In Britain, quite incredibly, the rules were far looser regarding re-hypothecation than even here in the States. The Brits even allowed U.S. brokerage firms to circumvent the fairly flexible U.S. rules! In Britain, there is no limit to the amount of leverage against borrowed collateral through re-hypothecation. Unlimited leverage? It is "as simple as having MF Global UK Limited, an English subsidiary, enter into a prime brokerage agreement with a customer; a U.S.-based prime broker can then immediately take advantage of the UK's unrestricted re-hypothecation rules.
America's shadow banking system -- the alternative system existing outside of the regulatory rules -- is highly dependent on derivatives and leverage. In particular, it is highly dependent on the sort of accounting fraud and credit games (like the re-hypothecation and off-balance sheet repos) that led to MF Global's demise, which has revealed an enormous degree of systemic risk that remains in the current banking system. Therefore, while MF Global was the first firm that tapped into segregated client monies to speculate and lose it all, it won't be the last.
Part 3: Crush Labor and Impose Austerity: The Bankster Goal in the Eurozone?
As Mike Whitney said recently in his article at Information Clearing House, imagine if your banker offered to lend you $150,000 to make up for the money that you'd lost on your home since the housing bubble burst in 2006. And, let's say, he agreed to lend you this money for 3 years at rock-bottom rates of 1 percent, provided that you post the contents of your garage (i.e. rusty bikes, a bent basketball hoop, an old dollhouse, and rodent-infested luggage) as collateral on the loan. Would that seem like a good deal to you? Of course you'd jump on it.
Well, quite recently the European Central Bank (ECB) made this very same offer to over a hundred underwater banks in Europe, awarding them $640 billion (489 euros) in dirt-cheap 3-year loans in exchange for all manner of dodgy collateral for which there is currently no market. Now you, dear reader, know that when you try to sell something on Craig's List, and there's very little interest; you have to drop the price in order to attract a buyer. That's just how supply-demand dynamics work in a free market, right?
Au contraire. In fact, this rule never applies to bankers. When the junk assets on a bank's balance sheet begin to fall in value, the banks just ring-up their big brother at the ECB or the Fed and demand a bailout, er, I mean, "swap liquidity for collateral that is temporarily impaired." But the truth is, the garbage that the banks have accumulated -- particularly the sovereign bonds from Italy, Spain, Greece, etc. -- is not merely "impaired": These bonds will never regain their original value because the loans were made at the peak of a bubble. So, there's as much chance that Greek bonds will bounce back in three years as there is that that tacky $650,000 McMansion you bought in Encinito in 2005 will claw its way back to par.
But that's not going to happen, as Mike Whitney points out.
So, the $640 billion that the ECB forked out on Tuesday, is basically a whopping-big gift to the banksters that will probably never be repaid to any large extent. And if you have any doubt about this, just take look at the Fed's balance sheet which has exploded to nearly $3 trillion. You'll notice that the $1.45 trillion in mortgage-backed securities (MBSs) that Bernanke so "generously' bought from the banks two years ago are still on the Fed's books. Why? Because no one in their right-mind would buy these turkeys. And, if the Fed were to put their stash of MBSs up for auction; the sale would further depress the assets (the remaining MBSs, not yet unloaded to the Fed) on the banks' balance sheets triggering another financial crisis. (In fact, this actually happened about a year ago when the government experimented with bonds from the AIG fund. Not only did the auction fail, but it also sent the equities markets into a nosedive.) So, just as the Fed will eventually have to account for the losses on their pile of MBSs, so too will EU banks have to write down the losses on their sovereign bonds. And that will push many of Europe's banks into bankruptcy, which will undoubtedly trigger another round of loans. When financial institutions are insolvent, their only choice is to extend and pretend. Obviously, the ECB sees its job as helping with this fakery. The show must go on! You've heard of political theater? This is financial theater.
This is a familiar pattern with central banks. They create the easy money and loose regulatory environments where bubbles emerge, and then they provide "limitless" liquidity so that their bankster friends don't lose money on the inflated value of their assets. That's what the recent $640 billion boondoggle was really all about: propping up toxic bonds that are worth a mere fraction of their original value. Financial theater. And the show must go on. (The raw truth would bring down the entire house of cards, and we can't have that!)