You can’t dust for vomit
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A word about credit risk mitigation
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Marty DiBergi: And what happened to Stumpy Joe?
Derek Smalls: Well, it’s not a very pleasant story, but — he died. He choked on — the official explanation was he choked on vomit. He passed away.
Nigel Tufnel: It was actually – it was actually someone else’s vomit. You know, there’s no real —
Derek Smalls: Well, they can’t prove whose vomit it was. They don’t have the ability—there’s no way of—
Nigel Tufnel: You can’t really dust for vomit.[1]
You can’t custody cash.
This is the banker’s version of Nigel Tuffnel’s famous dictum, and yes it is just a weak excuse to include one of JC’s favourite lines from one of JC’s favourite movies.
But it’s also an opportunity to hold forth on the critical difference between pledged security interests and title transfer security interests particularly insofar as they relate to cash.
Insofar as non-cash assets are concerned the practical differences of a pledged credit support arrangement with rehypothecation and a title transfer arrangement are rather formalistic. Oh, there are differences, to be sure but they are only of interest to legal eagles and those with fiendish interests in the minutiae of security lore. Magic words and horcruxes abound.
With cash, it is different. For deep philosophical reasons — none of whcih seem to have any magic words or horcruxes — you cannot separate legal and beneficial interests in cash.
This is because cash — physical, hard, folding, green currency — is not an asset, but an anti-asset. It is a certificate of what its holder does not have. On its most charitable analysis, a physical bank note is the marker of the holder’s own loss. Or indebtedness. You can only reclaim what you lost, or compensate for your debt liability, by giving it away.
If you give it away in return for something your contract with your counterparty is at an end. If you give it away without consideration, your counterparty owes you its return. That is to give money away without consideration is to lend.