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dkf's Journal
dkf's Journal
December 29, 2011

Thomas Friedman on hyper connectivity, the super wealthy and why being average won't get you far.

MR. FRIEDMAN: Well, you know, I think, David, if we step back, I think we can explain a lot of what's going on in the country and, and in the world by the fact that we've actually gone from a connected world to a really hyperconnected world. And what that's done, actually, if the world were a single math class, the whole global curve has risen. Because every boss today has access to more cheap automation, cheap software, cheap robotics, cheap labor, and cheap genius than ever before.

And as a result, average is over. Average is officially over. We've all got to find our extra, come with something new and extra to the table. So, on the one hand, that's creating a lot of anxiety, understandably, throughout the population. At the same time, that
hyperconnectivity is giving people the tools to, to organize and protest against it from the right and the left.

And, at the same time, that hyperconnectivity is creating these huge income gaps because if you do have the talent, if you are really, really above average, if you're J.K. Rowling, you know, you can now make more money in a totally connected world than ever before. So it's all wrapped up together in one process.


December 29, 2011

Fed seeks to curb repo market risk


An industry task force sponsored by the US Federal Reserve is working on a plan to scale back systemic risk in the funding market at the centre of the financial crisis and to reduce trader dependence on JPMorgan Chase and Bank of New York Mellon .

The changes would be aimed at bringing greater automation to the $1.6tn tri-party repurchase, or repo, market but could increase financing costs for other banks.

In the repo market, banks pledge securities as collateral for short-term loans from money managers and other investors.

While the issue is technical, it raises questions both about the ongoing vulnerability of the two so-called clearing banks in the market, JPMorgan and BNY Mellon, and their power over the Wall Street community in general.Many officials at the Fed believe that such a role may not be appropriate for private institutions and that a public sector body may be more appropriate.

December 11, 2011

The decline of “safe” assets

Presenting the unwanted mutant offspring of the most important chart in the world*…

You’ll find the above on page 143 of the Credit Suisse 2012 Global Outlook, which we’ve stuck in the usual place.

It shows how the world’s outstanding stock of safe haven assets denominated in either dollars or euros has evolved, adjusted to account for the Fed’s purchases of US Treasuries and other assets in recent years as part of quantitative easing.

The chart helps explain much of what’s happening in global financial markets now, especially in Europe (not on its own, mind you — we said “helps” explain):

– Begin with the ongoing collateral crunch, and how the decline of safe assets is directly tied to the dramatic fall in the availability of high-quality collateral in European lending markets. So much of it is now encumbered via direct bilateral funding agreements or by sitting at the central bank drawing liquidity.


December 11, 2011

The (sizable) Role of Rehypothecation in the Shadow Banking System

The United Kingdom provides a platform for higher leveraging stemming from the use (and re-use) of customer collateral. Furthermore, there are no policy initiatives to remove or reduce the asymmetry between United Kingdom and the United States on the use of customer collateral. We show that such U.K. funding to large U.S. banks is sizable and augments the measure of the shadow banking system. Supervisors of U.S. banks that report on a global consolidated basis need to enhance their understanding of the collateral funding that the U.S. banks receive in the United Kingdom.

Rehypothecation occurs when the collateral posted by a prime brokerage client (e.g., hedge fund) to its prime broker is used as collateral also by the prime broker for its own purposes. Every Customer Account Agreement or Prime Brokerage Agreement with a prime brokerage client will include blanket consent to this practice unless stated otherwise. In general, hedge funds pay less for the services of the prime broker if their collateral is allowed to be rehypothecated.

There has been very little research in this area. One of the first papers on this topic showed how the collapse in rehypothecation levels was contributing to global deleveraging after Lehman’s demise (Singh and Aitken, 2009a). Adrian and Shin (2009) provide an analytical model where collateral assets can be recycled by pledging and re-pledging; the model shows that during a crisis, the cumulative haircuts (or ‘margin spiral’) on pledged collateral can be sizable. Gorton (2009) shows that during a crisis, haircuts on collateral can result in a run on the shadow banking system. Singh and Aitken (2009b) show that counterparty risk during and in the aftermath of the recent crisis resulted in a decrease of up to $5 trillion in high- grade collateral due to reduced rehypothecation, decreased securities lending activities and the hoarding of unencumbered collateral.

This paper contributes to the ongoing policy debate on the size of the shadow banking system and how it impacted the funding for large banks. We show that in addition to the previously documented research (Adrian and Shin, etc.), that the shadow banking system was at least
50 percent larger than previously estimated. We also provide estimates from the hedge fund industry and their prime brokerage relationships with large banks for the “churning” or the extent of re-use of collateral. The rest of the paper is organized as follows. Section II discusses rehypothecation in the United Kingdom and the United States and the associated regulatory regimes; the United Kingdom provides a platform for higher leveraging (and deleveraging) not available in the United States. Section III highlights the collapse in rehypothecation levels in the United States, especially after the demise of Lehman. Section IV shows that the shadow banking system in the United States was much larger than envisaged, if we adjust for rehypothecation. Section V calculates the ‘churning’ factor for pledged collateral via hedge fund’s relationships with their prime brokers. Section VI concludes with some suggestions for regulators to enhance their understanding of the funding sources for large banks.


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