Rehypothecation
mechanismMoney & Finance
The same collateral gets pledged over and over across the financial system, so if everyone demands their asset at once, some are guaranteed to lose.
Who they are
Rehypothecation, described as the leverage-multiplication machine of the financial system.
What they do
It lets the same underlying collateral be pledged multiple times because it exists only as electronic entitlements, not physical assets.
How it works
A prime broker takes an asset a hedge fund pledged as collateral and re-pledges it to a clearinghouse or another bank; post-Lehman rules cut the reuse rate to about 2x, shrinking global liquidity by $4-5 trillion, but the system still assumes not everyone will demand their asset at the same time, so if multiple parties claim the same pledged Treasury bond in a crisis, the clearinghouse has to pick winners and losers.
Why it matters
A system meant to eliminate the risk of failed delivery instead created a hidden leverage risk that can blow up in a liquidity crunch.
The engine's record — word for word
Report #72. The leverage multiplication machine. Because underlying collateral exists as a fungible mass of electronic entitlements, it can be pledged multiple times. A prime broker takes an asset pledged by a hedge fund as collateral and re-pledges it to a clearinghouse or another bank. Post-Lehman regulations reduced velocity to ~2.0x, shrinking global liquidity pool by $4-5 trillion. But the foundational vulnerability remains: the system assumes not all entitlement holders will demand delivery simultaneously. If multiple parties claim the same rehypothecated Treasury bond during a liquidity crisis, the clearinghouse declares winners and losers. The system that was supposed to eliminate delivery risk created leverage risk instead.
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