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Reply #51: MF Global and the great Wall St re-hypothecation scandal [View All]

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Demeter Donating Member (1000+ posts) Send PM | Profile | Ignore Thu Dec-08-11 09:05 AM
Response to Reply #33
51. MF Global and the great Wall St re-hypothecation scandal
http://newsandinsight.thomsonreuters.com/Securities/Ins... /

A legal loophole in international brokerage regulations means that few, if any, clients of MF Global are likely to get their money back. Although details of the drama are still unfolding, it appears that MF Global and some of its Wall Street counterparts have been actively and aggressively circumventing U.S. securities rules at the expense (quite literally) of their clients. MF Global's bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MFs dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation. A loophole appears to have allowed MF Global, and many others, to use its own clients funds to finance an enormous $6.2 billion Eurozone repo bet.

If anyone thought that you couldnt have your cake and eat it too in the world of finance, MF Global shows how you can have your cake, eat it, eat someone elses cake and then let your clients pick up the bill. Hard cheese for many as their dough goes missing...Up until now the assumption has been that the funds missing had been misappropriated by MF Global as it desperately sought to avoid bankruptcy. Sadly, the truth is likely to be that MF Global took advantage of an asymmetry in brokerage borrowing rules that allow firms to legally use client money to buy assets in their own name - a legal loophole that may mean that MF Global clients never get their money back.

REPO RECAP

First a quick recap. By now the story of MF Globals demise is strikingly familiar. MF plowed money into an off-balance-sheet maneuver known as a repo, or sale and repurchase agreement. (A repo involves a firm borrowing money and putting up assets as collateral, assets it promises to repurchase later. Repos are a common way for firms to generate money but are not normally off-balance sheet and are instead treated as financing under accountancy rules.) MF Global used a version of an off-balance-sheet repo called a "repo-to-maturity." The repo-to-maturity involved borrowing billions of dollars backed by huge sums of sovereign debt, all of which was due to expire at the same time as the loan itself. With the collateral and the loans becoming due simultaneously, MF Global was entitled to treat the transaction as a sale under U.S. GAAP. This allowed the firm to move $16.5 billion off its balance sheet, most of it debt from Italy, Spain, Belgium, Portugal and Ireland.

Backed by the European Financial Stability Facility (EFSF), it was a clever bet (at least in theory) that certain Eurozone bonds would remain default free whilst yields would continue to grow. Ultimately, however, it proved to be MF Globals downfall as margin calls and its high level of leverage sucked out capital from the firm. Puzzling many, though, were the huge sums involved. How was MF Global able to lose $1.2 billion of its clients money and acquire a sovereign debt position of $6.3 billion a position more than five times the firms book value, or net worth? The answer it seems lies in its exploitation of a loophole between UK and U.S. brokerage rules on the use of clients funds known as re-hypothecation...hypothecation 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 brokers 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.

MUCH MORE AT LINK....A VERY TECHNICAL AND FRIGHTENING EXPLANATION OF EVENTS--BOTH TODAY'S, AND PAST (LEHMANS)

ANYONE PUTTING THEIR FAITH AND MONEY IN A BROKER IS ASKING FOR IT
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