When you sign up to a margin account in almost all cases you pledge your securities to the broker with the ability for them to repledge.
The reason to broker-dealer must be able to repledge is that it needs to finance the loans to you – and to reduce the cost of that financing it needs to offer collateral.
So, when I take my million dollars worth of securities to the broker and borrow 100K on my margin account it looks like I have pledged a million dollars to a broker who might be questionable in order to get 100 thousand worth of financing.
There is one word for this. Dumb. They can – on face of it – take your assets and pledge them to finance their risky business.
If you do not believe it is dumb have a look at my post on Opes Prime, a small broker-dealer that went down in
What the broker dealer act does is (a) ring fence the
I am hardly a lawyer – so take the bush lawyer caveat – but the way it works is that the broker dealer may not borrow against your securities to finance their own business, only client business. So Lehman Brothers US broker dealer could take collateral of securities and if they had 100 million out on client margin loans the most that they could raise using client securities is 100 million and not a brass razoo more. This is really important because it meant that client assets were not used to finance Lehman’s disastrous commercial real estate and other businesses.
Moreover when you deposit a million dollars at the broker dealer and give them the right to repledge those securities they can only rehypothecate 140 percent of your outstanding balances.
If you have 1 million deposited and you have 100 thousand borrowed then only 140 thousand can be rehypothecated and the rest must sit in a segregated client account. [If your broker wants to steal from the segregated client account there are precious few defences – but…] You can not contract out of this requirement.
So (provided the broker is not acting criminally) you should get the bulk of your money back if the broker dealer fails. And provided the capital requirements are adequate (and they mostly are) the broker dealer won’t fail. Even the Drexel Burnham Broker Dealer did not fail.
Goldman Sachs claims that they can determine the capital requirements of their broker dealer intra-day. I have no proof of this claim – but in this age of computers that is plausible.
The result. Whilst Lehman brothers went bust Lehman US broker dealer did not. This pretty well saved the
In some sense this is the end of the City of
I am on record as saying the
But now with the biggest bank in the world by balance sheet (Royal Bank of Scotland) effectively nationalised and the and a large part of the UK hedge fund community lying with open veins it looks a little stupid.
This puts in a different light the 8 billion dollars that Lehman London transferred to the
So here is a plea for US Depression style financial regulation. Some of it (such as the Broker Dealer regulation) was well thought out and should be duplicated. (Some of it was less sensible…)
If I have a plea to my home country (