Econintersect: Richard Smith has written a description of how new products created by financial engineers at JP Morgan Chase (JPM) create enormous risk for the financial system. Smith uses terms like “Doomsday Machine” and “Dragon” to describe the products and the risks.The myriad of arcane devices involved in the new products include repos, haircuts and hypothecation. Repos are short-term overnight deposits between banks involving cash and bonds (or other securities). Hypothecation is the subsequent transfer of interest in something that one party holds to another (third) party. If this hypothecation process is repeated, then interest is transferred multiple times and can create a bookkeeping multiplication of assets.
Yes, 10% of interest is maintained at each hypothecation step, but a bond may end up being used as a security many times. If someone asks for their money or their security back a house of cards falls down.
This rehypothecation process is adding another layer of fractional reserve activity on top the original layer, which dealt with the cash only.
Read the exacting details at the GEI Analysis Blog.
