The Lunacy of Unlimitted Re-Hypothecation

Discussion in 'Economy' started by JimBowie1958, Jun 24, 2012.

  1. JimBowie1958
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    JimBowie1958 Old Fogey

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    Why The UK Trail Of The MF Global Collapse May Have "Apocalyptic" Consequences For The Eurozone, Canadian Banks, Jefferies And Everyone Else | ZeroHedge

    Wow, the possibilities of money laundering alone are kind of mind-boggling.

    Isnt it funny how bankers can simply make up cash out of thin air and never get charged with counter-feiting?
     
  2. Widdekind
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    Widdekind Member

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    Hypothecation - Wikipedia, the free encyclopedia

    "Hypothecation" means pledging collateral for a loan, until the loan is fully repaid. That collateral is "hypothetically" bought and controlled by the lending bank, until the loan is fully repaid.

    "Re-Hypothecation" means the bank can turn around and lend, against that collateral. So, the bank had money, and lent it out, to somebody who pledged collateral. Then, with that loan on their books, they re-lend again, against the collateral they "bought hypothetically" with the money. Some "double counting" can occur, if-and-when the loan is partly repaid, so that the bank only partly owns the collateral -- yet is able to lend against more of that collateral, than it owns, even up to the entire amount, of the original loan / all of the collateral.
     
  3. itfitzme
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    itfitzme VIP Member

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    This idea of re-loaning seems to go way back to the days of simply gold coin and some guy with a bank vault, where the gold coins could be stored securely. I haven't heard the modern process described in the level of detail that I find satisfactory. Unfortunately, the more generalized explanations quickly open up to multiple interpretations.

    In the old gold coin-bank vault example, as I read it, it is fairly simple. Bob has a bunch of gold coins that he deposits with the bank, having then stored securely. The bank now can loan out the gold coins to Chuck who uses them for payment to buy cattle from Doug. Being a small community, Doug deposits the gold coins right back at the bank. Now, the bank has the gold coins again and can loan them out to Edward who uses them to purchase something.

    In our more modern system, the community is pretty large, spanning the globe. And while Chuck may not deposit them back into the same bank, there is someone else redepositing funds from some other bank.

    Is that the basic idea here?
     
  4. Widdekind
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    Widdekind Member

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    the key is the bank's Balance Sheet. Deposits, for which banks are liable (like an accounts payable), are their "liabilities" (L); cash, loans (like accounts receivable), or other assets (collateral), are their "assets" (A).

    "Re-hypothecation" is where a bank has a balanced Balance Sheet; and their assets include a collateralized loan (say $1000). As that loan is paid back, their asset column shifts, from "all loan" ($1000), to "part loan part cash" ($500 loan, $500 cash). But, when the loan is not repaid fully; and because the borrower could "hypothetically" default, in which "hypothetical" case the bank would wind up with a $1000 collateral (some jewels, say); then, the bank can "pretend" that it has $1000 cash-value in its A column. So, it really has ($500 loan outstanding + $500 cash repaid), but can act like it has ($1000 cash). Vaguely, "re-hypothecation" allows banks to count collateralized "secure" loans as "Tier I" assets, which are "as good as cash", and can count as legal "cash reserves". Thereby, the bank can lend more of its actual cash, which is now "excess reserves", making more loans, and earning more interest.

    Inexpertly, perhaps 'tis better to say, that banks can "lend against" excess cash in reserve -- banks don't lend only cash. Instead, if they have excess reserves, they can generate new deposits (L), facing new loans (A), lengthening their balance sheets, until their new total deposits are at reserve-ratio limit. So, if cash is deposited:

    A | L
    -------
    $1 $1

    If the reserve ratio is 10%, then when somebody walks in, wanting a car-loan, the bank can:

    A | L
    --------
    $1 $1 (cash facing original deposit)
    $9 $9 (loan facing newly loaned-into-existence deposit)

    the bank has assets (A) = $1 cash, $9 loan accounts receivable; and liabilities (L) = $10 deposits. The guy wanting a car walks out with $9 added to his bank account; and a legal debt to the bank, for the same amount. But, in the short-term, with his fattened account, he can buy the new car. So, inexpertly, banks don't take in cash, and then on-lend suitcases of cash. Instead, they take in cash, and then use the same to underwrite new loans (A), the value of which is deposited into the borrower's bank account, as a new deposit (L). In the long-term, the borrower owes the bank. In the short-term, their own deposit account gets a boost. The point being, loans take the physical form, not of suitcases of cash; but of checks, drawn against "loan-fattened bank accounts". The loan (A) balances against the expanded deposit (L) of some one of their customers.

    With "re-hypothecation",

    A | L
    --------
    $1 ... (cash facing ...)
    $1 ... (loan outstanding facing ...)

    is legally as good as

    A | L
    --------
    $2 ... (cash facing ...)

    So, legally, the bank has (pseudo-)cash, more reserves, more excess reserves, and so can make more new loans. If the loan is fully repaid, the bank has the actual cash, anyway; if not, the bank keeps the partial payments ($500), and pawns the jewels for ($1000), and, again, has more-than-enough cash on hand, to count as legal cash reserves. Simply stated, albeit inexpertly, "re-hypothecation" counts collateral, as cash (for reserve requirements).
     
    Last edited: Jun 29, 2012
  5. Widdekind
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    Widdekind Member

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    bank lending depends on depositing (of cash)

    trying to keep track of units, both borrowing from, and lending by, banks, are flows of credit-money [$/year]. Over-simplistically, banks attract cash off the street, with their interest-rates; then use the cash to back new loans, to borrowers. Now, interest-rates are the 'price' of credit, reflecting the ratio of demand for credit, to supply of credit. And, since banks rapidly on-lend the excess reserves they accumulate, the "supply of loanable credit" is basically the flow of cash in off the street [$/year]; whilst the "demand for loanable credit" is the flow of loans from banks [$/year]. For example, if banks stopped loaning, then they would still gradually accumulate cash, from the street. So, "supply" would increase, tending to decrease interest-rates, until inflow of cash off the street [$/year] matched outflow of loans [$/year]. Interest-rates match inflow of cash (new deposits) to outflow of loans (new loans), with a "money multiplier" effect.

    Historically, for the US, most recessions involve decreasing employment, decreasing wages, & decreasing depositing into banks. Thus, recessions reduce the supply of loanable funds, raising interest-rates (i% ~ D/S). But, during depressions, interest-rates fall, implying that even demand for credit has fallen. So, in a short-term recession, people keep borrowing, even whilst not actively earning -- evidently, they expect recessions to be short. But, in a long-term depression, people even stop borrowing -- evidently, they expect depressions to be long. Inexpertly, the different behaviors of interest-rates, in recessions vs. depressions, implies different psychological estimations of the duration of the downturn. In depressions, for some reason, people stop borrowing, as if not foreseeing any income, in the near future, with which to repay new debts. Perhaps some index, resembling "consumer confidence", remains higher in recessions, such that people keep borrowing through expectedly short downturns. Whereas, in depressions, some ratio of debt to (estimated) future income exceeds some threshold, such that everybody even stops borrowing. High debts (from speculative bubbles) and low estimates of future incomes generate depressions ?

    From Richard Koo's concept of "Balance Sheet Recessions", where borrowing ceases, when net-worth is negative; then perhaps there are "Balance Sheet Expansions", when borrowing increases, when net-worth is positive? To get the units to work out, perhaps the demand for credit [$/year] is some fraction per year [1/year] of net-worth [$], defined as the net present value, of assets [$], and (discounted) future income streams [$], less liabilities & (discounted) interest payments [$] (D ~ f NW) ? If so, then net-worth (NW) would be correlated to the rate of borrowing new loans, and to interest rates.
     
    Last edited: Jun 30, 2012
  6. dilloduck
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    dilloduck Diamond Member

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    It's weird how money manipulators work. If I save cash in the bank I get some measly 2% interest on it or something but if they lend the very same cash to someone else it's suddenly important enough to bring in 10-20 % interest rates.
     
  7. Widdekind
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    Widdekind Member

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    The "price" (real interest rate) vs. "quantity" (real per capita borrowing) chart for the US credit market seems to show the effect of banking deregulation under Pres. Reagan. Before 1980, the "demand for credit curve" (in real per capita terms) was low; after 1980, the "demand for credit curve" was high. Deregulation seems to have shifted the credit demand curve outwards. At all times, recessions (OPEC oil embargo 1974-75, S&L bubble 1989-95, Housing bubble 2007) restrict credit, such that annual borrowing falls far below trend. Generally, a 2% fall in the real interest rate generates an additional one thousand real (2005) dollars of borrowing per person per year. During downturns, demand for credit retracts to a minimum, of about a thousand real (2005) dollars per capita, perhaps representing some "autonomous" borrowing, for "autonomous" expenditures ? During bubbles, demand for credit can balloon far above trend.
    [​IMG]
     
  8. waltky
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    waltky Wise ol' monkey Supporting Member

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    Those who disregard the past are doomed to repeat it...
    :eusa_eh:
    Financial Crisis Offers Lessons for Future
    September 11, 2012 - Four years ago, the collapse of Lehman Brothers, a huge financial firm, marked the start of the worst recession in decades. Frightened investors dumped stocks, banks stopped lending, the economy shrank, and millions of people lost jobs, homes, and savings. The crisis prompted financial firms and regulators to make changes intended to prevent another financial disaster. But some experts say it could happen again.
     
  9. expat_panama
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    expat_panama Silver Member

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    One thing is to understand that this is how the world's been for hundreds, if not thousands of years. Another is to see how this is a good thing. What I'm finding on these threads is that too many people can't see and understand the process and cling to a blind hatred and a willful ignorance.
     
  10. EdwardBaiamonte
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    EdwardBaiamonte Gold Member

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    as a liberal you lack the IQ to understand capitalism. Here's how it works: if you want to go heavily into debt to make lots of risky loans you are free, just like the banks, to do it.

    If you want 100% safety and 2% interest you are free to do that too!


    If you are a liberal or communist you want the government to regulate everything only because you lack the IQ to understand how capitalist experimentation and creative destruction works.
     

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