Just a few years ago, central bankers dared not breathe the word rehypotehcation - after all it was the secret fabric that held the shadow banking system together, which was a critical hub to perpetuating the central bankers' plan of reflating assets and creating a wealth effect if only for the 1%, while keeping the rest content with free Obamaphones and endless promises of "trickling down" which four years into Bernanke's grand monetary experiment has yet to materialize. Then, little by little, more and more started to realize that the shadow banking system, whose fiath-based (sic) liabilities amount to somewhere between $60 and $100 trillion (of credit money) globally, is precisely the inflation buffer that has allowed central banks to engage in round after round of QE, which has sent global stocks to all time highs, while keeping the world mired in the longest economic depression since the 1930s (explained here).

Of course, the one inadvertent side effect of all this constant meddling which be definition requires the monetization of quality collateral in order to generate new fungible money, was the gradual disappearance of all such quality assets which private investors could buy, then pledge back via repo and other conduits and use proceeds for risky investments. Such as Treasurys. Which is why recently none other than the TBAC warned that the US is suddenly facing a $10+ trillion high quality collateral shortage in the next decade. As we have also explained, this is a major problem for the Fed which at current rates of QEeing, will monetize all Treasury duration exposure in roughly 5 years - at that point there will be virtually no collateral left and the Fed will be finally out of both tools and ammo. Which in turn is why the Fed is desperate to restore the "moneyness" of assorted private sector assets in the time it still has with QE, and convert them to "high quality collateral" status, or eligible for repo and money creation via conventional bank conduits.

Indeed, the TBAC admitted as much in the confidential appendix to its Q2 slide presentation to the US Treasury when it said:

Private sector generation of money like collateral helps policymakers over long periods by:

Slowly reducing the demand for money

Increasing financial deepening

Supporting financial globalization

The more restricted the private sector’s ability to create safe, liquid, and moneylike collateral, the harder the public sector must work to supply it through deficits and easy monetary policy.

We will have more to say on this in a future post when we discuss just what the real catalysts for the Fed's unwind are (hint: nothing to do with the market, and nothing to do with inflation or unemployment) and what Ben Bernanke is seeking to accomplish. It is a fascinating topic, and one which we are confident means Bernanke's replacement will be none other than... Bernanke.

But before we go there, a key thing to ponder is that in all activities involving shadow banking, and now that quality collateral, in its definition of being "accepted by all", is scarcer than ever, involve the rehypothecation of certain assets using collateral chains of assorted lengths, which in turn dilute the links of title and ownership between owner and owned, in some cases (like MF Global and Lehman) to infinity, in effect confiscating an asset and plunging it into the bottomless abyss of the shadow banking system.

Furthermore, as we reported recently, none other than Europe has started a crack down on rehypothecation. We are confident that once Deutsche Bank et al realize that this may in fact be serious - a development which would, if completed, collapse their ability to operate on shadow margin and extend their asset base, they will promptly put an end to the silliness.

However, the good news is that with every incremental public instance of the rehypothecation discussion, more are focusing their attention on just how it is that true credit money creation works in the modern world (hint: nothing at all like how the textbook monetarists, Magic Money Tree growers, and all those others who still rely on economic concepts developed in the 1980s and before think).

The most recent, and perhaps most notable, observation on the topics of asset encumbrance, collateral and rehypothecation was none other than the BIS with its just released report titled appropriately enough, "Asset encumbrance, financial reform and the demand for collateral assets." In this report, variants of the word "rehypothecate" appear no less than 24 times. More importantly, the whole point of the paper is to serve as a warning, which means that slowly but surely the world's bankers are finally willing to expose in broad daylight (ironically), the true risks permeating the real financial system located deep in the shadows, where maturity, risk and collateral transformation all take place, however without the nuisance of deposits. Whether this is so they can abuse it all over again (most likely) or out of actual altruistic (unlikely) motivates, is unclear.

However, for those still confused by what remains a very nebulous topic for most, here is what the BIS has to say on the key topic of rehypothecation and its assorted instances in modern finance.

Rehypothecation and reuse of collateral assets

Rehypothecation refers to the right of financial intermediaries to sell, pledge, invest or perform transactions with client assets they hold; and it allows prime brokers and other financial intermediaries to obtain funding using their client collateral. Collateral reuse, in turn, usually covers a broader context where securities delivered in one transaction are used to collateralise another transaction, including the ability to reuse collateral through change in (temporary) ownership. Yet the terms rehypothecation and reuse of securities are often used interchangeably; they do not have distinct legal interpretations.

Certain types of collateral rehypothecation (and reuse) can play an important role in financial market functioning, increasing collateral velocity and potentially reducing transaction and liquidity costs. Rehypothecation decreases the (net) demand for collateral and the funding liquidity requirements of traders, since a given pool of collateral assets can be reused to support more than one transaction. This lowers the cost of trading, which is beneficial for market liquidity.

Securities lending-type transactions (including collateral swaps), which have been structured as collateralised loans, would not exist without rehypothecation. In the repo market, participants would not be able to cover short positions without the ability to reuse collateral. However, repos do not directly rehypothecate collateral because they are structured as a sale and repurchase transaction.

While certain types of rehypothecation can be beneficial to market functioning, if collateral collected to protect against the risk of counterparty default has been rehypothecated, then it may not be readily available in the event of a default. This, in turn, may increase system interconnectedness and procyclicality, and could amplify market stresses. Therefore, when collateral is rehypothecated, it is important to understand under what circumstances and the extent to which the rehypothecation has occurred; or in other words, how long the collateral chain is.

And some of the more vocal warnings:

A particular aspect that has received considerable scrutiny in the policy debate on securities financing markets is the extent to which rehypothecation activities should be permitted. The recent crisis experience suggests that greater reliance on rehypothecation in financial intermediaries’ balance sheets will increase interconnectedness and make them more vulnerable to financial shocks. Rehypothecation of client assets can also delay the recovery of assets or even impose losses on beneficial owners. In addition, it can prompt intermediaries to build up leverage in good times, contributing to increased procyclicality of the financial system.

But most importantly:

Financial intermediaries should provide sufficient disclosure to clients when collateral assets posted by them are rehypothecated; rehypothecation should be allowed only for the purpose of financing the long position of clients and not for financing the own-account activities of the intermediary; and only entities subject to adequate regulation of liquidity risk should be allowed to engage in the rehypothecation of client assets.

Ironically, using rehypothecation for the purposes of financing the own-account activities of the intermediary, is precisely what happens every single day in every single, and certainly TBTF large (see JPM) bank.

Could it be that some of the forces behind the bank of central banks are starting to realize just how close to the precipice the world truly is and are now actively cautioning their private sector peers to step back from the ledge or everyone gets it?

If so, and here is a chance this is true, we expect to see one of the most epic public-private sector conflicts in financial history, because in a world rapidly devoid of collateral and quality assets against which to margin and build leveraged operations, without rehypothecation the ability to generate mindnumbing bonuses for the banker superclass becomes null and void.

And after all, preserving the cash flow associated with levering every possible asset as many times as inhumanly possible and wagering it, preferably with zero risk, in a coopted and manipulated market, is what it is all about...

http://www.zerohedge.com/news/2013-05-29/solid-5-year-auction-follows-poor-2-year-dealers-left-lowest-ever-allocation

Solid 5 Year Auction Follows Poor 2 Year; Dealers Left With Lowest Ever Allocation

Submitted by Tyler Durden on 05/29/2013 13:15 -0400

Bond

High Yield

POMO

What a difference 24 hours makes: if yesterday's 2 Year bond auction was weak from beginning to end, today's 5 Year showed that any fears of a "great vortexing" in the market can be largely forgotten. The 5 Year, which was expected to price 0.1 bps over 1.05%, and whose WI was trading at 1.048% at 1 pm, just priced at a stop through high yield of 1.045% - quite better than many had feared. The Bid to Cover also was hardly disappointing, coming at 2.79, just shy of the TTM average of 2.83. But the most notable component was the Dealer take down: if yesterday Dealers couldn't get their hands on enough bonds in the final allocation, today it was the Directs and Indirects that took down a combined 67.4% of the auction, leaving just 32.6% for Primary Dealers, the lowest in our dataset, and likely ever. Something tells us Dealers are very eager to load up on as many repoable bonds as they could yet failed: earlier today, the OTR 10Y CUSIP was among the Fed's exclusions in today's POMO, which brings the question - is the TSY collateral shortage starting to spread?

http://silverdoctors.com/jim-sinclair-entire-us-banking-system-missed-a-bail-in-collapse-by-a-hair-tuesday/#more-27229

From Jim Sinclair:

The entire Western World banking system just missed the need for a bail-in by a hairs length.

The next crisis in finance in North America will be a product of the FASB, the Guardians of Auditing, allowing banks to value OTC derivative paper at whatever the bank wishes. This is a camouflaged black hole loss unstated that Western Banking system deposits could fall into to disappear partially or wholly, made up of your deposits. Washington made moves to override the CFTC, mandating proper valuations which the FASB has run away from. Had the banks been required by the CFTC to value these derivatives at anything resembling a real market (there isn’t any markets for the legacy OTC derivatives of 1991 to 2008), we would have had another banking crisis in the USA on Tuesday after Memorial Day. The USA just missed another banking crisis by a hair’s length. Next time it will be closer.

If the banks had to realize the real loss in this paper, now valued way above real worth, facing that loss would vaporize the bank’s entire capital, impacting the next line of financial defense which is the funds of the depositors, seriously reducing to totally wiping out your deposits. This distance between the bail in of Cyprus and of the entire Western financial world stands on the question of honestly valuing OTC derivatives or not lying about the value of the legacy paper banks are carrying. This is the real PONZI of not just the century but all written history in finance. The real number of notional value of OTC derivatives outstanding is not $700 trillion but rather over a quadrillion as it stood and was reported by the BIS printed hear before the BIS reduced the number to $700 trillion by adopting a new computer program for valuation named “Value to Maturity,” a total cartoon.

We, the entire Western Financial World, are a bankruptcy just waiting to happen.

Had the CFTC implemented this regulation before it’s alteration, which is in fact a cancelation, you would have been bailed-in. Without this cancellation of this standing regulation, the USA would have had to have Bail-In Tuesday.

This is why I will be speaking in London next week, not because I need to see the place for the 100th time.

5 Biggest Banks Gain another Victory in Control of $700 Trillion Derivatives MarketTuesday, May 21, 2013

Federal regulators have softened a new regulation intended to make the derivatives market—which helped cause the financial crisis—more competitive among banks. A derivative is a contract whose value is based on other underlying assets, such as stocks, bonds, commodities, currencies, interest rates and market indexes.

Currently, just five banks control 90% of all derivatives contracts: JPMorgan Chase, Citigroup, Bank of America, Morgan Stanley and Goldman Sachs. The Commodity Futures Trading Commission (CFTC) had planned to require firms wanting a price for a derivatives contract to contact at least five banks.

But after lobbying from financial institutions, the CFTC lowered the requirement to two banks. CFTC officials claim the standard will increase to three banks in about 15 months.

The $700 trillion derivatives market allows companies to essentially gamble on deals made on Wall Street. Such activity nearly destroyed insurance giant American International Group before the federal government rescued it.
-Noel Brinkerhoff

More…

Copper as collateral - and with CFFDs unwinding......

http://www.zerohedge.com/news/2013-05-29/copper-withdrawal-orders-lme-soar-record

Copper Withdrawal Orders From LME Soar To Record

Submitted by Tyler Durden on 05/29/2013 21:00 -0400

While some (such as Bloomberg) see the unprecedented rise in orders to withdraw copper supplies from inventory at the LME as an indication of "improving demand," we suspect the huge demand bias from Asia (read China) suggests more is at play here than 'hope' in economic surprises. While the reasons are still unclear, the timing of this spike in demand is very close to our recently discussed concerns over the collapse in the Chinese Copper Financing Deal (CFFD) rehypothecation-based funding system. The unlimited "collateral" capacity of the previously described funding chains means that there may simply not be enough copper in bonded warehouses to meet the Letter of Credit needs once the copper warrants start being demanded upon LC termination. So, perhaps, the surge in LME delivery requests reflects a desperate demand for physical copper to meet these unwinding funding deals' needs. Either way, just as we saw gold vaults promptly emptied post the mid-April precious metals crash (especially that of JPMorgan), this sudden surge in physical demand bears very close watching.

Here is the chart of the record demand for copper from LME inventories...

And as a reminder (from our previous deep dive),

And remember that the final step of the CCFD debacle involves the overissuance of L/Cs related to any one specific bundle of copper, without limitation.

Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration.

Hence this spike in demand in the LC (letter of credit provider) trying to meet the demand of real collateral (as if a fractional reserve banker suddenly had to meet all his account needs at once). This offers some explanation for the recent pop in copper prices but misses the critical next step.

Once that copper is delivered to the LC issuing bank, and the CCFDs are unwound (due to the state intervention that is expected) then the bank has no need to carry a high cost commodity and may deluge an already over-stocked market.

http://www.billbonnersdiary.com/articles/bonner-fed-tarp.html

What TARP Boss Neil Barofsky Told Me Yesterday Should Shock You

Thursday, 16 May 2013 17:44

2 Comments and 0 Reactions

The financial news is getting boring. The Dow goes only one way – up. But gold fell below $1,400 per ounce yesterday.

Rather than trying to figure it out, yesterday evening we drove down to Zombietown. A friend in Washington had promised to introduce us to Neil Barofsky, inspector general of the TARP program.

You remember TARP? It was the feds' $700 billion program to rescue the US economy from a correction. Neil Barofsky was in charge of it. So we decided to go down and ask him how it turned out...

Meanwhile, in yesterday's International Herald Tribune was a small note: "Economists agree that spending cuts and tax increases have slowed the US recovery."

Readers will recognize this as the usual claptrap.

Government spending does not bring a genuine "recovery."

C'mon... how many times do we have to explain? You take $5 worth of resources and give them to an armed 19-year-old in Afghanistan. He shoots a round or two into a mountainside... poof... the $5 is gone. Or you have an ATF official. He's idling his motor as he stakes out a house believed to be used by a cigarette smuggler. In a few minutes, or even seconds, the $5 has vanished. Or give the money to a disabled person; he buys a MoonPie and a Coke. Economists may record the spending as part of GDP... But how are you better off?

You're $5 poorer, not $5 richer.

But GDP growth is something economists feel they can control. So they go to work on it like a sex maniac strangling a prostitute. Nothing good comes of it. But at least they get results.

And here comes Paul Krugman with more garroting wire! The New York Times Magazine:

Keynesian economics rests fundamentally on the proposition that macroeconomics isn't a morality play – that depressions are essentially a technical malfunction. As the Great Depression deepened, Keynes famously declared that "we have magneto trouble" – i.e., the economy's troubles were like those of a car with a small but critical problem in its electrical system, and the job of the economist is to figure out how to repair that technical problem.

Back to Neil Barofsky...

Rewarding Mistakes

So... where did the $700 billion go? Did that fix the magneto trouble?

"I wondered the same thing," he said (from memory). "It was amazing to me that no one knew. We gave it to the banks. But no one knew what they did with it. I proposed to Tim Geithner that we find out. He was outraged. He cursed me out, using the F-word. He said it would bring the whole banking system down, if I asked.

"I went ahead and sent out a letter. I didn't really have the authority or the staff to insist. But all of the big banks wrote back. And most of them gave me dodgy responses or gave me the brush-off.

"What did they do with the money? They were supposed to increase lending to help bring about a recovery. None of them did that. Instead, they used it to repay each other's loans. In other words, they used it to reduce the amount of credit available... not increase it. And they bought US agency bonds... just as you'd expect. And they paid out their bonuses.

"In other words, they looked out for themselves... just as you'd expect. I didn't know this information was going to bring down the banking system...

"The whole thing was so perverse, I can barely believe it. In a normal financial system, if a bank made a bad bet, it would pay a penalty. Counterparties might lend more money to it, but they'd want higher rates of interest to protect themselves.

"But here, in the bubble years, all the big banks made some of the worst bets in history... and what happened? The government stepped in... and lent them money... at lower rates of interest. They were rewarded for their mistakes. The good banks – that didn't have the backing of the government – actually paid higher rates of interest to borrow money than the bad banks.

"Another thing I wanted to know was exactly how much money was really at risk. We gave away $700 billion. But we also guaranteed loans... and gave lines of credit... and stood behind various financial transactions. I asked how much was at stake... how much was at risk. No one seemed to know. So we added it up. We found a total of $23 trillion. That's ‘trillion' with a capital ‘T.'

"Again, I'm not saying that we would ever have to pay out that much. Some of this was guarantees on top of guarantees and cross-guarantees... very murky... very difficult to disentangle. But I thought it was worth knowing how much we had at risk. And again, the banks didn't want to tell. And the people in the Treasury department didn't want to know.

"The more questions I asked, the more I found myself isolated... and at odds with the Treasury Department, as well as the banks. I was having shouting matches in the Treasury. The banks hated me. And then the undersecretary of the Treasury called me into his office.

"He explained that if I eased up on the banks, I could have a very nice career after the TARP appointment expired. If I didn't play ball with them, I would find it hard to find a job.

"That's how it works. You go along and you get along. If you don't go along with the scams and the technical mumbo jumbo... you're out."

That's how a zombie economy works, dear reader. The zombies throttle the girls. You look the other way. Or else...

Regards,

Bill

Catharsis Ours

Wednesday, May 29, 2013

Central Banks' Central Bank Warns About Rehypothecation Threats

Solid 5 Year Auction Follows Poor 2 Year; Dealers Left With Lowest Ever Allocation

Copper Withdrawal Orders From LME Soar To Record

What TARP Boss Neil Barofsky Told Me Yesterday Should Shock You

Rewarding Mistakes

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