Sunday, November 25, 2012

Recession Predicted for 2013: Why? Because the Shadow Banking System Continues to Drain the System of Capital

Morgan Stanley’s Doom Scenario: Major Recession in 2013 Published: Tuesday, 20 Nov 2012 | http://www.cnbc.com/id/49898014

[Excerpted] The global economy is likely to be stuck in the “twilight zone” of sluggish growth in 2013, Morgan Stanley has warned, but if policymakers fail to act, it could get a lot worse....

..Morgan Stanley isn’t alone in warning about a recession next year. Noted bear, Nouriel Roubini warned on Monday that certain key developments would exacerbate the downside risks to global growth in 2013....[end excerpt]

Majia here: Now why is the global economy heading for recession again?

Could it be because the SHADOW BANKING system is now larger than before, and requires more bailouts of derivatives that have been re-hypothecated?



'Shadow Banking' Still Thrives, System Hits $67 Trillion 18 Nov 2012 | 5:37 PM ET http://www.cnbc.com/id/49877573

[Excrpted] The system of so-called "shadow banking," blamed by some for aggravating the global financial crisis, grew to a new high of $67 trillion globally last year, a top regulatory group said, calling for tighter control of the sector.

…The multitrillion-dollar activities of hedge funds and private equity companies are often cited as examples of shadow banking.But the term also covers investment funds, money market funds and even cash-rich firms that lend government bonds to banks, which in turn use them as security when taking credit from the European Central Bank.

Even the man credited with coining the term, former investment executive Paul McCulley, gave a catch-all definition, saying he understood shadow banking to mean "the whole alphabet soup of levered up non-bank investment conduits, vehicles and structures," such as the special investment vehicles that many blamed for the financial crisis....[end excerpt]

Majia Here: Washington's Blog provides a good analysis here

One important reason that the shadow banking system remains in dire straights is because of the practice of re-hypothecation that allows financial players to all use the same underlying collateral. Below find an excerpt from an essay I've written on the subject of financial fraud:

Christopher Elias, in his article "MF Global and the great Wall St re-hypothecation scandal" explains that customer accounts were essentially re-hypothecated, or used as collateral for borrowing billions of dollars in a complex repurchasing (i.e., “repo”) agreement:

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.  
What is particularly of note is that the agent that lent billions to MF Global may have used the re-hypothecated customer funds as its own collateral for further trading. This is described as “churn:
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.
Essentially, the “churning” of re-hypothecated funds allows many different financial players to use the same collateral base. That means if any player defaults, they all are in danger of default because the re-hypothecated funds would be vaporized. The MF Global disaster illustrates both vacuous capital accumulation has become and how vulnerable the entire system is to shocks.
 
Elias, Christopher . "MF Global and the great Wall St re-hypothecation scandal" Thomas Reuters News and Insight (2011, December), http://newsandinsight.thomsonreuters.com/Securities/Insight/2011/12_-_December/MF_Global_and_the_great_Wall_St_re-hypothecation_scandal/
 
RELATED POSTS
Nov 16, 2012
MF Global and the great Wall St re-hypothecation scandal Christopher Elias http://newsandinsight.thomsonreuters.com/Securities/Insight/2011/12_-_December/MF_Global_and_the_great_Wall_St_re-hypothecation_scandal/ ...
Jul 26, 2012
Christopher Elias, in his article "MF Global and the great Wall St re-hypothecation scandal" explains that customer accounts were essentially re-hypothecated, or used as collateral for borrowing billions of dollars in a complex ...
Jan 30, 2012
The significance of re-hypothecation of re-hypothecation is that the structure of debt is based on such a tiny pool that if the system starts crumbling there is grossly insufficient capital reserves in the system to shore up losses.
Dec 08, 2011
MF Global and the great Wall St re-hypothecation scandal Christopher Elias http://newsandinsight.thomsonreuters.com/Securities/Insight/2011/12_-_December/MF_Global_and_the_great_Wall_St_re-hypothecation_scandal/ ...
 
 

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