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 a weak excuse to include one of the best 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[2] are concerned, the practical differences between pledged credit support — where the pledgee typically may reuse posted assets to optimise its financing, but ultimately return it — and credit support that is transfered outright against a promise to return an equivalent thing — are rather formalistic. Oh, there are differences, to be sure and they jazz those with fiendish interests in the minutiae of security lore but leave others cold: so much hocus pocus, you know.
With cash, it is different. For deep philosophical reasons, you cannot separate legal and beneficial interests in cash. that means you can’t pledge cash. You can pledge your right to be paid cash, but that is a profoundly different thing. That is an asset; cash is not.
You what, JC? Cash is not an asset?
Indeed, no. Far from being an asset, cash — hard, physical, folding, green stuff — is an anti-asset. It is what you give away to get an asset.
Cash is a certificate of what its holder no longer has. I had this Chippendale commode[3] but I sold it to you and now I have £20 instead. This tatty cotton banknote is of no intrinsic value to me; its value derives purely from I may achieve with it by the act of giving it away. I get no value from just holding on to it. Its “give-away” value will, indeed, decline the longer I hold it.
Importantly, “giving it away” includes giving it to my bank. In return for it, they promise
You give cash away in return for something your contract with your counterparty is at an end. If you give it away without consideration, then, unless it is a gift, or you are being robbed, your counterparty owes it back to you. That promise — it is called a loan — is an asset. To give money away in that way is to lend.
If you exchange cash for an asset — that is, give it away against transfer to you of an asset in return, there is no loan — or the loan is instantly settled by transfer of the asset in lieu. This is called a sale.
There are no other intermediate states. Being an anti-asset you can’t own cash, only hold it — so therefore talk about pledging cash, or declaring a trust over it, is incoherent. You can pledge, secure or declare trust over your legal rights to the asset that your cash payment leaves behind — that loan, or bank deposit — but not cash itself.
On its most charitable analysis, a physical bank note is the marker of the holder’s own loss. Or indebtedness. This is quite a difficult idea to get your head around, but consider what cash is and where it came from. Physically it is, as near as possible, a pure abstract symbol: a token. We want it to have no intrinsic value, weight, shape or heft. It should not occupy space, require energy, or need maintenance. (As far as banknotes wear out, they are an imperfect substrate). Its only value should be symbolic. It is what I give you to signal that I have received value from you.