REHYPOTHECATION—A SCARY ARTICLE.

REHYPOTHECATION—A SCARY ARTICLE. I came across this story in the middle of the night. I will give a very cursory summary, but if you’re not yet worried enough about the financial crisis, you should read the excellent article (by Tyler Durden at Zerohedge.com). Hypothecation is another term for a borrowing supported by collateral. Customer provides MF Global (for the sake of example) with securities as collateral. MF Global provides in its contract with Customer for the right for MF Global to use the Customer’s securities as collateral for a borrowing (a rehypothecation) by MF Global. In the United States, there are regulatory limits on how much MF Global can use of the collateral for its own borrowing. In London, there are no regulatory limits; the English subsidiary of MF Global can use 100% of the customer’s collateral for MF Global’s own collateral. The next lender can repeat this. And the next…This is what happened with Lehman Brothers. (The article says about Lehman : “With assets being re-hypothecated many times over…”) The result is “chains of counterparty risk, where multiple re-hypothecation borrowers use the same collateral over and over again.” The amounts of rehypothecation engaged in by major institutions are staggering. The article gives as examples JP Morgan($546.2 billion) and Morgan Stanley ($410 billion).