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Don’t think the word rehypothecation is some astronomically complex financial term. It simply means reusing collateral. Take this example:

You go to the bank to get a loan. The bank will not give you a loan without you posting collateral. You decide to post an expensive painting as collateral. Just in case you do not pay the loan back, your bank can seize your collateral (painting). Imagine if the bank decided to use your collateral (the painting) to get another loan from another bank. So, the collateral that you used to get a loan is now being used by the bank to get a loan. This is rehypothecation in essence.

Now lets take it a step further. Warehouse receipts are issued to someone who holds a commodity in a warehouse. Lets say you own a few pounds of copper. You decide to keep your copper stored in a warehouse and collect a warehouse receipt to prove that you own the copper sitting in the warehouse. Once you have a warehouse receipt, financial alchemy can pursue. Major banks and trading houses around the world are essentially rehypothecating warehouse receipts. This simply means more warehouse receipts are being issued than physical commodities exist in the warehouse. This is a dangerous leveraged financial creation. What happens when people demand their physical copper. If 20 different people have warehouse receipts for the same amount of copper sitting in a warehouse, somebody is not going to get their physical copper. Here in lies the danger in this financial creation.

Keep your eye on the news regarding warehousing of commodities and warehouse receipts. This seems to be a recipe for disaster that is beginning to unravel in our financial system as I speak.

 

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