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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BandGap's picture

IF this becomes common knowledge, and I think it will, what would be the impedement to removing funds from these types of schemes? I understand the overall ramifications, but is there a risk to the depositors themselves? if not, they should run for the hills with their holdings.

Corzine, what the hell are you thinking?

Bruce Krasting's picture

You use the word "depositor". That implies money in a bank. This is covered by the FDIC and is different from having money in a brokerage account. 

There is risk that account holders will get nervous. It's already happening.

Read this piece from ZH last night re Lind Waldock.

Amish Hacker's picture

Bruce, do you mean to include margined retail stock brokerages, or only commodity accounts?

I think every small investor knows that their stock broker is working against them, far beyond the usual fees and commissions. (e.g. your mining stocks are routinely loaned out to short sellers, driving down the price). We tacitly accept this as part of the entry fee to the crooked casino we play in.

But if it comes out that, say, Schwab has been commingling and re-dodeca-hypothecating Joe Sixpack's meager account holdings, it really will be Game Over.


PMakoi's picture

This will be the game ender, when the smaller managers/investors really see the game is rigged, then they will take their marbles and go home.  What is of real concern with this debacle is a bigger hand reaching into the circle and grabbing the wrists of these smaller guys trying to pluck their marbles back.  "Whatcha think you're doin'?"  "Them ain't your marbles!"

There won't be enough lawyers on the planet to straighten out all the hypothicated collateral owners.  Ahh, but those lawyers will be wanting to be paid.  Hmm?  Who's going to have all the money?  The Primary Dealers, of course.  Get your marbles out while you can.


crzyhun's picture

Verrry good. Thanks for this and this still does not help the one hanging out to dry. Sorry but we need some Arabic justice here!!


PaperBear's picture

Everything these bankers touch turns to a pile of excrement, it has always been the case and without proper legislation it always will be the case. As the Federal Reserve Act of 1913 was sold to the American people on the supposition that the legislation would tame the big banks but the legislation was written by the big banks to benefit the big banks.

Just so we are clear, if there is a worldwide run on brokerage accounts then it is because this legislation has destroyed all trust. Why place your wealth at risk by accepting the status of an unsecured creditor ?

Raynja's picture

The banksters find anything healthy and consume all of the nutrients and energy. They leave behind the waste product. This gives them a chance to get to the next meal faster, while everyone else has to wade thru shit to get to their next meal.

Azannoth's picture

Modern Banking has been invented and pioneered by the Jews not surprising to what has come out of it

cbaba's picture

Thanks for the insight Bruce.

machineh's picture

Ditto, Bruce.

This statement of yours stunned me: 'SIPC provides zero protection to account holders in the event of a broker default.'

It doesn't seem to align with what SIPC itself says:

The statute that created SIPC provides that customers of a failed brokerage firm receive all non-negotiable securities that are already registered in their names or in the process of being registered. All other so-called "street name" securities are distributed on a pro rata basis. At the same time, funds from the SIPC reserve are available to satisfy the remaining claims of each customer up to a maximum of $500,000. This figure includes a maximum of $250,000 on claims for cash. Recovered funds are used to pay investors whose claims exceed SIPC's protection limit of $500,000. SIPC often draws down its reserve to aid investors.

How does SIPC manage to skate from making up the missing funds at MFG? 

Commander Cody's picture

The Fed has NO credibility.  They have facilitated the theft of capital from productive sources to enrich the few by allowing a fiat ponzi of incredible dimension.  When more people begin to understand that their money can be expropriated by criminals, they will seek the safest vehicles around.  Wait for it.

LawsofPhysics's picture

Yes, and the mad dash for physical assets of all kinds will begin.

Uchtdorf's picture

But so far today, that realization has not sunk in. Keep some cash handy as prices go lower.

Divine Wind's picture

This will hurt.

I would be particularly interested in seeing overlayed charts comparing exposure in this area vs executive bonuses.

Alea Iactaest's picture

Do I have this right?

Choice #1: Regulation T is modified in a way that limits rehypothecation and the markets experience a sharp drop in liquidity.

Choice #2: Regulation T is not modified and people pull their accounts leading to a sharp drop in liquidity.

Is there a 3rd alternative?

And as long as I'm asking questions, does anyone else think Bullard cited MF Global as an example of how failure should work because it highlighted the loophole which allows account holders to be looted?

SWRichmond's picture

Choice #3:  Continue to use the MSM to lie your ass off, and when that fnally stops working, start a war, declare martial law, use your infinite new power to round up all of the truth-tellers, food-hoarders, home-schoolers, and anyone who ever spoke a bad word about the central bank.

If you think I'm fucking kidding, I'm not.  Imagine how Nazi Germany would have used the powers and surveillance capabilities that the U.S. government now has and uses.

spanish inquisition's picture

Here is an alternative

Based on previous behavior, the FED can print as much as it wants and give it to whomever they damn well please.

Also, the Fed has guaranteed $7T and lent out only about $1.2T. If they are not going to give me cash directly, I can always call JG Wentworth. I will sell the guarauntees at 50%, take the cash and lever up in the UK.

Edit: Nobody tells baby not to print Edit 2: I just put this up on a previous post 

DonutBoy's picture

They can insure the client accounts by expanding the SIPC - that way they don't have to print yet - another "optical backstop" to borrow from Kyle Bass.

Getting Old Sucks's picture

Did Corzine lie to Congress when he said he didn't know what happened?

Oleander's picture

That would depend on his state of mind during testimony. 

TheMerryPrankster's picture

his "state of mind" when answering questions before the "Mind of State".

I see a semantic mirror.


sunnydays's picture
Explosive Interview Jim Willie "JP Morgan Crashed MF Global to Avert COMEX Failure, they stole all the accounts that were going to take delivery"

Bruce Krasting's picture

I say no. He has no clue what happened. No one esle in charge does either including FBI, KPMG, the courts, CME and a million lawyers.

That's the point. The system is flawed. There was leakage that almost everyone thought could not happen (and now can't figure out). I think it gets back to Reg T.

11b40's picture

Bruce...fisrt, thank you many times over fof the timely and extremely informative posts you give us here.  I learn a lot from your insider perspective. 

Your response here leaves me scratching my head, however.  This is all accounting, and there is a trail (if not, eveidence is destryed) left by every transaction.  Things no not just disappear in this world.  Stolen, concealed, misappropreatied...OK, but not just disappeared.  A forensic probe can surely discover all of this money, and show exactly where it went and when.

Mr Lennon Hendrix's picture

reg t and rehypothecation is pretty simple bruce, and the ceo should be able to track down the loans.  if not, then the problem is so big it will be a black swan

Miss Expectations's picture

I say no, too.  I say no because Corizine placed a bet that he believed would pay off big time and all his dreams of power and wealth would come true and he'd show those MoFos over at Goldman how wrong they were about him.  Corizine doesn't know what happened to his sure thing bet on  European Sovereign debt.  I think he was set up.  For some reason he bet the farm (just like his grandfather).  I think he was lied to.  I think he was played.  I think this because the bet didn't make any sense, or the timing was wrong.  I also don't think he's particularly smart.

I'd be interested in seeing some reporting on what's happening to all the farmer's whose finances have been wiped out. 

rufusbird's picture

I heard a few "I can't recall" and "Not as I recall" 's thrown in there...

spekulatn's picture

Lie is an ugly word. Congress prefers to prevaricate.


gina distrusts gov's picture

In the same tune vigilante is a "bad" word justice is far better yet when the "justice system is owned by the criminals  a time will com  when justice   is delivered by a rope and lamp post

LawsofPhysics's picture

You are fucking kidding right? Re-Hypothecation is simply another word for fraud.

The new American business model;

Promise your clients that your company will be wildly successful while betting that your company will fail AND selling insurance against it failing so that when it does fail the taxpayer (your customers) bail you out.  Triple profits bitches.

csmith's picture

Re-Hypothecation is simply another word for fraud.


If so, then fractional reserve banking is fraud as well. They're basically the same thing.

DonutBoy's picture

Yeah.  Now I see its Federally authroized fraud thanks to BK's post.  The regulation spells out how to conduct the fraud in case any of their client banks are slow.

Our fractional reserve system and fiat currency are doomed - but - here's the catch, the dollar is doomed last.  I feel like it's immoral to hold dollars now, but I will a while longer, because in the sequence of things the dollar will strengthen and PM's will continue to get waxed as the deleveraging goes on.

What happens when the rest of the paper gold market realizes that all US domiciled accounts are, in fact, completely unprotected?  More selling.  More deleveraging.

The dollar will collapse - but first it will reign mighty and the economy will sieze again.


TheMerryPrankster's picture

Fraud is too petty a word to describe what happened. Fraud is taking something under false pretenses.

This makes fraud look like lunchmeat.This was a delicate net, nearly invisible, woven into regulations so dense it would make a lawyer fall asleep, and yet this slender net was stronger than titanium and it pulled such plunder from the sea of investors. Over a billion dollars gone like magic, someone has that billion and someone has done a remarkable magic trick in making it appear like no one knows where it went.

poof - into an alternate universe.

Regulation T or Regulation XYZ, it makes no matter if the regulations are not enforced. If there are no cops, is there really any crime?

Wall Street the theft continues and the fools line up to give away there money. I think at this point you could have Cramer running hundred dollar bills through a paper shredder and people would still invest in this "sure thing" investment world.

I think it might be time to open a Tulip Exchange.

Mr Lennon Hendrix's picture

People sign the margin agreement not with a gun to their head.  people instead should have due  dillegence when making investments

TheMerryPrankster's picture

Due diligence requires all parties to act honestly. I see a problem with this.

Mr Lennon Hendrix's picture

if you sign a rehypothecatiojn agreement you are allowing the broker/dealer to loan out your securities to meet their margin

11b40's picture

I don't give a shit what the fine print says, your broker relationship should be sacrsant and he should always be looking out for the best interest of the client.  The system is based on trust, right?

This should not be legal under any circumstance.  Seems to me that eveyone up and down the line may get screwed when assets are pledged more than one time.  What a freaking mess.


11b40's picture

Did I step on a broker's toes, or is my troll out again today?

Mr Lennon Hendrix's picture

i agree but those aren't the rules.  changing the rules changes the system and we will see an unwind unheard of.  i say bring it on but it will reset the Fiat Ponzi

Got real monie?

TheMerryPrankster's picture

I'm old school. I won't sign anything I can't understand.

CrazyCooter's picture

You know, I see these guys make so much money selling fraud, I decided to try it on the weekend. So I stand on the corner, trying to get people to buy my fraud, just $10. When folks ask what they get, I say nothing. Its $10 for nothing, its a great deal, prices are going up!

Haven't made a damn dime!

Do I have to wear a suit? I mean, the homeless guys made more than me and they aren't dressed up.



blunderdog's picture

Tell people the money they give you is tax-deductible.

GMadScientist's picture

Tell em you'll pay them 15 cents to repo that cash for a week, that'll fuck with their heads (warning: watching sheep do division can sometimes be painful).

Another example, straight from E-Trade:

If you deposit >= $250k, we'll deposit $1000, >=$100k-$250k: $500, $50k-$100k: $250, $25k-$50k:$100.

<$25k?...oh, look, a poor person!

Figure out what's wrong with the "offer" above...I love how they aim for that sliver in the Venn diagram where innumerate overlaps "medium net worth".



TheMerryPrankster's picture

No need to get so complicated, you merely need to bypass their logic functions by going directly to their emotional desires, ie greed.

It worked for Madoff & Ponzi, its a proven tactic. Promise them you will double their money and then find a new corner to work from every following week. It works until you run out of corners.

Of course if you are the Federal Reserve, you are global and a sphere has an infinite number of corners, apparently.

Getting Old Sucks's picture

Kidding? No. Sarcastic? Yes.  After all the BS he unleashed in his testimony, how the hell can he come back and claim that rules allowed what happened?  Then he would had known that while testifying. 

knukles's picture

JonBoy (Who was that in some old western?) what with hiring one of the best Criminal Defense Lawyers (Mucho Cha-Ching per Hour) in the Biznezz has been prompted over and over again to say "I didn't know" as in unawares and "Without intent". 
It's all a misunderstanding that such a dumbshit golly gee whiz shucks guy like me was hired, so sue the fucking board of directors for not managing me properly.

The City of London will send Jon and Lloyd to the butcher for fucking up.  When a member of the team, as in doing the Rothschild's bidding, you Never Ever suggest that you're Doing God's Work or are a Dumb Fuck.
The Rothchild's are God and You Have Merely Been Permitted a Seat at The Table to Make It Look as If There are Playerswith Lotsa Chips. 
You Loose, You Pay for It.

It's all Illusion, Perceptions Management.
Why were the banks bailed out and not the citizenry?
Why is everybody mad at the banks, the Enablers?
The real Criminals are at The Central Banks.

Oh, but then again, they're just following orders.