Financial Shenanigans That Should be Crimes
by Robert Coutinho
Recently I was reading up on a financial situation that confused me at first. It is hypothecation. Why is hypothecation important? Because it has to do with some of the alleged happenings at MF Global. It is a word that any investor, including those with 401k’s and such should actually worry about. Here is why.
Way back when (okay colonial times here, but it was in England) people began to realize that their gold was probably not very safe if they kept it on their own property. They started storing it at banks. The banks knew that much of this valuable commodity was going to waste. They wanted to use it to fund investments. They discovered that only about 10% of the stuff was likely to be called on at any one time. So…they came up with the cool idea of hypothecation.
Hypothecation is where you pledge an asset without actually giving to someone. A mortgage or a car loan is a hypothecation. However, there is also rehypothecation. Stocks, bonds, gold, etc. are often hypothecated as security for a business transaction—particularly in the finance industry. Normally this should not be much of a concern, since the owner of the asset has been assured that he will receive fair value for his asset plus a small sum for the use of his property. In case you have not noticed recently, we are not in normal financial times.
If you own gold, I have one question for you. Do you have it in your possession? If you are like most owners, you do not. You don’t have a vault, and even if you did, it would probably be unsafe to keep the stuff at your residence. If you keep it at a commercial site then you do not own gold. What you have is a piece of paper that says that you own it. The reality is much more convoluted. How do I know this? Because there is not one single commercial enterprise that holds gold without requiring a hypothecation and rehypothecation agreement. That means that the place where you keep your gold can use it as collateral for loans. What happens if those loans blow up? Ask Jon Corzine and MF Global. Of course, if you do, they will likely not be able to answer you.
The reason for the confusion is that this stuff gets hypothecated, rehypothecated, re-re-hypothecated, and on and on. Figuring out just who happens to own the stuff is really complicated. Meanwhile, the finance industry has made the rules, so you can imagine just how important an individual investor’s concerns are. Yes, you read that correctly, the finance industry wrote the rules and picks the adjudicators for any complaints. As one can imagine, private investors usually come out on the short end.
Meanwhile, what happens to the hypothecated stuff? Well, recently some U.S. corporations began making sure that they were the ones holding all the hypothecated assets. Remember from above when I mentioned that stuff that is hypothecated is not delivered? Well, possession tends to be nine tenths of the law. So, when MF Global became insolvent its assets were frozen. Allegedly just before that happened J. P. Morgan Chase went into the home offices of MF Global and took everything that wasn’t bolted down. It is little wonder that Venezuela is moving its gold from Britain to its own vaults. Granted, they are likely doing it because they don’t want to have to pay off Exxon/Mobil for the assets they stole, but still, this gives them a good excuse.
Meanwhile, if you own a piece of paper saying that you own gold…
Robert Coutinho is a disabled pharmaceutical chemist living in Massachusetts. He has been learning about life, the universe, and everything since he was born in 1963. He has had little else to do since his disability began in 1997.