Coming Collateral Crunch Charted
To better comprehend the chaos that is currently viciously circling in European funding markets, its critical to understand the difference between 'linear' collateral needs and the highly non-linear self-destroying re-pledging collateral crunch that is about to occur. Perry Mehrling, of INETeconomics, does a good job of explaining, in his chalkboard-style video, the three lending-based demands for collateral among the European banks and their central banks (Interbank, National Central Bank, and TARGET-2). He notes the IMF's proposed interjection might help to relieve the collateral crunch that we have been so actively discussing. However, these are all lending channels that rely simply on haircuts and specific collateral needs, what is being missed here is the much bigger problem of re-hypothecation (or re-pledging) of the collateral which leaves the considerably larger shadow-banking system facing a run on ever-decreasing piles of assets. So simply put we have a crunch in credit as increasing needs for collateral for 'pure' lending will be greatly exaggerated by the shrinking 'net' availability of collateral (as risk manager after risk manager tightens up their systemic risk criteria and reduce availability of funds for re-pledging). Put another way, while policy-makers focus on the big bazooka top-down, it is the smallest fund manager 'cog' in the chain of re-pledged collateral that will inevitably bring the system down.