YAY! It's Rehypothecation for Dummies!
Why is Greece actually just a small domino in a trail to a much bigger problem?Well. Lets see if I can make this nice and simple...
It's all to do with clever banking and this fun thing called "Rehypothecated assets".
What the hell is that then??! Like most things in clever banking. It's got the kind of name that makes most sane people want to hide behind the sofa. But actually. It's fairly simple. I'll try anyway...
Hypothecation is when I want something, and I say I'll put some asset up (collateral) so I can take on the debt for the thing I want. Simple example. A mortgage on a house. The house is the asset, and I take on the debt as the mortgage to pay off. I get ownership of the house while all is going well. But if it messes up, the mortgage people can take the house back. So simple terms. I get ownership of a thing while I still owe the debt at risk of having to give it back if I can't pay the debt.
Simple huh?
Ok now in to money market land. "Rehypothecation" time. Ready?
I put £100 in my bank account. Pretend that £100 is now a house. It's easier to get a grip of it following on from the above if we pretend it's a house. So I've given the bank a £100 house. Lets say, under banking law, the bank can take that asset and pretend 90% of it is their house. So off they trot and put down a £90 house on to someone else's books for an asset they want to take on. That trader / bank takes the £90 house, and under the same laws, they can now keep £9 of that and put down an imaginary £81 house as an asset on something they want ... and so on and so on and so on ...
Righto guys. We can drop the house thing now. You probably get the idea. Instead of houses, it's bonds & equities. Same deal in effect. The various banks / brokers / investment houses have used a sort of mortgage trick to get themselves a chain of assets against that original deposit. That's the simple version of "Rehypothecation".
Like my house in the original mortgage game, the deal is, if someone in the chain can't keep up margin payments, or securities drop and investors can't boost collateral to meet the new financial requirements, then assets can be claimed back by the broker that did the lending. (I'm trying to keep this simple folks, don't bother writing in with detailed technical analysis of why that isn't 100% correct in all cases). Broadly speaking, that's the effect we are dealing with.
In most sane countries. There are banking limits on the assets that should be held by the broker when they are rehypothicating client accounts. This helps (a bit). Clever banks / brokers will find ways to stretch limits within those countries, and big enough banks / investment houses will run to places like ... the UK.
Uh oh. Wait? Why the UK? Because the "Great" in Great Britain largely comes from having an unregulated banking system. That means (amongst other things) in the UK brokers will routinely use 100% of client assets in the rehypothication chain. That's why people like Goldman Sachs, Credit Suisse, Morgan Stanley and many many more have UK based 'investment pools' and 'lateral assets'. We'd call it cheating. They'd call it maximising leverage.
Ready for the fun stuff?
In this global banking industry world, everything is recorded and understood. Right? Wrong. Rehypothicated assets are completely off balance sheets. Basically nobody has a clue who holds what against who's what until something goes wrong and a whole chain of people start trying to claim back assets. "Ohhh that's where it went?" time.
Some talented market guess work suggests actual asset backing may be around 25% of the value at risk. Wait? What? Ok say Bank of Kryptonite has £25 billion of rehypothicated assets. They might be at risk for around £100 billion in off balance sheet transactions. So take that "We may need around 250 billion Euro to sort Greece out" that was banded around in 2011. Now add in your new found rehypothecation knowledge of likely damage caused by 250 billion Euro suddenly vanishing from the system. Sure. Not all of that will fall in to the trap, but damage caused could well be nearer say 750 billion Euro if you don't give them the 250 billion bailout ... Now does the political / financial action on Greece make more sense to you? Cool!
Pause!
Take a breath!
With any luck you just got a pretty simple view of the rehypothication game. Pretty big huh? It's a huge part of the reason it takes trillions to fix billion dollar banking problems, and why there is now more money in the world than can possibly make sense.
Now count to 10 and lets go back to another aspect.
What's happening to the money printed by the Bank of England and the Fed and thrown in to Europe by the ECB? For a start. It's not being printed. It's buying bonds in the main which has the effect of maintaining what you might call the end weight of the rehypothication leverage chain. It's keeping that magical mystery tour of rehypothicated assets floating and stopping the unknown freak out scenario of lots of people (brokers / banks), suddenly having to claim back assets because the system failed and a chunk of money got defaulted on.
See how I snuck that "defaulted" word in there? That was the fear with Greece. A hard default. Not for any particularly humanitarian reasons. Simply because it's an uncontrolled event that would definietly have an effect on at least some of that re-hypothication chain. And as we now know ... Nobody knows what effect exactly .. But lots of people seem scared enough that it's such a big effect, that they'll throw billions at Greece to avoid it happening.
Crisis avoided. Greece did not hard default. YAY!
But ... (booo)
It leaves two rather obvious problems.
First: Inflation.
Chucking all that new money in at the leverage end of the scale is great for keeping the banking industry afloat, and better yet. It doesn't have an immediate inflationary effect. For once, "Trickle down economics" will actually work here though. It does have an inflation effect initially on the larger institutions dealing at government bond levels. Think insurance, pensions, banks, mortgages. The first people to realise money isn't going as far as it was thanks to all the new 'printed' stuff, will be those guys. And those guys will pass costs on in terms of higher mortgage payments, higher insurance premiums, lower pension pot growth, less savings account interest, higher debt charges, etc .... Oh ... Ow!Those costs, after a few months (in some cases years depending on the bonds initially purchased), when they do trickle down to average citizen, are the initial inflation signs. Keep in mind. Those costs also trickle down to shops, businesses, factories etc. It all .. slowly but surely starts to creep up in cost to maintain, run, insure, finance. Neatly, the heads of banks, fed, finance ministers that pressed the big red button on the cash injection are not obviously implicated. The costs appear gradually over months or years and have an air of political plausible deniability.
The really bad thing? That's already happened. Nothing in the world can be done about it. Watch and wait as it takes a bite out of your fiscal ass in the next few years. By 2016? The worst will hopefully of settled. Dunno about you. But I'm not calling that a good thing.
Second: A broken model.
Scenario One - Lets assume the best for the banking world. Lets assume all the trillions of new cash injected in to the system does keep it afloat and chains of rehypothication nightmare asset collection are never triggered. You're still left with the same system. Give it 10 years or so of crippling hardship coupled with mystery inflationary pressures (see above), and average area citizen begins to get back on track. They start to make a bit of money. They go to the bank and put that £10,000 savings deposit in .. and .. Uh oh. The bank .. they wouldn't? Yeah they would. Starts the whole chain of rehypothication off again safe in the knowledge they'll get bailed out with printed trillions every decade or so ... Dunno about you. But I'm not calling that a good thing.Scenario Two - Something. Somewhere. Snaps. Seeing as back in 2011 predictions of a European financial crash worse than "The Great Depression" were already surfacing. And .. noting that no one has the faintest clue where all the money really is. Add to that the likes of UBS predicting social unrest and possible all out wars if even just Greece defaulted ... I think it's safe to say .. Dunno about you. But I'm not calling that a good thing.