Hypothecation

Hypothecation is a fancy word for offering security on a debt; thus hypothetically (sic), a bank owns a house until a lender repays the mortgage. Stretching this definition, if a Government wants to persuade private investors (rather than call on their hard-pressed Treasury) to support the building of new roads, they can hypothecate on the assured income from another aspect of the road system, such as vehicle excise duty (aka car tax or road tax). That sounds clever, because it gives investors a low-risk security against their funds. However, the same investors who put money into such a scheme, could themselves re-hypothecate from the same collateral – the road tax income – to support their own borrowing! Meanwhile, the Government, who are the owners of the duty, can also use the collateral for their regular activities; just as you may use a house whilst it’s under a mortgage.

Does this kind of behaviour sound familiar or worrying? The International Monetary Fund (IMF) examined this practice in a paper, which the Financial Times later brought to light whilst researching the causes of the 2008 financial crisis. It specifically notes the use of re-hypothecation in the ‘shadow banking system’, those financial services beyond the reach of regulations and monitoring of individual states.

For this reason, when a Member of Parliament refers to the hypothecation of road tax income (which the Treasury has already committed to to build public infrastructure), I smell the undeniable rich country odour of the farmyard, despite there being not a single beast in view.