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Shadow Rehypothecation, Infinite Leverage, And Why Breaking The Tyranny Of Ignorance Is The Only Solution
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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Aye slewie, but only if they'll do it for my whiskey, cigars, and lead fishing weights.
Forget cash! Convert it to GOLD!
Aye, in $999 increments.
My banks kept calling and doing surveys recently. I thought it was strange that the few billions affected by that withdrawal day seemed to concern them. It appears that leverage is so high and reserves so tight, and maybe deposits repromised and margined to multiple parties, that a modest level of withdrawals is a matter of concern.
Any info/opinions on whether Forex brokers are also playing this 'rehypo' game?
Tyler, thanks for the great content! (sorry if someone has already mentioned this, but someone's mucking with your spell checker... Infinite and Tyranny)
Breaking the tyranny of ignorance : its a wonderful theme, as we get our daily dose of it here on ZH and it has galvanized me to reminding all our ZH crowd about this human paradox. Here is the gist of the matter :
One day an advisor made the following comment to Charles de Gaulle :
Advisor : We have so many assholes in this country. You'd think that we're back in the days of ancient Gaul, no pun on your name, Sir. But these "Algerie Française" guys are getting my goat as those of our countrymen.
de Gaulle : Could you come to the point. I have President Kennedy on the phone. He wants to bring his wife to PAris. Horrendous problem! We'll have a double agenda and I hate that! It's bad enough having to talk about Berlin and Chairman K to President Kennedy, who is now surrounded by hawks wanting to make Europe into their new nuclear toys playground!
I won't be part of it! But on top of that, I'll have to pull out the red Carpet for Jackie and present her with our ever petulant brigade of world famous "panzies", you know those "frills" that the world envies us, LA Haute Couture brigade. Imagine ME having to tolerate their hoity-toity prancing, and to kiss them on their pussified cheeks and to give them the high fives as if they WERE France. Dammit, I AM FRANCE, not they!
Advisor : Sir, I am referring to these OAS clowns who want to bring you down. There are rumours you are now targetted by these residual "frustrated, obsolete brass knobs" who have not won a battle since Verdun, forty five years ago.
de Gaulle : Yes, well don't rub it in, I happen to be from the same fold before I became President, Naturally according to my OWN rules to bring law and order to this historic rabble we call the French people.
Advisor : Dear God, Sir, I do not doubt your determination. It's time to wipe out these insufferable traitors who raise their guns against you; you who have saved us once already in 1940 and who will save us a second time after this political fiasco in Algeria. We lost the Election referendum. The writing is on the wall; we have to leave now.
de Gaulle : Are you bent on wasting my time? Must I suffer your dumb foreplay like a coy woman. Come on, tell me the punch line!
Advisor : Sir, they are planning an attempt on your life. Its programmed when you will visit the Pierre Cardin collection with Lady Jackie. You can't get more underhanded than that. Military men, hiding behind the skirts of the fashion collection. I want to puke to express my disgust as the lowliness of this ploy, concocted by so called 'men of honour'. Can you imagine a paratrooper disguised as a woman to shoot at you? Unthinkable.
de Gaulle : What an original scenario. I didn't think these dead-wood, thick headed chumps capable of such imagination.
Advisor : Sir, I woulld like us to organise a preventive purge. To clean out this recalcitrant military cabal. We need to capture the imagination of the French public. Execute in summary fashion a few targetted Generals and Colonels, I have their names. Then have the newspapers publish a major PUNCH WORD, to push home the message, like the men of Madison Avenue.
de Gaulle : You are mad to think I would stoop so low; but assuming I did what would be your punch line, for this gutter press. You are bent on bringing me down to their level. I will amuse myself by letting you propose your message. Spit it out!
Advisor : Sir, this is the consensus : "Death to the Ass Holes". It should obviously precede your military coup. Soften opinion by launching the raunchy punch line. "Death to the Ass Holes, enemies to the Republic". Let me propose this to our 'dirty dozen' hit men, our Barbouzes and their friends in popular press. It would create a sensation and soften public opinion to subsequent dragnet in military circles; operated by the Barbouze.
de Gaule : You are now at the same level as those military mad men, inconsolable idiots, who don't realise that the Colonial game is over. We have to recenter on our nuclear capability. Become twentieth century. To talk as eqauls to President Kennedy and Chairman K. I will never stoop to fighting these dregs of past colonial grandeur by sinking to their level. Its over this backward gazing strategy that brought our predecessors to this political 'cul de sac', in Dien Bien Phu and now Algiers. No, I have another response to those "Algerie française" shills.
Advisor : What is that, Sir?
de Gaulle : Spread the message to the Press: Allege that THEY sing "Death to ass holes", Not US!
We sing in response : "Huge task". (de Gaulle looks ironic and sarcastically towards advisor).
It's much more subtle that! I think the French have enough sense of humour to appreciate that.
Now leave me alone to plan Jackie's programme. It's much more redoubtable challenge for France!
Advisor : Sir, What a stroke of media genius! They sing : death to assholes...we respond : vast programme. Wow, Sir you understand the Media!
And it got printed. And it made the legend of the decade. Now thats great Media play! Maybe Ron PAul could learn a lesson!
This as all very interesting, but "So What?" There are financial trick to loot, the actual productive economy, it will all collapse very, very hard, but no one knows just when, and London is the center of it. That's the Real World 101, basic knowledge.
How do we shape the world so that mankind has a future our youth can look forward to, rather than a horrid reply of the Decline and Fall on Civilization? As a starter, get rid of Ocrap (peacefully and constitutionally), recognize the bankruptcy and default of the financial system thrugh Glass-Steagall, issue credit for actual production uin massive, nothing else. Then we go to Mars.
all comes to head in 2012. it'll be known as the "DEVIL"S MESSIAH." AD 2000 + 12yrs before Jesus began preaching at 13, (bar mitzvah.) at 13 He became a man. 2012 yrs have now passed before manhood. check out lindsey williams latest video for more info. the satan worshipping globalists have been waiting for this time for NWO. huh, even the mayans, hopi indians, and webbot knew!
My daughter, age 20, just yesterday said she was having reservations about having children in light of the mess the world seems to be in. She speaks more from an ecological bent than of economics, but I told her that her feelings were not so different than her mother's own views at the same age. Each generation seems to fear that it will be the last. I told her that faith in your own ability to survive will carry the day. Your intelligence, your skills, your tools. The real things that you acquire, maintain, and can produce with, sell, or barter with. And, if you live with the faith that you will survive, and if you teach your children these values, they WILL survive. And, you have to believe that they deserve a chance to be born for this reason, because if you don't, there are plenty of crackheads downtown that will be having babies and the world will continue to get dumber. Something will happen, hand of God or hand of Man, but something will happen... and the strong will survive.
Well, I am going to start to take cash out of the Bank and keep in an undisclosed location. Yes, fiat Dollars. But, with no interest in a savings account it does not pay in my opinion not to have cash on hand. Nor does it pay in these perilous times to keep it all in the Bank(s).
I am worried that if there is a run on the Bank(s) that there will not be enough Fiat Dollars for everyone to take their money out of the Bank. I do not think that the Fed has actually printed enough Money to keep up with all of the Money electronically created.
Plus, it would give me peace of mind knowing that I can pay my bills even if my Bank account got frozen like MF Global. It would really be a shame to ruin a good credit history if you cannot get access to your Money. Much less have a House Foreclosed on when you have the Money but cannot get access to it.
I guess my greatest fear is losing a property with lots of equity thru no fault of my own and would rather be prepaired with cash on hand to make sure those payment are made. During the S&L Crisis may People had their Money locked up for over 3 years.
Waterfallsparkles
I have a similar set of issues.
Different, but similar.
Firstly, I have owned my home for over 15yrs outright.(I am stuck with it, unless I want to sell,most likely would profit but not to a huge degree).
But, owning it, keeps me STUCK where I am geographically,until I could sell.
Second, I am sick of what once made me feel good about being debt free, and owning it.I wish I had not paid it off.
Now, it's a trap,instead of a feeling of peace,its a prison.Funny, how I knew better than to let things OWN me,and didn't, wound up happening anyway.
Until the reset(if there is a Reset),I would pay as little as posible,if I had to do it over,ON everything.
As far as the paper fiat being printed and there being enough?.
NO way is there enough.Why?, with a 9-1 rate required by the Fed in Normal times,that banks had to hold against our deposits.
There is no real need for excess(inflationary cash sitting around,that they pay the Fed interest on).
Two thirds of all printed USD currency is outside the USA.
Doesn't leave us much here huh?.Feel like making ATM stops?...............LOL
Hi DosZap,
I think you have two options. One is to sell you house even though it is not worth what it was at the peak, you would also be able to buy another house that is equally depressed in value. So, you should not feel trapped.
Second you could consider if you are not moving very far away and have some cash on hand, buying another house and renting the one you currently live in. With it paid off it would make a great investment vehicle. That way you could collect rent while you waited for the Market to come back. You would get a double because you would be able to buy a home under value to live in and still hold the one you have and wait a few years to capitalize on the true value of your home. If you are moving farther away you could hire a management company to take care of and rent your property.
Right now Real Estate is probably the best investment there is. Your money is safe and there are lots of people that need to rent right now. And as Will Rogers always said they are not making any more of it. Even with the Collapse of the Dollar the value of Real Estate has not gone down in value, it has appreciated. Hard to believe but true. The only thing that makes us feel that the value has gone down was the intense spike higher because of the Banks lending to anyone. Yet, most property have not really gone below their prices from around 2004. And the Banks have been dumping below market value just to unload. Once that stops the Market will recover quite well.
Keep in mind we always have choices. We just have to explore the opportunities we have not thought of. So, use your lemmons and make lemmonaid. Never feel depressed or hopeless. Explore the opportunities.
So, take advantage and buy something else and rent the house you have.
p. s. The mortgage on my principal house is paid for. I just owe small mortgages on some of the Rentals.
doszap,very well put.
I see the Stock Market as a Gambling Casino. You put your chips down and hope the price swings in your favor. By the end of the day you take your chips off the table and book your profits or sometimes losses. But, you never keep your Money on the Table over night as someone might steal it.
Kind of like the song. Know when to Fold em know when to hold em. Never count your Money when you are sitting at the Table. Once the Dealing's done take your Money and Run. My Moto.
i see a lot of red flags in the mob outside the kremlin today..............hmmm.
High Plains Drifter
Yes, they do not want Pukin.
They had the Fascist Bstd once, and he really never has left power(he fooled some of them).
He's a damned RED Dictator.Period.
And the protestors know the SOB is more death & decay,and a millstone around the neck of any hopes of freedom.
If you is passing judgement based on FOX news then you be watching the hole and not the dough nut - they be wanting you to do that. Fox reports used videos of the Greek Protests and has not yet apologized. CNN used video from a soccer game and apologized.
It seems the The state depart, through NGO emissaries like the Orwellian branded United States Peace Institute, whose goal is sacrifice Israel and bomb Iran back to the Shah Age are behind the violence in Syria and contracted AL KADA to play the "out of nowhere and never seen before", Libyan Rebel Army.
You gotz to vette your info `fore it be shilled 4 sure.
Any idea on the relevance of this about PM owned through Goldmoney or Bullionvault?
Time of taking delivery?
As long as it's off-balance sheet, who cares?
If the same re-hypothecated securities appear in the footnotes of several brokers and banks on the same day, that's informative, not dangerous.
I love Gorton's comment: "Liquidity requires symmetric information, which is easiest to achieve when everyone is ignorant."
By ignorant, I assume that he means being aware of all material information, per the '33 Act.
This has been an informative article. From what I gather, there have been several attempts over the years to create a workable banking system. In all cases, it appears, that such a system requires either a ‘lender of last resort’ or information insensitivity. Without one of these, we’re forced to conduct all business on a cash and carry basis; not very practical.
There appears to be two different types of broker accounts: custodial and investment. The former is similar to a retail bank account and the latter an actual investment in the broker. The MF Global failure seems to highlight the investment nature of the latter where the clients lost their investment.
Are clients simply naïve, or am I missing something?
The clients lost their collateral...which was posted by the clients with the Futures Commission Merchant (Bear, Lehmans, MFGlobal) as security for the trades (investments) that the clients wanted to make...so, clients' cash, Treasuries, gold etc was repeatedly rehypothecated as allowed under UK law, and directed to UK by US client/broker agreements (Fine print) and when the FCM failed the cllateral was not available anymore to the clients...and they were locked out of their "investments" as well.
Good luck with that. Wait until you see what DTC charges your brokerage firm - which will be passed on to you - to print a certificate. This is virtually no longer done. It could be $500/cert. Now I guess we all know why the brokerage firms went to street name registration.
re Breaking the tyranny of ignorance
Impossible without understanding the words and symbols of language.
Tyler et al, define/spell out all acronyms and obscure terms unknown to, say, an average reader of this blog. The elites do not need your education. The rest of us want to understand.
"the banking cartel need to make everything of virtually infinite complexity so that no one has a clear understanding of what is going on!"
Amen, brother.
It's mindboggling how complex the financial system is for if you strip away the fancy words and ridiculous mathematics, the business model of modern financial institutions is simply that of how to massively leverage other people's hard-earned real assets and skim a nickel in the process.
It's sickening.
I look forward to the reposting of the King report.
The deeper the read on this hyper-whatever-it-is-thinga-ma-bob the more it sounds like pawing a pawn ticket - and then pawning it again all those iteratives make it look like there's more gold, by ordera of Mag, than there really is.
All this stuff is being run out of the UK. It's the center of the shadow banking ponzi - AIG, Madoof, MF Global - Lehman - and who knows how many others. No wonder Cameron vetoed the E-Zone restructuring proposal: He has to protect "The Shadow".
UK has 300 tons of gold. The E-Zone has 10,000 tons. The pound steriling is junk. Yet its been moving higher against the USD. Tells bunches 'bout the sorry state of the USD.
Bear did it, Lehmans Bros. International Europe did it...they all do it...it is part of the miracle of financial innovation.
That giant sucking sound you hear, that is the sound of collateral being returned world-wide. Deleveraging is a bitch, and with re-rehypothecation (ie, multiple repledging leading to multiple claims on the one asset), when Party A calls for its collateral to be returned then a lot of trades have to be unwound...start with Party Z and work your way back...and if everyone does it at once then a vicious deflationary cycle sets in...
One man stands between us and this nightmare scenario...Ben offers us an alternative nightmare scenario, it is up to us to choose wisely.
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"
************
There are no brakes on fractional reserve in the US-
Greenspan bypassed the 12-1 requirements when he allowed nightly checking Sweeps to be implemented
http://2.bp.blogspot.com/_nSTO-vZpSgc/R055UiyjvhI/AAAAAAAABo0/6bjtpLgtI4...
"not NY but London is true hub of financial engineering and infinite leverage " but as stated in the previous article, doesnt any NY firm just set up an office in London and trade infinite leverage there? It's off balance sheet, but it's still there. If London is f(*&ed so is NY. Let them all fail, someone new with hard assets will come in and pick up the pieces. Ron Paul LIQUIDATE THE DEBT, F*() THE BANKERS THAT LEVERAGED THEMSELVES INTO OBLIVION AND PUT THEM IN JAIL IF THEY DID IT WITH OTHER PEOPLES MONEY.
When the collapse happens, eyes fixed on the past firmly, is it Weimar Germany or Russia after Lenin? Or is it Germany of an earlier time?
Lunacharsky's notion of Communism as an artistically enhanced mass religion violated Leninist thought. And yet, Engles thought the Anabaptists had the right idea. During the German Reformation hundreds of thousands of commoners were mobilized by the hope that established clerical and aristocratic order could be replaced by justice and equity based on the divine law of the Bible. After the defeat of the commoners in the Peasants' War, some of the most ardent adherents of social and religious reform attempted to achieve these same aspirations by trying to implement the apostolic model of Acts 2 and 4 through the Anabaptists.
OK ..TYLER ,,, finally ,,, THANKS !
And this is the REAL STUFF : The CITY OF LONDON where more than 75 % of all shady leveraged financial deals in THE WORLD have been incepted and carried out for DECADES ( as I have been trying to SHOUT now for a long time ) with extremely little transparancy and without regulation
And one should also NOT forget .. WHO INVENTED the WORLD of OFF-SHORE HAVENS ( where companies and financial sharks AVOID pying the same TAX as is levied on all normal common people on their exorbitant illgained profits ?
Answer : The CITY of LONDON and BANK of ENGLAND ...and later after initial misgiving also Wall Street ... when they " saw the light "
REf : " Treasure Island : Tax Havens and the Men who Stole the World" by Nicholas Shaxon http://www.amazon.co.uk/Treasure-Islands-Havens-Stole-World/dp/0099541726/ref=ntt_at_ep_dpt_1
And NOW ... the UK with its Prime Minister ,Mr Cameron cannot and does not want to participate in bringing ORDER to the European Financial House ...BECAUSE ... he cannot accept TRANSPARENCY and REGULATION of the CRIMINAL FINANCIAL SYNDICATES of the CITY of LONDON .. which together with the US GOUVERNMENTS insatiable NEED for borrowing ..have brought the WORLD to its Financial Knees ?
And WHY does Mr Camerion not want to do that.. BECAUSE .. the City of London contributes with 46 % of all TAX INCOME in the UK through its FRAUDULENT BUSINESS.. and cannot AFFORD to be without those Funds ..
It is not far from the OPIUM WARS .. the UK waged on CHINA ..in days gone .. what is claimed to be in UK ' LEGITIMATE " INTEREST .. and Americans should understand what are the real questions on the table .. before judging Mrs Merkel and Sarkozy and all the other european leaders... WE ARE TIRED OF THOSE ANGLOSAXON FINANCIAL SHARKS ... who have done NOTHING but bringing MISCHIEF and BANCRUPCY to the World .. the US included ! And NOW ..it is ENOUGH !
well said, the US oligarchy and surrogate UK kleptocracy exposed.
The Charter of the City of London pre-dates the Conquest. William's Charter was merely an affirmation. There is evidence the City of London (meaning the Crown Corporation) has existed since Roman times.
Another epic Zerohedge post. Amazing information. Really, why go to grad school? It's all here.
Tylers, i would love to read a post that explains the inner workings of the on balance sheet/off balance sheet distinction. The IMF article shows that the Flow of Funds report from the Fed only tracks the on balance stuff. The MF Global story has shed some light on off balance sheet techniques.
I'm sure you know of some great report on that.
Off-balance sheet | shadow banking | rehypothecation
The story of our oppression.
Yes ... to depict REAL CAPITAL FLOWS and LIABILITIES ... would be of utmost IMPORTANCE .. in order to UNDERSTAND
And as a small OBJECTION : since when have assets been "Information - IN-sensitive " ?
NEVER ! Anyone claiming such should be viewed as a highly suspect Car-dealer wanting to sell You an old wreck .. polished up by a make-up artist
Below a LINK which further tries to clarify the SUBJECT ... well worth a read and study !
1. http://www.bis.org/publ/joint26.htm
2. http://www.bis.org/publ/otc_hy1111.htm
I dont know ..here on these pages ... wirth all these readers somehow a bit knowledgable ..at least INTERESTED in Financial matters .. with the mediation of ZEROHEDGE .. a PRIZED COMPETITION should be arranged .. WHO is able to come forward with the most accurate and representative FLOW-CHART depicting CAPITAL STREAMS on a GLOBAL SCALE .. incorporating all the shady financial instruments ..in play . I hereby PLEDGE the best bottle of RED WINE i can find .. to such a prize winner ( 2 ..if necesary .:)
5 stars for Zerohedge advertisement for Sniper Rifle Scopes.
Well, now we know what you have been shopping for. I keep getting adds about Pet Meds.
Well, now we know what you have been shopping for. I keep getting adds about Pet Meds.
"Which is where sites like Zero Hedge step in - to expose "shadowy" places where things are best left unseen".
Amen to that. Thank you Tyler and ZH.
DavidC
So, the lowest event horizon is made up of constants, with no change and minimum diversity. As you go up the rungs, variables increase in number and lies increase in complexity. Anxiety is a function of deviation from normalization. Anything/anyone that does not fit within the band of an event horizon is considered dumb or dangerous by the insiders.
As you build your rung, you want to fit, or at worst be considered dumb. If you attempt to pull individuals or organizations up to another rung, their anxiety increases and you become dangerous. Their social programming will automatically employ increasing anxiety as necessary to stop you. Trade incremental organizational improvement for your individual rung, to load your spring as you go, separating charge accordingly.
After the holiday, we will begin with twisted pair catalysis of the vortex and time control through the channel - drilling the tap.
"Thus the heavens and earth were completed in all their vast array...In the middle of the garden were the tree of life and the tree of knowledge of good and evil...For this reason a man will leave his father and mother and be united to his wife, and they will become one flesh...I heard you in the garden, and I was afraid because I was naked; so I hid...Cursed is the ground because of you; through painful toil...It will produce thorns and thistles...After he drove the man out, he placed on the east side of the Garden of Eden cherubim and a flaming sword flashing back and forth to guard the way to the tree of life...sin is crouching at your door; it desires to have you, but you must master it...because you have not witheld..."
"About $2 billion worth of European bonds owned by MF Global were bought by billionaire investor George Soros's family fund, the Wall Street Journal wrote on Friday, quoting people close to the matter."
We Zero Hedge readers love "shadowy"places where things are best left unseen......stories.......
Like getting candy...