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    Default NF Global Corzine Testimony exposes huge Shadow Finance Risk Exposure ...

    for what it's worth ... from


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

    Reposting by popular demand, and because everyone has to understand the embedded risks in this market, courtesy of the shadow banking system.

    In an oddly prescient turn of events, yesterday we penned a post titled "Has The Imploding European Shadow Banking System Forced The Bundesbank To Prepare For Plan B?" in which we explained how it was not only the repo market, but the far broader and massively unregulated shadow banking system in Europe that was becoming thoroughly unhinged, and was manifesting itself in a complete "lock up in interbank liquidity" and which, we speculated, is pressuring the Bundesbank, which is well aware of what is going on behind the scenes, to slowly back away from what will soon be an "apocalyptic" event (not our words... read on).

    Why was this prescient? Because today, Reuters' Christopher Elias has written the logical follow up analysis to our post, in which he explains in layman's terms not only how but why the lock up has occurred and will get far more acute, but also why the MF Global bankruptcy, much more than merely a one-off instance of "repo-to-maturity" of sovereign bonds gone horribly wrong is a symptom of two things:

    i) the lax London-based unregulated and unsupervised system which has allowed such unprecedented, leveraged monsters as AIG, Lehman and now as it turns out MF Global, to flourish until they end up imploding and threatening the world's entire financial system, and

    ii) an implicit construct embedded within the shadow banking model which permitted the heaping of leverage upon leverage upon leverage, probably more so than any structured finance product in the past (up to and including synthetic CDO cubeds), and certainly on par with the AIG cataclysm which saw $2.7 trillion of CDS notional sold with virtually zero margin.

    Simply said: when one truly digs in, MF Global exposes the 2011 equivalent of the 2008 AIG: virtually unlimited leverage via the shadow banking system, in which there are practically no hard assets backing the infinite layers of debt created above, and which when finally unwound, will create a cataclysmic collapse of all financial institutions, where every bank is daisy-chained to each other courtesy of multiple layers of "hypothecation, and re-hypothecation." In fact, it is a link so sinister it touches every corner of modern finance up to and including such supposedly "stable" institutions as Jefferies, which as it turns out has spent weeks defending itself, however against all the wrong things, and Canadian banks, which as it also turns out, defended themselves against Zero Hedge allegations they may well be the next shoes to drop, as being strong and vibrant (and in fact just announced soaring profits and bonuses), yet which have all the same if not far greater risk factors as MF Global. Yet nobody has called them out on it. Until now. (snip)

    (snip)As Reuters points out, it was not so much the act of creating "repos-to-maturity" that imperiled MF Global, but what is a secret gold mine for those privy to it - the process of re-hypothecation of collateral.


    [h]ypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral but is “hypothetically” controlled by the creditor, who has a right to seize possession if the borrower defaults.

    In the U.S., this legal right takes the form of a lien and in the UK generally in the form of a legal charge. A simple example of a hypothecation is a mortgage, in which a borrower legally owns the home, but the bank holds a right to take possession of the property if the borrower should default.

    In investment banking, assets deposited with a broker will be hypothecated such that a broker may sell securities if an investor fails to keep up credit payments or if the securities drop in value and the investor fails to respond to a margin call (a request for more capital).

    Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations much to the chagrin of hedge funds.



    So far so good, assuming there was regulation, and assuming if regulation failed, that the firms that blew up as a result of their greed would truly blow up, instead of being resurrected as TBTF zombies by a government in dire need of rent collection and lobby cash (because with or without regulation, if those who fail are not allowed to fail, then the whole point of capitalism is moot). But... there is always a snag.


    Under the U.S. Federal Reserve Board's Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140% of the client's liability to the prime broker. For example, assume a customer has deposited $500 in securities and has a debt deficit of $200, resulting in net equity of $300. The broker-dealer can re-hypothecate up to $280 (140 per cent. x $200) of these assets.

    But in the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated. In fact, brokers are free to re-hypothecate all and even more than the assets deposited by clients. Instead it is up to clients to negotiate a limit or prohibition on re-hypothecation. On the above example a UK broker could, and frequently would, re-hypothecate 100% of the pledged securities ($500).

    This asymmetry of rules makes exploiting the more lax UK regime incredibly attractive to international brokerage firms such as MF Global or Lehman Brothers which can use European subsidiaries to create pools of funding for their U.S. operations, without the bother of complying with U.S. restrictions.

    In fact, by 2007, re-hypothecation had grown so large that it accounted for half of the activity of the shadow banking system. Prior to Lehman Brothers collapse, the International Monetary Fund (IMF) calculated that U.S. banks were receiving $4 trillion worth of funding by re-hypothecation, much of which was sourced from the UK. With assets being re-hypothecated many times over (known as “churn”), the original collateral being used may have been as little as $1 trillion – a quarter of the financial footprint created through re-hypothecation.



    So let's see: a Prime Broker taking posted collateral, then using the same collateral as an instrument for hypothecation with a net haircut, then repeating the process again, and again... Ring a bell? If you said "fractional reserve lending" - ding ding ding. In essence what re-hypothecation, and subsequent levels thereof, especially once in the shadow banking realm, allows Prime Brokers is to become de facto banks only completely unregulated and using synthetic assets as collateral. Curiously enough it was earlier today that we also penned "ECB Confirms Shadow Banking System In Europe In Tatters" in which we explained that since ECB has to expand the eligible collateral it will accept, there is no real collateral left, meaning the re-hypothecation process in Europe has experienced terminal failure. Yet the kicker is that the "safety haircut" only occurs in the US. Not in the UK. And therein lies the rub. In the UK, the epic failure of supervision has allowed banks to become de facto monsters of infinite shadow banking fractional reserve leverage - every bank's wet dream! Naturally, Prime Brokers have known all about this which explains the quiet desire to conduct re-hypothecation out of London-based offices for every US-based (and Canadian) bank.(snip)

    (snip)"Yet Jefferies is just the beginning. It gets much, much worse.

    With weak collateral rules and a level of leverage that would make Archimedes tremble, firms have been piling into re-hypothecation activity with startling abandon. A review of filings reveals a staggering level of activity in what may be the world’s largest ever credit bubble.


    Engaging in hyper-hypothecation have been Goldman Sachs ($28.17 billion re-hypothecated in 2011), Canadian Imperial Bank of Commerce (re-pledged $72 billion in client assets), Royal Bank of Canada (re-pledged $53.8 billion of $126.7 billion available for re-pledging), Oppenheimer Holdings ($15.3 million), Credit Suisse (CHF 332 billion), Knight Capital Group ($1.17 billion),Interactive Brokers ($14.5 billion), Wells Fargo ($19.6 billion), JP Morgan($546.2 billion) and Morgan Stanley ($410 billion).


    And people were wondering why looking through the balance sheet of Canadian banks revealed no alert signals. It is because all the exposure was off the books! Hundreds of billions of dollars worth. As for JPM and MS amounting to nearly a trillion in rehypothecation... well, we are confident the market will be delighted to start pricing that particular fat-tail risk as soon as tomorrow.

    Yet it is Reuters' conclusion that strikes home, and is identical to what we said last night about the liquidity lock up in Europe and what it means for the shadow banking system, although from the perspective of an inverted cause and effect:


    The volume and level of re-hypothecation suggests a frightening alternative hypothesis for the current liquidity crisis being experienced by banks and for why regulators around the world decided to step in to prop up the markets recently.


    That's precisely right: the shadow banking system, so aptly named because its death rattle can never be seen out in the open, is slowly dying. As noted yesterday. But lest we be accused of hyperventilating, this time we will leave a respected, non-fringe media to bring out the big adjective guns:


    To date, reports have been focused on how Eurozone default concerns were provoking fear in the markets and causing liquidity to dry up....Most have been focused on how a Eurozone default would result in huge losses in Eurozone bonds being felt across the world’s banks. However, re-hypothecation suggests an even greater fear. Considering that re-hypothecation may have increased the financial footprint of Eurozone bonds by at least four fold then a Eurozone sovereign default could be apocalyptic.

    U.S. banks direct holding of sovereign debt is hardly negligible. According to the Bank for International Settlements (BIS), U.S. banks hold $181 billion in the sovereign debt of Greece, Ireland, Italy, Portugal and Spain. If we factor in off-balance sheet transactions such as re-hypothecations and repos, then the picture becomes frightening.



    And there you have it: in this world where distraction and diversion often times is the only name of the game, while banks were pretending to have issues with their traditional liabilities, it was really the shadow liabilities where the true terrors were accumulating. Because in what has become a veritable daisy chain of linked shadow exposure, we are now back where we started with the AIG collapse, only this time the regime is decentralized, without the need for a focal, AIG-type center. What this means is that the collapse of the weakest link in the daisy-chain sets off a house of cards that eventually will crash even the biggest entity due to exponentially soaring counterparty risk: an escalation best comparable to an avalanche - where one simple snowflake can result in a deadly tsunami of snow that wipes out everything in its path. Only this time it is not something as innocuous as snow: it is the compounded effect of trillions and trillions of insolvent banks all collapsing at the same time, and wiping out the developed world (snip)


    If this is for real, 2012 could be extremely 'ugly' !

    ~
    Last edited by Melonie; 12-08-2011 at 04:05 PM.

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    Default Re: NF Global Corzine Testimony exposes huge Shadow Finance Risk Exposure ...

    Nothing has changed since 2007...... If any other industry had created this mess.... things would be different...... People would be in jail, and the rules of the game would have been changed.



    What has the been the lesson learned? Crime pays..... Very well
    The country has been looted.

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    Default Re: NF Global Corzine Testimony exposes huge Shadow Finance Risk Exposure ...

    Nothing has changed since 2007...... If any other industry had created this mess.... things would be different...... People would be in jail, and the rules of the game would have been changed.
    Unfortunately something HAS changed since 2007 ... but not for the better. The amount of off balance sheet 'shadow finance' going bad is now significantly larger ... to the point where it's essentially impossible for any government ( or group of gov'ts i.e. the EuroZone ) to cough up a large enough amount of money to actually pull off a repeat 'bailout'. Well at least it's virtually impossible via increased taxation, via increased borrowing, or via gov't spending cuts that are deep enough to make any serious 'dent'. The nationwide strikes and other social unrest that resulted from the 'half-assed' attempts at 'austerity' in Greece and Italy pretty well cover the probable success of major tax increases ( affecting almost all citizens rich, middle class and poor alike ) or major gov't spending cuts ( primarily affecting gov't employees, social welfare benefit recipients, and retirees ) ... not happening.

    The 'talking heads' would tell you that there are really only two options still open in this regard. The first is for central banks to simply start 'printing money out of thin air' to pay for the bailout, as well as to pay for ongoing gov't spending in excess of actual tax revenues collected. The second is to allow gov'ts and financial institutions to officially go bankrupt ( they already are technically bankrupt if 'off balance sheet' obligations are properly accounted for ) and let the 'losses' fall where they may. For reasons of palatability, and given that a large chunk of financial institution investor 'losses' would fall on the uber-rich, I'm betting on the former !

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    Default Re: NF Global Corzine Testimony exposes huge Shadow Finance Risk Exposure ...

    Quote Originally Posted by Melonie View Post
    Unfortunately something HAS changed since 2007 ... but not for the better. The amount of off balance sheet 'shadow finance' going bad is now significantly larger ... to the point where it's essentially impossible for any government ( or group of gov'ts i.e. the EuroZone ) to cough up a large enough amount of money to actually pull off a repeat 'bailout'. Well at least it's virtually impossible via increased taxation, via increased borrowing, or via gov't spending cuts that are deep enough to make any serious 'dent'. The nationwide strikes and other social unrest that resulted from the 'half-assed' attempts at 'austerity' in Greece and Italy pretty well cover the probable success of major tax increases ( affecting almost all citizens rich, middle class and poor alike ) or major gov't spending cuts ( primarily affecting gov't employees, social welfare benefit recipients, and retirees ) ... not happening.

    The 'talking heads' would tell you that there are really only two options still open in this regard. The first is for central banks to simply start 'printing money out of thin air' to pay for the bailout, as well as to pay for ongoing gov't spending in excess of actual tax revenues collected. The second is to allow gov'ts and financial institutions to officially go bankrupt ( they already are technically bankrupt if 'off balance sheet' obligations are properly accounted for ) and let the 'losses' fall where they may. For reasons of palatability, and given that a large chunk of financial institution investor 'losses' would fall on the uber-rich, I'm betting on the former !

    Nothing has changed as far as the looting mentality is concerned....... The lesson learned was....... Crime pays.... Big time.

    As to the the ability of these debts to be paid...... Nothing really has changed...... The debt is unsustainable now..... as then.
    The country has been looted.

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    Default Re: NF Global Corzine Testimony exposes huge Shadow Finance Risk Exposure ...

    Agreed on 'crime pays ... big time', which our 'old buddy' Karl Denninger at summarizes in regard to Corzine :

    (snip)We No Longer Have A Justice System In The US


    It's simply gone.

    "I simply do not know where the money is, or why the accounts have not been reconciled to date," Corzine's prepared testimony read. "I do not know which accounts are unreconciled or whether the unreconciled accounts were or were not subject to the segregation rules."


    Sarbanes-Oxley requires him as the CEO of a company to (1) guarantee that effective risk controls and rules are in place and (2) monitor their compliance. It renders failure to do so -- that is, the old-fashioned "I didn't know" defense that was routinely used after 2000-era failures in the Internet space -- a felony.

    Now of course Mr. Corzine is entitled to the presumption of innocence and he is entitled to a trial before being pronounced guilty, but the law on this point is clear: Executives, the CEO and CFO in particular, are required under Sarbanes-Oxley to factually know about matters such as this and they are required to attest to that knowledge -- and the presence of appropriate and sufficient risk controls under penalty of felony indictment.

    It appears that Mr. Corzine has admitted in front of a Congressional Committee that he does not know, and therefore this appears to be a prima-facie admission that he is in direct violation of this law.

    If this is not dealt with on an expeditious fashion and the law is not enforced you have just seen proof on national television that there is no longer a rule of law in this nation of any substance.

    You must, therefore, presume that there is no longer any Constitutional protection afforded to you and you thus have no rights and no recourse to the law of any sort. Your "rights" have just been downgraded to only that which you are willing and able to personally enforce at any instant in time.

    This in turn means that it is impossible for you to engage in any sort of commercial transaction where performance cannot be verified before you hand over payment in full, because you have no means of compelling the other party to perform and no recourse of any sort to the law, nor do you have any expectation that someone who violates the law, irrespective of who it is, will be held to account.

    This sucks, to be blunt, but it is the world we live in as of today and if you have any hint of intelligence it is the operative assumption you must make here, now, today and forward until there is evidence otherwise.( snip)


    The obvious question that immediately emerges is why Jon Corzine is highly likely to escape prosecution, while Bernie Madoff must keep a firm grip on his soap bar in a Prison shower, when both 'misappropriated' investor money / assets ? Jon Corzine's personal history ( jumping between Wall St. and elected office in a Democrat state ), and the differing 'nature' of Corzine's investors ( i.e. many farmers and smaller businesses hedging their everyday commodities ) versus Madoff's investors ( Hollywood glitterati ), arguably provides a proverbial trail of bread crumbs to one obvious answer ... but SW's 'politics ban' precludes further discussion.


    Nothing really has changed...... The debt is unsustainable now..... as then
    While I would agree with the truth of this statement, there is still a major difference. In 2008 a BAILOUT was sustainable ... while today it isn't because the magnitude of the 'shadow finance' problem has grown much larger over the past 3 years !!! Arguably, the magnitude of BAILOUT funding necessary to re-stabilize the 'western' economic system is now beyond the ability of any 'sane' gov't ( or group of gov'ts ) to finance. This is why the EuroZone had been attempting to apply 're-hypothecation' principles to their BAILOUT funding !!!

    As of this morning, the UK has essentially told the EuroZone to 'piss off' re proposed new taxation mandates intended to augment BAILOUT funding. Tim Geithner is booked to travel to europe, presumably in an effort to deploy US taxpayer money toward EuroZone BAILOUT funding via the IMF. Arguably, at least two MAJOR EuroZone banks now stand on the precipice. And the 'dominos' of 're-hypothecated' counterparty risk are all lined up while praying that yet another BAILOUT injection will once again forestall the first 'domino' from being tipped over.


    Some 'non-neutral' commentary from analyst Tyler Durden at

    (snip)" Now it is time to bring the picture full circle, and put CDS front and center. As Bloomberg reports,

    "BNP Paribas SA, France’s biggest bank, sold a net 1.5 billion euros ($2 billion) of credit- default swaps on the nation’s sovereign debt, according to data compiled by the European Banking Authority. UniCredit SpA, Italy’s biggest lender, and Banca Monte dei Paschi SpA are net insurers of more than 500 million euros each of their government’s bonds, and Oesterreichische Volksbanken AG, the Austrian lender which has yet to pay interest on 1 billion euros of state aid received in 2009, has guaranteed a net 839 million euros of its national debt, EBA data show." (EBA source - link).

    For those confused by the above, here is the explanation: European banks, in order to generate modest cash flow from collecting on the pariodic interest premiums owed to them in order to plug increasingly large capital shortfall holes that otherwise would simply keep growing ever larger, have sold and continue to sell massive amounts of default protection on their very own host countries! As a reminder, it was precisely this that destroyed AIG when the illusion of the credit bubble burst.

    Furthermore, our speculation of what caused the mindboggling surge of over $100 trillion in derivatives in the first half of the year to a record $707 trillion, has been confirmed. It was nothing short of every single European (and likely US) institution dodeca-tupling down on wrong way bets. Nothing more. As a reminder we said:

    in order to satisfy what likely threatened to become a self-feeding margin call as the (previously) $600 trillion derivatives market collapsed on itself, banks had to sell more, more, more derivatives in order to collect recurring and/or upfront premia and to pad their books with GAAP-endorsed delusions of future derivative based cash flows. Because derivatives in addition to a core source of trading desk P&L courtesy of wide bid/ask spreads (there is a reason banks want to keep them OTC and thus off standardization and margin-destroying exchanges) are also terrific annuities for the status quo. Just ask Buffett why he sold a multi-billion index put on the US stock market. The answer is simple - if he ever has to make good on it, it is too late.

    Today's EBA data confirms this.

    Most importantly, this means that now US bonds are now completely irrelevant and don't need to blow out for the final unwind to occur: all that needs to happen is for European bonds to continue collapsing, which will in turn put the banks who have sold CDS on said countries into bankruptcy, as what selling CDS effectively is is a marginless way of going long the underlying security, i.e. naked longs. And no, ISDA's attempt to destroy the sovereign CDS market will have no impact as an event of default does not need to occur: banks will simply bleed to death due to daily variation margins demanding more and more and more cash each and every day as spreads blow out wider. Recall that in CDS trading, variation margins has to be posted and positions netted at the end of the trading day with virtually no exceptions. Which means that a CDS trading at infinity (or the underlying bond trading at zero which is equivalent) will put the seller of such product into insolvency, whether or not an actual event of default has been declared, thus making ISDA involvement irrelevant.

    At this point we would like to request a moment of silence for Europe (and thus America, which will promptly implode without its transatlantic counterpart) because it is now inevitable that AIG's fate will be shared by Europe when (not if) global central banks finally lose control of European rates, which in turn will collapse.(snip)

    ~
    Last edited by Melonie; 12-10-2011 at 07:59 AM.

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    Default Re: NF Global Corzine Testimony exposes huge Shadow Finance Risk Exposure ...

    this 'layman's language' explanation of what's going on in Europe would probably be helpful ... from


    (snip)"But why would BSC be so willing to sell protection? Well, the markets were very wide because of the fear that they would default. You sell as much protection as possible. If you default what do you possibly care? Your stock is wiped out, your job is gone, and your strategy is totallly explainable to future employees. If you don't default all this massive amounts of protection screams tighter and you have your best year ever. No brainer for the firm, an issue for the market.

    So, why are French banks selling protection on France like it is going out of style? Why are Italian banks doubling down on Italy? Because if the bailouts work, it is free money. Huge tightening on top of the spread income until the bailout finally wins. If the sovereign defaults, is the bank really going to be around anyways?

    It is the ultimate trade.

    If you make money, you get paid. If you lose money you were screwed anyways.

    Who would buy from them? Banks with silly risk management departments, or those who had sold to them when they were in hedging mode, and now are unwinding. That would create the bid for bank CDS that we see (as people need to hedge purchases of CDS). Some of these banks may qualify for no collateral from banks they trade with. Then they don't even need to come up with cash even if the market moves against them. Not posting collateral would be a huge deal, and I'm not sure how true it is, but I would bet someone like BNP has very big lines with most other banks, before the mark to market loss gets bad enough that they have to post.

    This may be the ultimate moral hazard trade. Heads I win, tails, I don't care because I'm dead. This couldn't happen if CDS was exchange traded (they could sell, but they would take mark to market margin call risk), but our regulators, have decided that putting CDS onto an exchange can wait."(snip)

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    Default Re: NF Global Corzine Testimony exposes huge Shadow Finance Risk Exposure ...

    I don't think anyone has been charged under Sarbanes / Oxley...... These days this country is a lot like corrupt Latin American countries, and Russia...... In that the people on the street KNOW there is corruption of the political class by the monied interests..... and they just don't think there is anything they can do about it...... And history is proving that thought right.

    Imagine if the transportation or food industries had done this much damage to the economy.... Think the head of Kraft Foods, or Greyhound Bus would be in jail?..... I do.
    The country has been looted.

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    Default Re: NF Global Corzine Testimony exposes huge Shadow Finance Risk Exposure ...

    ^^^ well, that leads directly back to my question about why Bernie Madoff was locked up while mainstream media is portraying Jon Corzine as a 'victim of circumstance'. It can even be backtracked prior to Sarbanes Oxley, as to why Enron's executives were locked up but Fannie Mae's executives were given 'golden parachutes'. Or it can be taken a bit sideways, as to why GM's bond investors were wiped out but Countrywide's bond investors were 'bailed' out. But again the 'politics ban' precludes much further discussion along any of these lines.

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    Default Re: NF Global Corzine Testimony exposes huge Shadow Finance Risk Exposure ...

    Quote Originally Posted by Melonie View Post
    ^^^ well, that leads directly back to my question about why Bernie Madoff was locked up while mainstream media is portraying Jon Corzine as a 'victim of circumstance'. It can even be backtracked prior to Sarbanes Oxley, as to why Enron's executives were locked up but Fannie Mae's executives weren't. But again the 'politics ban' precludes much further discussion along these lines.

    Well let's not forget that Harry Markopolos was sending warnings to the SEC about Madoff for years...... I also recall a Barrons article years before, that pretty much said the Madoff returns were a fraud.
    The country has been looted.

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