso's picture



Latvian bank customers have gotten 'wind' that farts are best avoided by not kneeling behind anyone's buttocks.     This brilliant maneuver is likely to be emulated.

rufusbird's picture

Look around...Rats are leaving the ship!

sangell's picture

we can only hope so ( the fed being neutered by this)

Mercury's picture

Are Candaian firms really out of the rehypothecation game?  One of the recent ZH stories implied otherwise:

 In the UK, the epic failure of supervision has allowed banks to become de facto monsters of infinite shadow banking fractional reserve leverage - every bank's wet dream! Naturally, Prime Brokers have known all about this which explains the quiet desire to conduct re-hypothecation out of London-based offices for every US-based (and Canadian) bank.

In this article numbers were given for RBC and CIBC funds rehypothecated via the UK.

And people were wondering why looking through the balance sheet of Canadian banks revealed no alert signals. It is because all the exposure was off the books!

Vint Slugs's picture

Very informative post, Bruce.  Thanks again for some original insight.  Might be time to hunker in the bunker.

filletandrelease's picture

Are you better off having a cash account vs. a margin account?

Darth..Putter's picture

Those are digital assets.  In hand is in hand.