Umm...

[Gumby]

I tuned into my daily ZeroHedge today, to peruse the latest doom and gloom from Europe. I usually find it somewhat morbidly entertaining. But, today the news seems to be taking a turn from bad to horrific. It's easy to take most gloom and doom predictions of inflation or deflation with large grains of salt. Most of these things don't pan out the way people think they will.

But the idea that Wall Street is starting to worry about the implosion of the US and European shadow banking system, well my eyes widen just a bit.

ZH: Why The UK Trail Of The MF Global Collapse May Have "Apocalyptic" Consequences For The Eurozone, Canadian Banks, Jefferies And Everyone Else

Thomson Reuters: MF Global and the great Wall St re-hypothecation scandal

Not only does this explain what happened to MF Global, but if the shadow banking system is really so leveraged that it is teetering on the edge of collapse, methinks some of our brokerage accounts and ETFs are not nearly as safe as we might think they are.

It kind of makes me want to move all my cash to TreasuryDirect.

[moda0306]

Thanks in advance... this is the only site where I'd take posts linked to doom and gloom seriously, and even then most are simply "interesting," and not necessarily all that scary... and you're one of a few posters here that I'm more in line with on most topics, so I'm a bit scared to click on the link.... Keep your ear to the street.

[Gumby]

It all sounds so far-fetched. And yet...entirely plausible. It's absolutely surreal to even be pontificating about the idea that we are one major default away from a shadow banking implosion.

[moda0306]

I'm a bit lost but this looks nuts.

[Gumby]

You mean you never learned about the consequences of "hyper-hypothecation" in college?  ;)

I can't say I fully understand every word either. But, physical gold and direct Treasury ownership are looking mighty attractive right now.

[moda0306]

Gumby,

I was just going to say that I think those two are appearing to be very good ideas.

The idea of relying on a chain of contracts to be honored is looking mighty scary.

I'm going to at the very least jump on moving TLT into Vanguard-purchased LT treasury bonds.  A little physical gold, too, at least.

Goodnight... I hope our retirement accounts are all still here in the morning.

[Gumby]

My impression is that a shadow-banking implosion could take months to play out. Lehman was actually a tiny example of that 'snowflake to cause an avalanche' cascade, and it took months to play out — and we are still feeling its effects. Except this time, the snowflake is a country.

This entire financial crisis is really a butterfly effect that started years ago. So, my guess is that these cascades can take some time to get rolling. But once they get rolling, I think the effects would probably accelerate tremendously.

[moda0306]

Maybe the prediction of massively higher interest rates stems from the fact that so many people will not even be trusting FDIC insured accounts that there will actually be demand for loanable funds in excess of supply.

[Gumby]

Maybe the prediction of massively higher interest rates stems from the fact that so many people will not even be trusting FDIC insured accounts that there will actually be demand for loanable funds in excess of supply.

Sorry, I must have missed that. Who is predicting massively higher interest rates?

[moda0306]

Maybe the prediction of massively higher interest rates stems from the fact that so many people will not even be trusting FDIC insured accounts that there will actually be demand for loanable funds in excess of supply.

Sorry, I must have missed that. Who is predicting massively higher interest rates?

The people I often laugh at...

It seems a chunk of people that are predicting crisis are somehow trying to carry it to commodity prices, interest rates on treasury debt and inflation.  I totally disagree with this, but sometimes try to walk through the facts to try to get to their conclusion.

[Gumby]

Well, the way I see it, if a highly-leveraged European shadow banking system collapses it would spread to the US shadow banking system. That would imply, to me, that US money market funds would be toast. Credit would grind to a standstill and companies would be unable to get any short term credit to pay their bills. Even FDIC accounts at many banks are presumably invested in assets that would be affected by a shadow banking collapse in one way or another. In which case, a run on the banks would be the next logical conclusion — even if it were only caused by a lack of confidence.

The Fed would step in to provide liquidity, but I don't see how the Fed would have the ability to fund an over-leveraged shadow banking system to the tune of $707,568,901,000,000.

It seems impossible that this could play out as described, but physical gold would be a must-have in that situation because my guess is that Gold ETFs would likely fail in an all out shadow-banking collapse as they tend to use large banks as custodians.

I still don't know if interest rates would be higher or lower. I suppose it depends on how many Primary Dealers are left standing. Typically the Fed prioritizes lending to Primary Dealers so that the Treasury market is uninterrupted.

[moda0306]

The term "interest rates" during a panic is also a bit of false precision...

In a massive crisis:

I'd loan the US gov't money at 0%.

I wouldn't loan a business money at 15%.

Spreads get so large that default risk skews the whole spectrum of rates.

[Storm]

Gumby, while I do think the MF global situation and the missing $1.2 billion is troubling, I've learned not to believe everything you read on Zerohedge.  Zerohedge provides a nice balance to the conventional media, but they have their own extreme biases and shouldn't be relied upon for accurate news coverage.

Don't get me wrong, I like to read ZH, but I look at it like this - if CNBC is providing the "market cheerleader" or market bull perspective, Zerohedge is providing a "permabear" perspective on the market.  The reality is usually somewhere in the middle.

For example, if you read Zerohedge and believed everything you've read you probably would have invested 100% of your retirement in silver at $50 an ounce and took a 40% loss this year.  You probably bought a decommissioned bunker in Montana and hide out there with your canned goods waiting for the "any minute now" global financial collapse and zombie apocalypse, clutching your silver eagles and saying "my preciousss...."    Just kidding, by the way, but if you're a regular ZH reader you might know what I'm talking about.

Ignore the noise of the news media.  I think CraigR recently went on a news fast.  This is a good idea, especially if you're invested in the PP.

ZH is a permabear so of course, every ten years or so they will be right on the money.  It's the old saying "even a stopped clock is right twice a day."

[Storm]

Here is an interesting rebuttal to the hyper-hypothecation claims by someone that works for Interactive Brokers.  Apparently a lot of people seem to think that all of the brokerages are using client funds to make their own risky bets.

http://www.elitetrader.com/vb/showthrea ... enumber=10

Wow - pretty serious accusations here but how many of you really understand what hypothecation is? This is all about margin and stock loan. Remove the ability to hypothecate and you might as well suck out a massive amount of liquidity from the system.

First, let me get this out of the way. The accusations or assumptions that IB client money is used to fund Timber Hill are completely false. The companies are separate.

Client money is segregated. However, if you utilize margin and are long shares, IB can lend some of those shares out to others. These are not risky loans as there are limits on how much can be lent and they can be recalled at anytime and marked to market real time. Those are the rules, they are fair, not risky and add a ton of liquidity into the system.

The comments and fears presented here are a classic over-reaction to margin lending. Do not put IB or other firms on the same plate as MF. IB has a very strict policy when it comes to margin and deficits (ie. real time liquidations) and a very conservative risk management and investment policy. Many clients scream that they want more margin and that the stock loan list isn't long enough and now many of you are calling the kettle black. Before believing everything you read, do your homework and then decide if the practice is risky. Some banks are silly when it comes to greed and what they lend out. Others are not. IB has a long history of being conservative and risk adverse. Our large capital base and handling of client credit should also provide additional comfort. Many of the comments and assumptions on this thread are baseless.

Let's not over-react and create fear where their should be none - and I say this in regards to the comments on the other firms mentioned in this thread as well.

I need to put in a days work now so do not expect any replies for quite some time from me. I agree this is something that needs further clarification so you can be better educated on the subject as well as placate the unfounded fears expressed here. However, this this discussion should be for the industry and not single out IB.

[Gumby]

Storm, I'm well aware that ZH is a permabear and therefore may not be correct. I certainly don't believe everything they say.

However, I am merely pointing out that the collapse of the highly leveraged shadow banking system is something that people are actually starting to talk about. And the article from Reuters is showing us that this idea (perhaps wrongly) is starting to enter the edges of the mainstream media. That in and of itself is pretty surreal.

I don't see the harm in talking about the hypothetical collapse of the shadow banking system because that would have severe consequences on everyone's brokerage accounts and ETFs. It's a healthy discussion to have.

[Gumby]

Here is an interesting rebuttal to the hyper-hypothecation claims by someone that works for Interactive Brokers.  Apparently a lot of people seem to think that all of the brokerages are using client funds to make their own risky bets.

Ah.. a representative of IB is assuring everyone that "IB has a long history of being conservative and risk adverse". What could possibly go wrong?