Marketplace Whiteboard:

If ever there was a word that you’d expect to find in a Harry Potter  novel, it’s re-hypothecation. This a classic example of financial  people inventing impenetrable terminology to make their business look  like a black art. “Oooh, re-hypothecation, it must be magic!”

Well it isn’t.

The term “re-hypothecation” came up a lot during the MF Global meltdown; It’s quite a common term in the securities market – but what does it mean?

To explain re-hypothecation, we have to explain hypothecation. And  hypothecation is pretty simple. It’s when you lend someone money and let  the borrower keep the collateral.

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Source:
Re-hypothecation: How it’s related to MF Global
Paddy Hirsch
Marketplace Jan 4, 2012
http://www.marketplace.org/topics/business/whiteboard/re-hypothecation-how-its-related-mf-global

Category: Derivatives, Legal, Video

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

5 Responses to “Re-hypothecation: How it’s related to MF Global”

  1. Savage1701 says:

    It seems to me the MF Global clients who lost their cash would be the “Helens” of this situation, not the “Jimmy The Sharks”.

    Much to the contrary, it would be as if Helen woke up and found her car gone, or at best, repossessed and sitting in a impound lot that was guarded. She could stare at the car, and would be expected to make payments on it, but she could not drive it to work to be economically productive. Instead, unable to get to work to earn a paycheck, she would become insolvent, as many MF Global clients have.

    Jimmy The Shark (JP Morgan, for example), is fine because they are sitting on 600+ million of cars still titled to all the “Helens” or clients.

    What Mr. Hirsch fails to point out is that the “Jimmy the Shark” crowd MIGHT get burned, but they, viz. arcane bankruptcy laws, are first at the trough for collateral (Helen’s car) that she never reasonably expected she would lose title to, or have taken away from, her, since she was “playing by the rules” in terms of a legally correct loan document, making her payments on time, etc. Which is, of course, what many MF Global clients also did. They maintained huge amounts of cash, held relatively small positions, and were in NO danger of a margin call.

    Furthermore, Mr. Hirsch is either being quite subtle or very naive in that he also fails to point out that most “sharks” get their money one way or another. Either pay up or get your legs broken. That is, indeed, what the counterparties have done to the allegedly sacrosanct segregated accounts of MF Global clients.

  2. luke says:

    Barry,

    I don’t believe this video is accurate. In repo’s and reverse repo’s that MF global and many money market funds do, the borrower does not get to keep the collateral like in an auto loan. They don’t get a clean title, but they have the actual collateral.

    In the type of reverse repo MF global did they would have had to send the collateral to the counterparty (if a bi-lateral repo) or to JPM or Bony (if a tri-party repo as JPM and Bony clear all tri-party repos). Either way they don’t keep the collateral. If the counterparty then decides to rehypothecate it they can, and the commentator correctly points out there is no limit to rehypothecation in the UK, but the limit is 130% in the US and 0% in Canada, thus explaining why Canadian account holders in MF global have already been made whole.

    The commentator is correct to point out that rehypothecation can be dangerous because essentially there are probably trillions of “collateralized” loans in the shadow banking system that are really not collateralized at all because the collateral has been re-used (re-hypothecated) over and over.

    This whole issue perpetuates the “too big to fail” mess where the counterparties have to be bailed out to keep the shadow banking system (money markets) from breaking the buck. You can let the MF globals fail, just not the counterparties on the other end.

  3. Yossarian says:

    If Helen is supposed to represent the MF Global customers who lost their assets then the analogy seems to be flawed. Did the customers supply the collateral to MF Global in return for a cash loan or were the assets just used as collateral due to the fact that they resided in a margin account that qualified for a cash loan? It seems that MF Global customers were left with nothing, rather than equivalent cash, in return for their seized re-hypothecated collateral. Am I missing something?

  4. luke says:

    Yossarian,

    You are not missing something. The video is flawed per my previous comment. MF global did reverse repos meaning they borrowed money in exchange for collateral. They used the borrowed money to buy Greece, Italy sovereign debt. In order to secure the loan they would have had to send their counterparty they entered into the loan with collateral. Probably what happened is they used the sovereign bonds they purchased as the collateral, and as the price dropped, their counterparty would have demanded more collateral for the loan to maintain the initial haircut and they couldn’t make the margin calls. With the leverage they were using it wouldn’t have taken long before they were in trouble. Probably as a last ditch effort they would have had to use customer funds/collateral from the segregated accounts to meet their margin calls and the rest is history.

  5. V says:

    A game of hide and seek would be a better analogy of the MF Global situation than this video.