STOCK MARKET WATCH, Monday, December 12, 2011

[Roland99]

73. Of course we don't need financial industry regulation!!!!

MF Global and the great Wall St re-hypothecation scandal
http://newsandinsight.thomsonreuters.com/Securities/Insight/2011/12_-_December/MF_Global_and_the_great_Wall_St_re-hypothecation_scandal/

In fact, by 2007, re-hypothecation had grown so large that it accounted
for half of the activity of the shadow banking system. Prior to Lehman
Brothers collapse, the International Monetary Fund (IMF)
calculated that U.S. banks were receiving $4 trillion worth of funding
by re-hypothecation, much of which was sourced from the UK. With assets
being re-hypothecated many times over (known as “churn”), the original
collateral being used may have been as little as $1 trillion – a quarter
of the financial footprint created through re-hypothecation.

...

Hence, when MF Global conceived of its Eurozone repo ruse, client funds
were waiting to be plundered for investment in AA rated European
sovereign debt, despite the fact that many of its hedge fund clients may
have been betting against the performance of those very same bonds.

...OFF BALANCE SHEET

As well as collateral risk, re-hypothecation creates significant
counterparty risk and its off-balance sheet treatment contains many
hidden nasties. Even without circumventing U.S. limits on
re-hypothecation, the off-balance sheet treatment means that the amount
of leverage (gearing) and systemic risk created in the system by
re-hypothecation is staggering.

Re-hypothecation transactions are off-balance sheet and are therefore unrestricted by
balance sheet controls. Whereas on balance sheet transactions
necessitate only appearing as an asset/liability on one bank’s balance
sheet and not another, off-balance sheet transactions can, and
frequently do, appear on multiple banks’ financial statements. What this
creates is chains of counterparty risk, where multiple re-hypothecation
borrowers use the same collateral over and over again. Essentially, it
is a chain of debt obligations that is only as strong as its weakest
link.

With collateral being re-hypothecated to a factor of four (according to IMF
estimates), the actual capital backing banks re-hypothecation
transactions may be as little as 25%. This churning of collateral means
that re-hypothecation transactions have been creating enormous amounts
of liquidity, much of which has no real asset backing.