Regulation T and SEC Rule 15c3-3, a broker-dealer may re-hypothecate assets to the value of 140% of the client's liability to the broker-dealer. In other words, assume a customer has deposited $1000 in various securities and has a current debt deficit of $500, resulting in net remaining equity of $500. The broker-dealer can then re-hypothecate up to $700 (140% x $500) of these assets. This now leverages the taking of client’s money on an undisclosed basis.

In the UK, there is unquestionably no statutory limit whatsoever on the amount that can be

re-hypothecated. In fact, brokers are free to re-hypothecate all and even more than the assets deposited by clients is truly astonishing. However, at least there it is up to clients to negotiate a limit or prohibition on re-hypothecation whereas in America it is not even disclosed. Therefore, US broker-dealers have an advantage when opening a UK operation allowing them to bounce back and forth exploiting both systems. Why do you think that AIG was operating in London? This irregularity of rules between the two markets enables exploiting the UK regime very attractive to international brokerage firms to employ European subsidiaries to create pools of funding for their U.S. operations, without the bother of complying with U.S. regulations even if they did bother to enforce them.

This is why the collapse was so devastating following the 2007 high. The

re-hypothecation in the REPO market had grown so enormous also using the mortgage backed securities rated AAA amounting to half of all the activity within this "shadow banking system" known as REPO. Prior to the Lehman Brothers collapse, the International Monetary Fund (IMF) had actually calculated that US banks were receiving $4 trillion worth of funding through this re-hypothecation scheme, most of which was being sourced from the UK. With even the mortgage backed assets being re-hypothecated many times over in London (the "churn"), the original collateral being used may have been as little as 25% of the total volume reported to have been $4 trillion. This is why $700 billion was needed in Tarp. Nobody was looking at just how big the bailout had to be and behind the curtain the Fed and Treasury had to see this degree of leverage. The fact that MF Global has blown-up, demonstrates that Congress did not address the real issues in this whole mess allowing the shit-to-hit-the-fan hoping that the bankers would make a ton of money and grow the economy out of this mess all on other people’s money!

The practice of

re-hypothecation today runs into the trillions of dollars and is faultlessly legal under current law. If Congress is not grandstanding once again, then write a statute and state banks and brokers can do NOTHING with client’s assets whatsoever without a contract and payment for the use of such assets. It can no longer be justified that banks and brokers on the basis that it is a capital efficient way of financing their operations that amounts to trading illegally with other people’s money. Investors in hedge funds should DEMAND that assets NOT be left on deposit in ANY Investment Bank right now until this issue is clearly made illegal.