Rehypothecation is the direct reuse of collateral received by a lender to borrow on their own account from a third party. It enables the intermediate lender to maximize investment in their profitable project by making efficient use of the collateral. I show that when a central bank removes collateral from the market through an open market operation, less collateral is available to be borrowed by the productive intermediate lenders, leading to retarded investment by them and lower aggregate output. This is due to a pecuniary externality: the presence of other competing lenders increases the cost of rehypothecation for the productive lenders to inefficient levels. I find empirical evidence for this channel in the cost of borrowing in the bilateral repurchase agreement (repo) market. The policy implications of this result include conducting open market operations when collateral is abundant and the repo rate is high. It also suggests that using interest on reserves may be more effective as a policy tool compared with open market operations when collateral is scarce.