One of the most feared terms among financial conspiracy theorists lurking on sites like Zerohedge, is “rehypothecation”. Know-it-all libertarians, anti-banker nuts and a variety of ill-educated lunatics in the darkest recesses of the internet scream that rehypothecation is a dangerous practice that puts the entire economy at risk, is a form of fraud, and is partly what lead to the collapse of Lehman Brothers and MF Global. To respected financiers however, rehypothecation is not a scary term at all, but rather an essential practice underpinning the financial system, and providing lucrative opportunities for the savvy and prudent investor.
So what exactly is rehypothecation, and what makes it so controversial in the alternative financial-sphere? Well, put simply, rehypothecation is a practice in which financiers use collateral that was pledged to them by borrowers, in their own transactions, usually for financial gain. It’s as simple as that. If a borrower pledges securities or margin to a brokerage firm, that firm might decide to pledge that collateral as further collateral in their own brokerage account. And the next broker might choose to do the same, allowing the same collateral to be pledged over and over again in countless transactions. Cool huh? Instead of just sitting there, backing up just one loan or agreement, collateral can now be used in hundreds of deals, meaning that hundreds of people are all relying on the same collateral being available in the case of a default. Sweet.
Rehypothecation ingeniously frees up useless collateral and allows many more deals to occur than would otherwise be possible. This multiplier effect generates billions of dollars in profits for savvy financiers, and consequently billions in tax revenue, billions for pension funds and billions in charity. Whatever allows investment bankers and traders to make money also benefits society, because these profits always flow back to the people.
When you understand how simple and commonplace rehypothecation is, you start to see just how crazy the critics of this common sense practice really are. It’s a practice that has been used for decades, and is still unregulated in London, where it is every-day business to use the same collateral for many transactions, helping to oil the works of one of the world’s most advanced financial systems. It’s sad that people who know so little about finance, and have never worked a day in their lives on Wall Street, would criticize a practice that has been carried out by professionals since before they were born. This is another example of how excessive free speech allows uneducated conspiracy theorists to spread misinformation to millions of people, and inspire tremendous hatred for bankers, an already persecuted group. Rehypothecation is not a dirty word, but an age-old old practice, contributing billions to the economy and keeping the financial system that we all depend on humming smoothly and generating growth and prosperity for every day people across the world.