Shadow Rehypothecation, Infinite Leverage, And Why Breaking The Tyranny Of Ignorance Is The Only Solution

Tyler Durden's picture

In the aftermath of the "rehypothecation" analysis exposing the quantum differences between the US and the UK, where the former at least tries to put some breaks on "fractional reserve" synthetic liquidity creation by Prime Brokers (which these days would be virtually anyone) while the latter believes that virtually boundless risk is a welcome thing, there has been a barrage of inquiries seeking further clarification of the nuances of shadow banking, a topic Zero Hedge has covered since July of 2010 (for much more see here) and which we will update on tomorrow for the latest Flow of Funds report (spoiler alert: in Q3 US shadow banking declined by at least $300 billion, a trend started at the credit bubble peak, over $6 trillion higher).

In order to bring some clarity to the matter we present two of the seminal pieces on the topic: first, fro the IMF: "The (sizable) Role of Rehypothecation in the Shadow Banking System" and then from one of the best scholars of shadow banking, Gary Gorton, "Haircuts." We will let readers digest the wealth of information contained in these two pieces on their own, however, we will point out the two key messages: on one hand we get a definitive explanation of why not NY but London is true hub of financial engineering and infinite leverage (recall that the UK is in fact the most levered nation on a GDP basis in the world when one takes into account all outstanding debt, not just sovereign - a fact well known to S&P and explaining why the UK will be the last to be downgraded as this would bring attention to the last domino in the chain) as follows: "Mathematically, the cumulative ‘collateral creation’ can be infinite in the United Kingdom" - that's from the IMF basically telling everyone that courtesy of no rehypothecation haircuts one can achieve infinite shadow leverage. And the other one comes from Gorton who explains why haircuts are the functional equivalent of information arbitrage: "Increases in repo haircuts are withdrawals from securitized banks—that is, a bank run. When all investors act in the run and the haircuts become high enough, the securitized banking system cannot finance itself and is forced to sell assets, driving down asset prices. The assets become information-sensitive; liquidity dries up. As with the panics of the nineteenth and early twentieth centuries, the system is insolvent."

And the punchline: "Liquidity requires symmetric information, which is easiest to achieve when everyone is ignorant. This determines the design of many securities, including the design of debt and securitization." Reread the last statement as it explains perhaps better than anything, the true functioning of modern capital markets and why they are terminally broken: in order to preserve the system, the banking cartel need to make everything of virtually infinite complexity so that no one has a clear understanding of what is going on! Which is where sites like Zero Hedge step in - to expose "shadowy" places where things are best left unseen.

Incidentally one of the catalysts of the market collapse in the Lehman aftermath was not some market scalar metric being breached, or a bunk shutting down physically, but the seminal report by Citi's Matt King "Are The Brokers Broken" from September 2008 which explained all of the above (and below) in clear and concise detail, in effect bringing the proverbial Eureka moment to every market participant, of why everything was terminally broken. Since we are now again at the same stage, we will shortly repost the same report from King to stop "everyone from being ignorant" and comprehend just how broken both the traditional and shadow banking systems are

... But first:

"The (sizable) Role of Rehypothecation in the Shadow Banking System

and "Haircuts"

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Jim in MN's picture

Look at it this way: Extend and pretend made a certain amount of sense in that time, time alone, allowed some derivatives to simply expire harmlessly--the 'weapons of financial mass destruction' (Buffet) have timers.  But if the banks start piling back in, then even the modest upside of can-kicking is lost.  And all the vast downside remains.

Looks like we're right back to square one, but with trillions already down the rathole.

FreedomGuy's picture

With only a fuzzy understanding of much of this stuff, this to me seems to be a great argument against central banks. In a sense a Fed or central bank puts you in the middle of the mess. In fact, it grows and multiplies it. Banks and financial houses left to themselves can invent any crap they want but the results are fairly limited to their own money and not backed by the public.

Imagine, like the early days of our country (the USA), mulitple private currencies, no central bank and limited leverage. Add to that no way for the government to TARP or stimulus or bail out. No one thing could take "the system" down as there would be no one system and plenty of escapes for those caught in financial stupidity.

Am I wrong?

Nobody special's picture

I see more. We now have an explination for why matching serial numbers of 'hard currency gold' showed up, though no duplicate bars were ever found. There are multiple first party claims on the same serial numbered asset. The bars were not duplicates; the same bar was moving into inventory multiple times. It proves that the shadow wealth is just that. It really emphasizes the importance of taking personal possession of your assets.

With rehypothecation, your serial number does not matter. Your evidence that the wealth is yours is no better than anothers, and likely no more legitimate. Those who hold paper are about to experience the ultimate fleecing.  In the past, when multilple parties held equally legitimate claims, courts usually ruled in favor of the party in possession.  So, who's in possession?

If you own but do not hold, you've already lost your gold.  Better trade out your paper fast to take delivery. Your gold as been taken from you, and your GLD will soon be unconvertable. Move to safety before it is too late.

jekyll island's picture

So we have a fractional reserve banking system that is backed by nothing.  On top of that we have a fractional reserve equity market, which always appear to be backed by someone else's assets when TSHTF.  On top of that there is a shadow banking system which is funded by someone else's assets from the prime brokers in the equity market which come from clients who take their funds from the fractional reserve banking system, which is backed by nothing.  On top of that there is a shadow derivatives market, where shadow banks write contracts to each other to hedge against loss, all of which is apparently backed by nothing.   The shadow banks and prime brokers can rehypothecate their collateral to increase their liquidity, which is backed by nothing, by as much as $2-4 trillion in the US alone, unable to calculate in the UK because there are no limits to churning.  Did I miss anything?   No wonder Germany said Fuck You when they were asked to pledge their gold to backstop the ECB bailout.  I am going to go give my gold a hug.  Uhhh, if I had any, that is.  

Ahmeexnal's picture

Switzerland about to jettison the euro-peg. Preparations for euro-collapse under way.

WmMcK's picture

“We are naturally (preparing) for possible alternatives” - Widmer Schlumpf

Naturally, we should be too.

trav7777's picture

The Rothschild BOE is the epicenter of a nearly 400 year ponzi of creditmoney.  In fact, this bank is a charter member of the FRBNY.  For centuries, London was the world hub of trade in real bills, the largest exchanges were there, and the Sterling Bill radiated power all across the world.

Like I said, all those Rothschild palaces did not build themselves.

pods's picture

Exactly.  Even though it seems like all these banks are US, Italy,or Germany based, most of the leverage, and the control, is right in the City of London, where the Rothschilds have made their living since Nathan Mayer usurped control over the BOE.


Manthong's picture

-----  SPX   > 1200 on 17Dec11

-----  SPX   < 1200 on 17Dec11

Not what you want.. what you think,


The Big Ching-aso's picture



Once upon a time ignorance was truly bliss.    Now everyone knows each other's pretending to be ignorant it's fake bliss.

Michael's picture

And we would of gotten away with it too if it wasn't for them dam bloggers.

Senator Rockefeller even said the Internet should have never been invented. I wonder why he said that? 

JW n FL's picture



Repo markets are a potential channel for liquidity risks, given their systemic importance, inherent leverage, and short tenor. For individual financial institutions that rely on repos as a source of leverage, loss of access to repo financing can both directly undermine funding liquidity and create negative market perceptions about the institution’s financial condition. Repo market disruptions, manifested in increased haircuts, aversion towards certain forms of assets as collateral, or elevated concerns about counterparty risk, can pose broader risks to asset pricing and the functioning of the financial system.


As illustrated in a hypothetical example (see “Repo Haircut Increases: Forced Selling?” chart), increases in haircuts can compel forced selling of the underlying repo collateral. In this example, a corporate bond portfolio requiring a 5% haircut for repo financing would enable an institution to take on a $1,050 exposure backed by $50 in equity, equivalent to leverage of 21 to 1.


JW n FL's picture



Federal Reserve Earnings verse Federal Reserve Loans to the United States of America


1. How much does the Federal Reserve Bank Earn in Interest Payments? From anyone other than the United States of America.

Federal Reserve $15 Trillion Dollars in Loans Bloomberg

Loans from 3 / 9 / 2008 to 3 / 9 / 2009 totaling $15,760,004,161,955.00

Getting Bigger

Instead, the Fed and its secret financing helped America’s biggest financial firms get bigger and go on to pay employees as much as they did at the height of the housing bubble.

Total ** assets ** held by the six biggest U.S. banks increased 39 percent to $9.5 trillion on Sept. 30, 2011, from $6.8 trillion on the same day in 2006, according to Fed data

** **

The Fed’s Secret Liquidity Lifelines




2. Who are those Monies Participated Out too? That the Federal Reserve Bank Collected?

Who owns the Federal Reserve?

The Federal Reserve System fulfills its public mission as an independent entity within government. It is not "owned" by anyone and is not a private, profit-making institution.

As the nation's central bank, the Federal Reserve derives its authority from the Congress of the United States. It is considered an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.

However, the Federal Reserve is subject to oversight by the Congress, which often reviews the Federal Reserve's activities and can alter its responsibilities by statute. Therefore, the Federal Reserve can be more accurately described as "independent within the government" rather than "independent of government."

The 12 regional Federal Reserve Banks, which were established by the Congress as the operating arms of the nation's central banking system, are organized similarly to private corporations--possibly leading to some confusion about "ownership." For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.


So! The question stands.. if the Federal Reserve is collecting .25% interest on $100 Trillion Dollars a Month (minimum).. Where Does ALL!! That Money Go?!?!?!?!?!

6% here.. 6% there.. Participated Out to the Shareholders.. into their Federal Reserve Bank Accounts.


So if the Federal Reserve is Collecting 6 times more a MONTH in Interest payments than is due by the United States of America (for our National Debt of $15 Trillion).. Why are the American People having too carry that debt? When the Federal Reserve is making AT LEAST 6 Times More than the Payment Due by ALL! of us?


Henry Ford-

"It is well enough that people of the nation do not understand
our banking and monetary system, for if they did,
I believe there would be a revolution before tomorrow morning."


If the Shareholders of the Federal Reserve are collecting their 6% of the $100 Trillion (minimum) Dollars a month in Interest payments..


Then why in the FUCK! Do We the People of the United States need to be taxed to death to pay for the Bank Bailouts?

How fucking hard is this for anyone to understand?

How can I dumb it down more for you?

How many people do you think you could explain this very simple FACT too?


When do you think would be a good time to let people know this?

Never mind Baby Boomers! I know you are just trying to sneak out without having to pick up this for shit bar tab the rest of us are saddled with!

But you younger people that will have to live this fucking nightmare going forward for a good long while should take a GREAT! Amount of interest in the facts that have been dumbed down and sourced and sited for even the most simplistic of mentalities to be able to grasp, easily.



Clip and Paste!

And then send it to everyone you know in your email box.. it is like you have to click the mouse 5 or 10 times total to educate everyone you know.. and feel free to let the dumbasses that you are sending this to as well know how simple it is to educate everyone they know..

And maybe..

Just fucking maybe!

We will be able to stop getting RAPED by the Federal Reserve and Washington DC via the Wall Street Lobby!


Thanks for Playing Along!

Add your name here! _____________________



Global Hunter's picture

At least it sounds really cool when I read it out loud in my hollywood German accent.  I don't know to say this in German, French, Italian or Romansh, please hurry up so I can see what life looks like after this great collapse and I can begin the next phase of life, survival.  

Al Gorerhythm's picture

A survival note.

The dollar that you have "saved" in a bank (using the international CB accepted fractional reserve hypotication ratio) has been rehypothicated 9 times over. Do you really own that dollar or does someone else have a claim to it? It now all depends on where you stand in the line, before your savings and loan or credit union or TBTF bullion bank goes bankrupt. You'll notice that the MF Global customers are now sitting in the cold, outside of the shearing shed, after they've been sheared. Released back to pasture. Bleating.

Don't join the herd.

s2man's picture

Yup.  Because of fractional reserve, he who runs on the bank first, runs best.

merizobeach's picture

sheeple vs. zheeple


Unlike it's domesticated cousin, the independent zheep is both somewhat literate and contemplative; it is also a much better 'sprinter' during bank-sponsored 'runs'.

yabyum's picture

Why they pegged to the doomed Euro will always be a huge question for all of us.

SWRichmond's picture

Not surprised here.  I still hold all of my CHF, I'm not as stupid as SNB must think.

Freebird's picture

Does that come in English - did not see a language option..(?)

homme's picture

Sometimes it has a problem with nuance and context but Google's translation usually works well enough:

Pitchman's picture

Jekyll isl. I think you have it.

Yet again we are exposed, the hard way, to the extent of manipulation the financial sector has gone to rig the game.  This City of London derived scheme has nothing to do with promoting organic growth and everything to do with extracting rents and transferring wealth.  What could be more blatant than putting your clients assets at risk for your personal gain.  It gives a new meaning to fiduciary responsibility.  And like all fascist manipulations; when things go wrong the people pay.  As for Corzine, this loophole will likely protect him in this case.

RE-HYPOTHECATION: Are Your Brokerage Accounts, Muni Bonds, Futures Contracts, Corporate Bonds... Safe?




Money Power And The Central Bank: Life Is But A MEME


”To the wicked, everything serves as pretext.” -Voltaire

 Trillions of CDS with nothing to back it

Europe's Voluntary Haircuts?, CDS Market Sham & B of A: Less Than Zero

MF Global is a fractal in a frying pan.

GiantVampireSquid vs OWS UFC 2012's picture

Fuck me drunk.  These cunts have created a complicated way to take your money.  At the same time, by creating inflation, they force you to give them your hard earned money, which gives them the ability to steal it.  Buy fucking tangible assets, GTFO of paper.

Teamtc321's picture

It does not look like it is just gld or slv, it is appearing like most brokerage account's use hypothecation. This some scary shit for all trader's to put it bluntly imo. Many have been checking there perspectus and saying there account's have verbing of hypothecation.   

Vint Slugs's picture

"It does not look like it is just gld or slv, it is appearing like most brokerage account's use hypothecation."

Correct.  The first thing to do if you have securities accounts with domestic US brokerage companies is to make sure that you instruct the broker that he may not loan your securities.   The second thing, assuming you're not in-and-out trading, is to take delivery of you stock certificates which you then put in a privately-owned vault -- keep no securities in "street name."

Mauibrad's picture

@Vint Slugs re: "take delivery of you stock certificates which you then put in a privately-owned vault" 

Most brokerages now tell their customers that they don't offer delivery of stock certificates.  What you say?

DosZap's picture


It does not look like it is just gld or slv, it is appearing like most brokerage account's use hypothecation.

Well, lets see just how many Intelligent traders,GLD/SLV participants there are after getting a whiff of the real truth.

If nothing changes,you got yer answer...........................

If these morons just PULLED out their fiat,these bitches would just collapse,until the point the OTB that run them, declared  BR, and hypothecated their Phyizzzzzzzzzzzzzzz.

Wonder how this would/could work, with GoldMoney, or PSLV/PHYS?.

ouchtouch's picture

I think it would be more accurate to say that ALL margin brokerage accounts use re-hypothecation.  I have not seen any NON-margin account customer agreement that allows hypothecation, and there is no reason why they would.  I have confirmed with Vanguard that my non-margin accounts can't be re-hypothecated.

Ropingdown's picture

And people laughed as if Kyle Bass was paranoid when he took physical delivery of gold.  So much glib talk is spouted in the financial tv/print press.  So many comments made by finance committee politicians have been revealed to be lies.  If Bass didn't take delivery, I'd consider him incompetent. 

Mauibrad's picture

@Nobody special  With all this re-hypothecation and gold talk, it makes all the more sense why that supposedly "stupid Communist" Chavez recently realized Venezuela needed to take possession of it's gold, at least some of it.  Better take possession of the rest of it, or he'll never see it. 

Rossalgondamer's picture

Good analysis -

but maybe add to your eulogy: a population that was still knowledgeable on the farm, in the wood, and at the forge.

Break fiat and the carrots for wagon wheel repair trade ends much of our clear and present danger. While at it - please unshackle me from FDIC type assurances given by a false daddy. Life's tough - but tougher with parasites.








anonnn's picture

My surprise, verb  hypothecate is in 1994 Webster's New World, in all its financial glory.

 Appears after hypothec, noun form,  "security or right given to a creditor over debtor's property w/o transfer of possession or title".

So re-hypothecate is appears to be typical use of financial clever strokes to move the boundaries and enable profitable chaos.


CIABS's picture

tyler, if you can, please provide a downloadable (not scribd) pdf of "Are the Brokers Broken?".  thanks.

Manthong's picture

It only takes a minute to set up a free Scribd account to download the .pdf.

Harbourcity's picture

I checked into that and no luck.

Manthong's picture

..maybe they changed. I set one up last year.

Jonathan E's picture

Hipoteca == Mortgage (Spanish).

WmMcK's picture

The "inversa' (reverse) versions are often predatory instruments used to steal lifetime savings.  Unfortunately many of the brokers of these contracts are trusted because the have the same heritage as the clients. Of course this happens in many (minority?) subsectors of our (failing) economy.

MissCellany's picture


Like I just said...sounds like MERS...

FatFingered's picture

Whoa!  The missing 'notes' were not missing, they were re-re-re-re-hypothecated!  Scandalous!

el Gallinazo's picture

Am I wrong?


Well it might require a little more study.  The earliest days of the Republic did in fact have a central bank.  In those days corporations had a limited life span dictated in their charters.  Andrew Jackson finally killed the central bank by preventing the renewal of its corporate charter, although it almost killed him first.  He was only saved by a double misfire of two flintlock pistols shoved in his belly.  If we had sixguns in the 1830's financial history would read differently.  In belated revenge, the Federal Reserve put his face on the $20 bill to remind his shade of their ultimate victory.  A fairly painless way to aquaint yourself with the role of central banking in the USA is Bill Still's The Money Masters downloaded for free from Google video.  All the central banks in the USA were puppets of the Bank of England.  J.P. Morgan was also a puppet of the Bank of England which wasn't really documented until his death when his will was made public.

Newsboy's picture

Nice historical context, El G.

(I sure miss getting to post on Automatic Earth...)

Right-on Left-off's picture

Am I wrong?

Nope!  Anytime there is centralization and a hierarchy to handle that situation .... you are talking a grand scheme for control and domination on a very broad scale.

You are also talking fertile ground for shadow systems and synthetic ignorance if you will (lies and obfuscation about the truth).

OttoMBMP's picture

But right in the intro abstract of Gorton/Metrick you can read:

"... which they maintain is a manifestationof an age-old problem with private money creation: banking panics."

Well, they are sponsored by a central bank....


Ghordius's picture

There are many arguments agaist Central Banking
IF you are not a bank, a government or a nation in deficit/overspending mode

Without the FED, it would be inpossible for the USA to spend half of the military expenses of this world, just so as a reminder...

So now the anti-EUR campaign is reaching the zenith while the "UK is the ugly butt of USUK" campaign begins. I expect a lot of articles about the way Soros attacked the Pound, the UnAmericanness of The City (vs blameless Wall Street), how the UK is a banker Island without other economy, etc. etc.

No idea yet how long the cycle would be, perhaps if Mr. King can induce more inflation Krugman will take him as a role model? Then we have the debate about how much which CB has really printed?