I’d like to make kind of a meta-point about what I see as two different ways that people are talking about the issue in this rather contentious thread.
To oversimplify a bit, there seems to be a crowd saying: “these pension fund managers gambled with my retirement to enrich themselves”.
There seems to be another crowd saying: “if you examine the details of these transactions you’ll find that it’s neither that simple nor fundamentally even true”.
I’d like to submit that the latter group, which I suspect is probably technically correct (the best kind) should possibly examine the possibility that while any isolated derivatives transaction probably makes sense and is governed by deep and sophisticated mathematics, it does seem to be the case that in sum total we see, decade after decade, a cumulatively destabilizing effect on both financial markets and the financial security of everyday folks: somehow the emergent system either is or really, really fucking appears to be privatizing profits while socializing losses while simultaneously driving up the swings of the business cycle.
I love the financial mathematics stuff intellectually and this is certainty a forum that welcomes experts discussing details, but at some point we need to acknowledge that it’s high finance’s job to convince the public that they’re actually helping, not the public’s job to learn high finance.
Elites that forget this for too long have historically come to very bad ends.
The destabilizing threat is real and systemic. Derivatives allow us to hedge local risks at the cost of creating the possibility of the whole system collapsing. It greatly concentrates risk in those who wish to gamble, and if their gambles go south allows them through leverage to threaten the whole financial world.
This is not just a contrarian view. Go to https://www.berkshirehathaway.com/2002ar/2002ar.pdf and start around page 13 where it says "Derivatives" for Warren Buffett's analysis. This is the one where he calls derivatives "weapons of financial mass destruction". (This was several years before the 2008 financial crisis.
He makes a number of good points. One of which is that we value derivatives is based on complex models. Those models inevitably have errors. And the errors are generally in favor of the side that you purchased. So those engaging in the trades always believe that they are making money (and bonuses etc get paid on this basis), no matter how disastrous it may later turn out to be.
In this case it is likely that the pension fund managers never realized what kinds of complex gambles they were making or what the real risks are. They were working according to models in which what they did was wise. And it may well be that they were right in the long run. But as Long-Term Capital famously showed, being right in the long run only matters if you survive to see it. It remains to be seen if these pension funds will survive.
But in this case, there was no error on derivatives. It was unforeseen and very violent market move in the response of Tory’s policy “more tax cuts” and the general loss in the faith that the UK economy will be productive and surplus any time soon.
Those who modelled the risk did not think Tories would do anything that stupid and risk the UK economy.
The fact that the model did not account for what actually happened as possible IS a problem in the risk model.
Pension funds are supposed to run for decades. Looking at the last 12 decades, I see many financial crises, a run on the pound, the Great Depression, a couple of world wars and so on. All of which were unthinkable until they happened. Any risk model meant to cover long periods should account for the possibility of similarly extreme events happening in the future, at roughly the historical frequency.
But you're telling me that those who modeled the risk failed to give this ANY consideration at all?? And then you say that you think that this oversight is not an error??
I would take even a somewhat kinder view of the pension funds involved. With no knowledge of the intimate aspects of the agreements UK pension funds make with employers, those involved knew that you could either pay for the risk margins involved up front, or via emergency capital.
Margin calls are nothing special. Derivatives are used for balancing assets and liabilities, since you cannot match the cash flows on pensions directly given the very long duration (cash flows for pension funds run for nearly a century). Swaptions etc are nothing evil. They are pretty clear cut tools for the job of limiting interest rate exposure for parties with very long liabilities.
This is not a pension fund problem (I agree up front: that's a reductio nearly ad absurdum), it's an employer and pensioner problem, created by a sudden loss in confidence in UK gov in an already very turbulent market. If sterling falls, purchasing power falls, interest rises, there is no way pensions can keep purchasing power or indexation. Margin calls are a tiny symbol that shouldn't worry a risk manager. It's the larger enviroment for the UK - that is very worrying.
It's all hocus pocus but a well run insurer or pension fund should have a pretty solid grasps on interest rates and a pretty low exposure to swings in that rate. Same for FX exposure. End of '21 you should have opened up some upward potential in interest rates and have some room to survive that volatility. The best managed ones keep afloat or even profit, without taking too many excess risks. The worst managed ones are the first to fall. Go and look at the Q3 financial results for the largest _worldwide_ insurers. I predict the largest insurers will show stronger financial capital positions. (Stocks will fall since large insurers are partially valued on general stock market performance since they are in essence also investment companies.)
Again, margin calls are a symptom caused by the underlying agreements, with not a direct relationship to which ones will fail or prosper.
It reminds me of a what a friend of mine said who priced Mortgage Backed Securities before the financial crisis "Oh, we never modeled different mortgage default rates - those were fixed assumptions. The really complicated math was driven by interest rates."
He did leave me with the impression that tnterest rate modeling was technically challenging and had lots of scope for sophisticated work - so that's where the effort went.
1. Just because papers always seem to know why markets move, doesn't make it true.
2. Margin calls happen when you are short, highly leveraged or not hedging properly (derivatives going wrong). Should "pension funds" do any of these things ?
Is the "tax cut" justification the real cause though? The Euro and Yen plunged in lockstep with GBP, which suggests a more fundamental issue beyond just the UK market. I have to wonder if the mini-budget was just used as justification.
There’s no complex modeling required here on an interest rate swap. The payout on swaps is easily calculable and the range of outcomes knowable. There’s not much overlap in the context of what Buffett talked about and what happened here besides the word “derivatives” and the idea of exogenous shocks tending to lead to outcomes outside your range of modeled assumptions.
I’d be glad to engage more but it seems like you are fixated on a slant and cannot be convinced otherwise.
I think the equivalent would be if, a very modestly able coder, were to insist on this forum that nobody should ever have loops in their code because sometimes they do weird things.
> The payout on swaps is easily calculable and the range of outcomes knowable.
While this is technically correct, it's the solvency of the counterparties that is not easily calculable or knowable. Derivatives must be viewed in the totality of the system in which they are used. Focusing on the fact that payouts are calculable and therefore perfectly safe in isolation is extremely myopic.
> I think the equivalent would be if, a very modestly able coder, were to insist on this forum that nobody should ever have loops in their code because sometimes they do weird things.
I think the equivalent would be if, a very modestly able coder, were to insist on this forum that because the database is up 99.9% of the time, there's nothing wrong with not handling errors, because the DBA team is running with an average IQ of 143, they all went to MIT, they know what they're doing, black swans do not exist, and that 99.9% might as well be 100.
Derivatives are inherently dangerous because they are a knowable mathematical system coupled quite tightly to an unknowable system of risks. You can't mentally decouple them and claim that welp, the math works, it's fine, ship it.
And given the web of interdependencies among the counterparties, every counterparty should be assumed to be overly exposed to a systemic risk that everybody is currently discounting. If that risk happens, it will be difficult to predict who will be affected, and it will be impossible to unwind the deals in a hurry.
We have had a number of financial crises that have required external intervention to keep the whole system from melting down. Most famously, 2008. And they show how quickly a solid counterparty that everyone trusts becomes a source of contagion that poses a risk to everyone touching them.
If we have a long planning horizon, what kinds of shocks should we be prepared for? Well here are a few sample scenarios.
1. Russia collapses, leading to nukes floating around to bad hands.
2. China finally invades Taiwan, threatening everything that needs computer chips.
3. A US government shutdown finally results in non-payment of Treasuries, causing a "risk-free" investment to have to be priced for risk.
4. A repeat of the 1859 Carrington Event happens, with damages in the trillions of dollars. No seriously, https://www.space.com/the-carrington-event shows how plausible this is.
The financial system treats all of these as unthinkable and therefore impossible. But between all of them, over a period of decades, the risk of SOMETHING on this order of magnitude happening is significant. It is a problem that the entire financial system fails to appreciate that there IS a risk, let alone fails to do anything to mitigate it. Indeed, quite the opposite, the 2008 bailout has let the financial system believe that the government will always bail them out. And so has become complacent about their role in creating various minor financial crises.
But there is no guarantee that the government will always be in a position to do that. The result has been a normalization of deviance that has to end badly at some point. See https://www.ostusa.com/blog/normalization-of-deviance-defini... if you're not familiar with the phrase "normalization of deviance".
Thank you. Although I think the risk of #4 is greatly overblown. We watch the sun constantly now, and detection of an X20+ class flare aimed at us gives us about 10 hours or so to disconnect as much as we can, limiting damage to maybe only a trillion or so.
My personal favorite pet risk is a combination of #1 and #4, though. A few HAEMPs de-orbited and detonated over North America by a collapsing or collapsed Russia gives us no time to disconnect anything. And the fantasy that neither defense.gov, nor mil.ru, have many of these in orbit right now because "OMG it would be a Space Weapons Treaty violation and nobody would ever do that", is as naive as the pre-Snowden "OMG the NSA would never spy on Americans because it's illegal" normie zeitgeist.
> the equivalent would be if, a very modestly able coder, were to insist on this forum that because the database is up 99.9% of the time, there's nothing wrong with not handling errors,
Any system that socializes losses to parties that are not embarking in the risk/profit is going to be exploited. Period. This is not just about finance. It's a leak. Anything that can leak for profit, will eventually leak.
These attacks (and I don't mean you personally) to the free market (and derivative products) are dangerous. If the "free" market fails because it's not so free after all(socialized losses), you don't fix this by having more bureaucrats/politics involvement to run the markets. This will only make matters worse.
The proliferation of politics in the markets, because of that, is also accelerating. The argument is now readily available (look at how these complex derivatives products are destabilizing the market!). This will lead to more chaos in the market, more dysfunction and more organized thefts of the market (if not from smart mathematicians than from politicians/bureaucrats) and eventually to a military rule.
We've been there a few decades ago. It's sad what's happening now.
> If the "free" market fails because it's not so free after all(socialized losses), you don't fix this by having more bureaucrats/politics involvement to run the markets. This will only make matters worse
This is deeply naive. Governments that don't take action when pension funds evaporate en masse will fall and be replaced by those which do take action. If this didn't happen, it would be a failure of democracy, not of markets.
Such a government would be illegitimate - and on-topic, that's pretty much where the UK government is at right now, it's pursuing a set of policies it has no electoral mandate for and is currently 33% behind the main opposition.
(Yes — and it feels like we have a systemic problem when the people have no way to get rid of a government this unpopular — except relying on them to do the decent thing and bow out, which this bunch, having been basically purged by Johnson of anyone with intelligence or principles, will clearly never do).
But the public -- pensioners and future pensioners -- are embarking in the risk/profit side of things. We want to fund our pension with less money than we ultimately take out, and additionally have guaranteed outflows regardless of market conditions. To put it shortly, we want profit.
The average pensioner may not understand that they were joining in a risky undertaking. Whose fault that is I could not even begin to suggest -- too many possible candidates depending on your world view. But a lack of understanding will avail you little when your counterparty is the fundamental financial reality that there is no free lunch.
As annoying as it is that the bankers made a bunch of money, the alternative, where all pension monies go into a savings account, would leave people much less happy.
And fundamentally it must be risky. You are engaging in a deal to be paid a sum of money 30 years down the road, there’s 30 years of mandatory uncertainty and risk involved with that deal. With defined contribution plans at least the worker observes that risk directly (401k goes up or down) but you can’t, no matter what you do, make it not risky.
Free markets only work for certain markets - and it works in those markets exceptionally well. HOWEVER somewhere in history we decided as a group of people that free markets worked so well for these specific markets that we will apply this ideology to all markets and that will solve the problems of appropriate capital allocation.
This is indeed a fallacy and has led to the rampant problems and the perpetuation of the simplistic & naive belief that free markets will allocate capital properly and efficiently and if the free market doesn't its a function that the market isn't free enough.
I think you are assuming the derivatives in question are wild, complex, speculative derivatives. This is almost certainly not the case. They are most likely long dated interest swaps.
Pension funds have a duration problem, they are managing long term liabilities (what they owe to pensioners) and need to ensure they have enough assets to cover the present value of those liabilities. If interest rates move, then the present value of those liabilities may change a lot because of the new discounting. So they try to reduce that risk, either by buying assets that behave in a similar way with respect to interest rates, or by entering into long dated interest rate swaps. I think the leveraged repo positions they are refering to is doing the same thing as an interest rate swap by going long a long term gilt and short a short term gilt (or the other way round), but basically they try to create an interest rate mismatch to take some duration exposure.
So this is pension funds reducing the risks, not speculating.
The systemic risk here seems to be mostly a concentration problem and feedback loop. I.e. the more interest rates move up the more pension funds need to sell gilts to hedge their duration or post collateral, the more gilt prices collapse, the more interest rates move up.
Agreed, the problem isn't at pension funds; the problem is the whole financial system's excessive systemic risk.
That systemic risk can be effectively reduced, and policymakers haven't done much to address it at all due to regulatory capture. Many financial mathematicians and popular intellectuals (Nassim Taleb, James Rickards) have pointed out the need to descale the financial system to decrease systemic risk, and prevent the financial blowups that are inevitable at the current scale.
The problem has two sides. On the one hand there's finance where some people are taking risks, creating instability that will mostly hit every day folks when things blow up.
But on the other side are those every day folks. They want their pension money to gain a profit each year so they'll have a decent pension when they retire. At the very least it should match inflation but preferably a bit extra.
Investing money (almost) without taking risk is possible but you'd have to stall all the money at the ECB or some other central bank, and until recently you'd have to pay a negative interest rate. This wouldn't make pension holders very happy.
So pension fund managers take risks. They surely take as little risk as possible and they are excellent in picking opportunities that give a comparatively high yield for their risk: but they are taking a risk, otherwise they would never come close to beating inflation.
And sometimes the risk blows up, and everybody is all upset. It's easy to blame those filthy rich fund managers but people should also look into the mirror sometimes.
[1] points out that you can have a perfectly boring, safe pension fund by investing all the money into gilts with positive interest rates which means you only need to put in £48 now to get £100 in 30 years.
>it does seem to be the case that in sum total we see, decade after decade, a cumulatively destabilizing effect on both financial markets and the financial security of everyday folks
I'm not an expert in finance by any means, but for the most part this doesn't seem true. Besides the mortgage bubble, the market has only seemed to get smarter over time. There's definitely a lot of weirdness, but
that's to be expected when interest rates are less than inflation for over a decade.
>it’s high finance’s job to convince the public that they’re actually helping, not the public’s job to learn high finance.
People go into finance to make money, not to help people. It happens that making money in finance tends to make the market more efficient, which helps people. All the low-hanging fruit has been picked, so very little benefit is going to trickle down to the common folk these days, but as a whole, I don't think they're harming people.
Meanwhile, I do think that it's the public's job to learn finance, or rather strive to be more informed in general. When the public's priority is to scream out that we should eat the rich, politicians will happily virtue signal along with them and outsource the boring work of legislating to a corporate lobbyist.
> Besides the mortgage bubble, the market has only seemed to get smarter over time.
An incongruous comment on an article pointing out that the market has got dumber (ie turning the "should be perfectly safe in gilts" UK pensions market into "hours from 90% collapse because we gambled with shares")?
I don't think fundamentally that the problem here is derivatives. I think fundamentally that it is pensions themselves.
Think about what a pension is. A pension is a deliberate inefficiency in a labor market. It's a promise to pay someone for not working, and in some cases even, children of people who once long ago worked. It is also a central lever for people to look to profit on through managent, and a tool with which to overinflate demand for financial products.
The commitment taken on by a pension fund is an increasingly impossible one to uphold as time goes on and markets get more efficient. They have a bag of capital they have to make grow to continue to honor an open ended commitment, so they have to continue to find interesting and clever (and risky) ways to do that. Compounding on this, they're big bags of capital, so they will invariably become load bearing pieces of a nation's financial portfolio. Of course they're going to wind up intimately tied to the overall financial health of a nation.
"We take some chunk of money we would otherwise just pay you, promise to invest it wisely to indefinitely pay you later for not working, and in return we get a chunk of capital to play with and a sink to help stabilize the financial system." That's the proposition of a pension, right?
You might be tempted to say "pensions are just a part of agreed to compensation, a contractual obligation and nothing more. There's nothing special about a pension that gives it these negative properties your ascribe to it" and to that I'd ask, then why don't people just take the capital through their working years as monetary compensation? Surely they could hand that to a money manager and achieve the same result as a pension achieves? The answer is because people wouldn't be able to expect what they get out of a pension, they go with a pension because they think they're getting something more out of it, and that excess is the ultimately impossible commitment I am referring to.
The premise that a pension should beat the market without taking on risk does seem suspect. Other traders have the same idea with higher risk tolerance. Maybe gambling over multiple decades is a significant advantage but that's also difficult to see.
>> A pension is a deliberate inefficiency in a labor market. It's a promise to pay someone for not working...
That's and extreme simplification of pension and probably the worst definition You can think of. I guess if You were a marxist as opposed to some form of capitalist/liberal I would expect that You would base Your definition on class struggle.
I much more prefer to think about pension as a form of insurance against the risk of getting old. And as such the free market "implementation" is only one of possibilities (for ex. here in Poland we have state pension with a bit of free markets sprinkled on top). I personally believe that "old age insurance" is one of flag inventions of our times and do not think that there is a place for free for all solutions in civilized society (we are in this together and should work out a way to protect the weakest).
>> It is also a central lever for people to look to profit on through managent, and a tool with which to overinflate demand for financial products.
That's an implementation detail in my view - if You look at it from insurance perspective, You just need to search for a way to redistribute effects of current work between workers and retires. And using financial products (stocks and derivatives) may just be a wrong tool for the job.
> while any isolated derivatives transaction probably makes sense and is governed by deep and sophisticated mathematics, it does seem to be the case that in sum total we see, decade after decade, a cumulatively destabilizing effect
It's not true that derivative transactions are good in isolation and add up to something bad. The bad derivatives transactions add up to something bad. The good derivative transactions do no harm, and are good for everyone involved.
If you see a wheat grower hedging their variable yield, that's not going to add up to something bad. If you see derivatives on junk loans in a low interest rate environment, obviously that's different.
> If you have a pot of money that is immune to bank runs, over time, modern finance will find a way to make it vulnerable to bank runs. That is an emergent property of modern finance. No one sits down and says “let’s make pension funds vulnerable to bank runs!” Finance, as an abstract entity, just sort of does that on its own.
Agree with your point, but as far as I understood that “gambling” done by the pension funds mainly happened because there’s no other way for them to pay what they’re due, i.e. the pensions themselves. In other words the pensions system slowly reveals itself as the Ponzi scheme it was from the very beginning.
"I know this is bad but I find something aesthetically beautiful about it. If you have a pot of money that is immune to bank runs, over time, modern finance will find a way to make it vulnerable to bank runs. That is an emergent property of modern finance. No one sits down and says “let’s make pension funds vulnerable to bank runs!” Finance, as an abstract entity, just sort of does that on its own."
I have leveraged positions on the stock market and never got a margin call, and probably never will. Being margin called is purely and simply unprofessional and irresponsible. There is no way around that.
The maths will never justify a margin call. LTCM has tried taking on extra risk justified by their oh so clever math models and ended up blowing up. People will keep repeating these kinds of mistakes until the end of capitalism.
What is going on in the UK is not, in any imaginable sense of the expression, "financial tightening": the "mini-budget" that prompted the response from the market is a $161bn tax-cut and spending plan funded by government borrowing.
» The September 2022 United Kingdom mini-budget was a set of economic policies announced by the Chancellor of the Exchequer Kwasi Kwarteng on 23 September 2022. Although not an official budget statement, it was widely referred to by the media as a "mini-budget". Among the policies announced by Kwarteng were: bringing forward the planned cut in the basic rate of income tax from 20% to 19%; the abolition of the 45% higher rate of income tax in England, Wales and Northern Ireland; the reversal of the April 2022 increase in National Insurance; and the abolition of the proposed Health and Social Care Levy.
» The budget, which was unveiled against the backdrop of a cost of living crisis, was immediately followed by a sharp fall in the value of pound sterling against the United States dollar as world markets reacted negatively to the increased borrowing that would be needed. By the next day of trading, the pound had hit an all time low against the US dollar. The statement drew widespread criticism from economists, some of whom feared its reliance on increased government borrowing to pay for the largest tax cuts in 50 years could lead to a situation like the 1976 sterling crisis when the UK was forced to ask the International Money Fund (IMF) for a financial bailout. The IMF took the unusual step of issuing an openly critical response to the budget, saying it would "likely increase inequality".[4] It urged the UK government to "re-evaluate" the proposed tax cuts.[5] The HM Treasury announced plans to outline how the proposals would be costed in November, alongside an independent forecast from the Office for Budget Responsibility.
I don't get it. Why can't the government walk back these changes? Does the prime minister think they will get ousted if they reverse this nonsense?
Once the taxes are lowered and most of the EU regulation removed the UK will become global again. Golden years are ahead. Asia(which experiences biggest economic growth) will start trading like never before with the UK. The U.S will provide Tuss with a bespoke trading deal. Or so they said...
I just wanted to point out that your comment is quite useless as unless someone already knows what you're talking about (I don't) then it's basically devoid of any useful.
> Why can't the government walk back these changes?
Largely because they've only just got into power (about a month) after the last prime minister was forced out, and as their first major act, having to walk it back would cause an unacceptable loss of face.
If they are forced to roll it back somehow, which may or may not happen, they get to look like they stuck by their 'principles' and it was other people who lacked faith in the plan.
They can't be ousted easily, party rules give her a year without the possibility of another leadership challenge, but she could start facing open rebellion in the ranks, which might lead the whole thing to collapse, requiring a general election. And right now she'd lose one of those by a country mile.
Why would they want to walk back these changes? My take on the situations is they are doing exactly what they want to do - help their rich pals make more money. Kwarteng's background [1] especially seems very interesting (worked at a hedge fund, friends with oil industry, etc).
> Because they believe that tax cuts will ultimately stimulate the economy at a time when people are experiencing increased cost of living.
It doesn't make any sense from what I understand because we are raising interest rates to cool down the economy and lowering taxes to heat up the economy. I am not an economist but I think we should be pushing in the same general direction.
Not really because the changes caused higher (anticipated) interest rates which will have the opposite effect on the economy. Also removing the 45% tax rate would not have had any measurable impact on the economy aside from the aforementioned negative one, it was just a pointless handout (hence the crisis of confidence).
What the government actually needs to do is to get back confidence so that interest rates don’t have to go so high to compensate for the loss of confidence. They could do that by walking back the changes and appointing an experienced and “safe” chancellor.
> I don't get it. Why can't the government walk back these changes?
The lion's share of proposed borrowing is going toward subsidizing energy bills for the public and for businesses for at least the next 6 months. Walking back the tax aspect might please some but it isn't going to make any real difference, aside from political suicide.
I also don't think walking back the energy subsidy is going to win much approval from anyone either.
Mortgage interest rates in the US are nudging 7% and the UK is going to follow the same path regardless of any interventions. Almost all other currencies are also falling sharply against the dollar, btw.
The vast majority of the unfunded borrowing is paying for the energy bill subsidies, at least up until the next general election (and who knows what will happen after that). The IMF have also specifically warned against those blanket subsidies, not that you'd know this from the BBC's coverage of their statement for some reason, and there are really fundamental economic reasons why they're likely to tank the pound and force the BoE to put interest rates up to do with balance of payments and the global supply of fossil fuels. This is probably less obvious from the media coverage because most of the reporting on the size of those tax cuts seems to quote a hypothetical figure for how much they'd be worth in 2025-6.
If you know the bigger your failure, the quicker you can get bailed out and if you are successful, you get to keep most of the profits, you will do whatever and never hedge properly or take losses on the books. This is the current system with central banks.
...borrowing more money and minting new bonds, and committing to do that indefinitely in the future, while your central bank is literally trying to QT at the same time, is not "financial tightening". they've had to go back to QE temporarily to stop a liquidity crunch because the midwit running fiscal policy decided to run literally the opposite direction. and worse, he didn't just do it for a year, he committed indefinitely into the future to keep doing it and keep printing more bonds. so yeah the gilt got hella whipsawed but there's a reason it happened in england when all the other countries are tightening as well.
The UK has had some of the most banal, insiped leadership for awhile now. It seems to me that this is both a tragic and entirely predictable outcome that's ultimately going to hurt everyday folks the most.
In fairness, the set of lunatics currently in charge are anything but banal. Banal and insipid would be lovely. Banal and insipid wouldn't e.g. blow up our relationship with Europe, or attempt to out-Thatcher Thatcher. I'd love banal and insipid right now...
Hahaha, fair. I (personally) find them evil but in like a creeping sort of way. But on the flip side I just think of Liz Truss bragging about opening new pork markets and I cannot imagine anything more banal.
> this is both a tragic and entirely predictable outcome
Well, Sunak did predict during the leadership contest that this would happen - admittedly we haven't had the actual IMF in yet but if there's another severe slump, I wouldn't bet against it.
Yes, it’s practically impossible currently given both the size of their majority, and also the clear indications that a large number of Tory MPs would be personally voting themselves out of a job. (The current polling may well be underestimating the scale of the defeat)
It’s more likely that the Prime Minister will be kicked out.
But all those 'Red Wall' Tory MPs representing poor Northern constituencies are going to lose their jobs either way at this rate. They might calculate that they stand more chance of being reinstated under Rishi Sunak (or whoever) than they would of winning their seats again at the next election under Liz Truss. I don't think the Tories as a whole can let Truss carry on for many more days though as they are burning credibility faster than an Saturn rocket burns fuel. The country hasn't had an even vaguely competent leader since Cameron, this has mostly been ignored by people as they have been able to go about their daily lives as normal but the current shambles is affecting peoples finances across the spectrum and people are waking up to the fact that the Tories have dropped the ball.
Edit: totally missed the repeal - so this is no longer the situation.
Under the Fixed-term Parliaments Act, which has governed how UK Parliamentary elections are called since 2011, an election could only be triggered outside of the normal five-year Parliamentary cycle by one of two scenarios: if two-thirds of the House of Commons voted in favour of one, or if the Government lost a vote of no confidence and no alternative government was confirmed by the House of Commons within 14 days.
2/3 vote in house is basically the only way it can happen.
I am trying to figure out what replaced it, and it appears the only way is for an election to occur is a) the Prime Minister to request and recieve consent from the Monarch, b) it has been 5 years since the last election.
I'd like to know if other constitutional norms have been restored as well (e.g., are supply bills & major manifesto bills automatically considered confidence votes?)
2019 as prior art required full passage through commons and lords. Without compliance of the governement getting a bill read is not going to necessarily be easy.
As far as I understand, the act prevents the prime minister from dissolving the parliament unilaterally, but in practice the parliament still only need a simple majority, by just passing a law stating 'notwithstanding the Fixed-term Parliament Act, the parliament is dissolved'. This happened in 2019 ([1], [2]).
Or it could have just repelled the act, which is what happened this year.
This can happen when there is no entrenched constitution and the parliament has complete freedom to legislate.
Since either a no confidence vote without a new government (simple majority without a replacement government getting one) or a 2/3 vote would require a rebellion within the Tories, and the former would require fewer rebels, wouldn’t it necessarily be more plausible than a 2/3 vote.
I had missed the repeal, so these are academic now, however, were relevant back in the day, and were interesting in coalition times.
Voting no confidence path would allow the government to attempt to form another government (with a more unifying leader perhaps?) where there would be another round of votes / haggling till the 14 day limit to carry the confidence of the house. Getting the rebels to vote against the government multiple times over 2 weeks (they would be expelled from the party for the forthcoming election anyway) is extremely hard.
Getting 2/3s to vote against, while requiring more rebels, is politically probably easier, if a smallish minority have infected the party and are acting against the party core, and the opposition are dire. You can probably carry your safe seat and oust the toxic HQ leadership at the same time.
Both paths are effectively impossible. The idea back in the day was that you would just vote to repeal or amend the act, as it was easier than actually fullfilling the criteria of the act.
The King doesn't dissolve the government. The King can dissolve parliament and dismiss the government. If the King dissolves parliament, the people have to elect a new one. If the King dismisses the government, the King must immediately appoint a new one.
didn’t the UK prime minister Liz Truss just pass tax cuts for the rich? And isn’t the UK in a massive recession right now with a heating crisis expected this winter? And wasn’t Liz Truss sworn in somewhere like, less than a month ago (expecting she won’t stay elected for long with the way things are going)?
The "tax cuts for the rich" aspect of the mini budget was miniscule (and possibly not even a net loss of tax revenue) compared to the absolutely massive borrowing-funded subsidy of fuel costs this year, on top of the unbelievably colossal spending on the lockdown, all coming at the end of decades of generally living beyond our means. The only mistake the this new Government made was to drop the facade that we were ever good for the money.
> The "tax cuts for the rich" aspect of the mini budget was miniscule
In the grand scheme of things, that is true. However, that isn't the only issue - and public perceptions count. Here's how it's put in an article [1] in the Economist:
> Cutting taxes is the politically easy bit of a growth plan, in other words. But by needlessly cutting the top rate of tax on the highest earners and whacking homeowners with higher mortgage payments, the government has associated growth with unfairness in the public mind. That impression will strengthen as Ms Truss slashes public spending to regain market confidence.
Not surprised to see the the whining over-mortgaged home "owners", who've had it far too good for decades, at the expense of priced out renters, cited as victims in this riposte. Seems to be a common theme in the wall of media-driven protest against this turning of the economic tide.
Can't wait to see the housing market crash to through the floor.
If this happens then private equity funded businesses will sweep in and buy as many houses as possible, for cash with no upward chain and no mortgage issues. You can't compete with that; a serious price crash will probably lock you out of home ownership forever.
Realistically I am already locked out of the housing market. Companies are already buying as many houses as possible to rent them out. It won't be worse than the current situation we have in UK.
So you'd prefer to see millions in negative equity unable to sell while companies buy up the ones that are repossessed? I think that would actually be worse than the current situation.
If large businesses owned a huge number of rental properties, it would be politically easier to regulate them -- limiting rent increases, requiring insulation etc.
Conversely though, it would also be easier for them to lobby the government to deregulate the rental market. A company with £50bn of housing stock on its books would be very powerful.
Even ignoring that though, and assuming that companies could be regulated well, you'd still be looking at a situation where all young people would be transferring most of their wealth to the owners of these companies forever. There would be no way for people to use property investment to fund their retirement, people would never feel secure enough to have kids, and ultimately whether or not people would be able to live in an area would be at the whims of whether a business will rent them a home. It's a massively dangerous situation for a society.
People use the equity in their homes to do things like funding startups. Loads of successful business started out with founders mortgaging their properties. This is would bring about the end of that being an option.
I think you can both complain about long term problems in the UK housing market and seek a long-term solution while realising that a sudden and unexpected tripling of mortgage rates isn’t likely to help anyone.
Task cuts to the rich was not big compared to borrowing need of various social help but compared to its need (which equals to maximum of zero or maybe strong negative) it is huge!
Apart from the 1% future(!) cut in lower bands and NI rise reversion the rest helps more those receiving a lof of money or already have a lot to spend, investing, potentially in property.
The direct benefit portion of the mini budget for the rich accounts for dozens of billions in a period when any money is desperately needed for common budget and through that by those not having it and are in trouble, for those forming the dominant part of society, operating the country.
The tax-cuts-for-the-rich aspect of this is bad PR, but removing the 45% rate probably only costs the public purse about £2bn a year; the real problem is energy subsidy expected to cost £60bn over the next six months.
That borrowing was known well before the mini budget and didn't spook the markets. I don't think the tax cuts for the rich really bothered the market either (bad politics, but small amounts of money relatively).
The real issue as far as I can see was that none of it was costed and they had no analysis by the OBR. It just looked entirely shady and planned on a napkin.
Isn't it 60 billion for private citizens, another 60 billion for companies and 45 billion for tax cuts, so 165 billion pounds and everything financed from new debt.
Yes and no. The £45 billion a year figure is how much the tax cuts will supposedly cost in some future tax year - 2025/6 or 2026/7 or sometime around then, well after the next general election. Also, I'm pretty sure most of that is from foregone tax increases that would've happened under the previous plans - both a direct increase in corporation tax planned for 2023 originally and a bunch of people moving into higher income tax bands through inflation decreasing the real value of the income tax thresholds. Of course, because those figures are in 2026 or whatever pounds and the cost of the energy subsidies are incurred much earlier than that, you also can't directly compare them because of inflation.
might not be totally bad as many rich might consider moving away from uk to switzerland or usa. that might be a good way to keep uk attractive for them on short term
If they're not paying for anything enough to keep things afloat (as their currency, government services, and now pensions are having a hard time doing right now...) it doesn't matter if they're there or not – they're just plundering the ship and crowding the lifeboats.
rich people are still very much net contributors. cutting the top tax rate will still leave them paying a high tax rate on a large income. if the choice is some super-rich people money and no super-rich people money it seems smart to choose "some".
Unless they're using more in public services/subsidies than they're contributing in taxes!
Think their university system, for example -- it's almost entirely subsidized by the government, but the generationally wealthy are by and large the biggest users of it, especially at Oxford and Cambridge. Not here to debate the merits of that system -- but the wealthy are objectively using disproportionality more of the services compared to the rest of the country.
Apply that across entire government sectors (healthcare, transit, pensions, real estate) and you have a government that, yes, while the wealthy are nominally paying the most, they're paying less into it than is sustainable for the amount they use it and expect it to function.
There's a whole separate debate about efficiency/"austerity", but "some" is not better than "none" if each of the "some" is a net-negative on the system.
do we know they are net receivers rather than net contributors? i would expect 30-something percent of the lifetime earnings of a very rich person to be more than the cost of putting that person through oxford? and do they really use more services around things like healthcare or less because they might lean on private insurance? seems like pensions are probably concentrated in lower classes as well. i'm not british though so you probably know of better data on this.
Government services need to be effective, not efficient. If increasing efficiency reduces effectiveness, as it sometimes does, then we're going to rapidly enter a cycle of "make it more efficient! The service doesn't meet our needs! It's costing too much for what we're getting! Make it more efficient!"
Many public services eventually get asked to be revenue neutral, which kills their value, which leads to people saying things like, "See! Public transit is a waste!"
Pension funds take money from poor people and give it to rich people, just like everything else. When the economy is doing well, rich people make billions by managing them, and when it's not doing well rich people still make billions until the funds become insolvent. Here's a PBS documentary on the state of pensions in the US: https://youtu.be/_r0htm5uHPQ
Here is one thing to consider. A pension trades returns for stability. People pick a pension as their form of retirement because they have a lower risk tolerance. Anytime these tradeoffs are happening you are going to see wealthy people who took the risk side and came out ahead.
Did you know your insurance company is getting rich off your premiums? Are you going to stop paying them and get out of this "greedy" arrangement that takes from poor you to rich them?
Obviously my comment isn't the full picture either. These institutions often have moral hazard, etc.
> Did you know your insurance company is getting rich off your premiums? Are you going to stop paying them and get out of this "greedy" arrangement that takes from poor you to rich them?
You chose the worst example possible. For profit insurance is a scam, as the insurance company ultimate goal is to pay the minimum amount possible for claims, even after people have diligently paid very expensive premiums. It is one of the most rigged system, which amazingly is culturaly acceptable. (I am sure it is going to go the way of the "private firefighters" in the future).
Here is an example of exchanging risk voluntarily that I don't fits your comment. Farmers will often make deals to sell their goods for a fixed amount before planting. The other side of that deal is a futures contract where investors speculate on commodity value. The farmers accept lower returns while the investors may get fabulously wealthy. Are the farmers being scammed?
My insurance company should be, imo, unable to get rich off me. Insurance should be nationalized, imo.
But it's the only game in town. I'm a socialist, but until there's a world where we're all taking care of each other and running worker co-ops, I'm going to have to operate in the existing structures.
> My insurance company should be, imo, unable to get rich off me.
Where I live, there's a cap on the profits from insurance. I've gotten letters a few times saying due to high profits, the premium for the last month of the year was going to be lower.
That doesn't prevent them from running other scams like 10 year 'insurance savings' with 1% total yield, but those are optional.
How do mutualised institutions — building societies, credit unions, profit sharing with employees — fit into your world view? Are there credit unions that offer insurance products, or is it too risky lumping peoples savings with a risk-forward product like insurance?
Generally I'd prefer them over capitalized institutions. At least the people who are making things work are seeing direct positive results.
In some cases (eg health insurance) I believe a single large national pool is preferable.
Should credit unions offer insurance... I am not sure. I think it's reasonable if that's what the credit union members want, but they'd need to be very careful about the policies they were issuing and the potential payouts.
It's not the full picture only because a handful of pension funds do their job properly, they come up with a sensible diversification and put it into passive instruments.
Everything beyond that is a scam. High fees for what should be a simple task, or taking reckless risks or allocating to active managers, is where the scam part comes in, and most of the industry is guilty of that.
Complaining about finance compensation is common, but like sales, it's directly tied to earnings. Suppose you take an easy strategy and get 6%. Suppose a professional can work hard and get 6.2%. It's well worth paying for that top performer when you have a pension of $500 million.
My guess is that much of the distortion is caused by moral hazard where pensions know they will be bailed out for taking ridiculous risks, not because they pay professionals to manage money.
Have you considered that you have the causality flipped, and that people are generally rich because they're good at making money under adverse conditions? Would you expect someone who was capable of accumulating large amounts of wealth to get BTFO by a market downturn?
If pensions have a problem, it's because they were never economically viable, and at this point basically serve as a vehicle to transfer money away from the majority of people and towards retired boomers and government employees.
> Have you considered that you have the causality flipped, and that people are generally rich because they're good at making money under adverse conditions?
They might have. However any look at generational wealth dynamics quickly dispels that idea. Any above market performance rich people have are simply able to have better managers because managing bigger pools pays more and maybe an education which focuses on maintaining and building wealth. This education could be widely available but it is not made widely available. I am not going to imply a conspiracy here or appeal to class interests for explanation and just leave it as a statement of fact.
> However any look at generational wealth dynamics quickly dispels that idea
Generational wealth statistics, as well as heritability research, are consistent with the idea that expected wealth is causally preceded by genetically heritable factors.
Wealth is mean-reverting along genetic lines on multi-generational timescales. The idea that wealth is self-perpetuating per se fails to explain the degree to which e.g. poor lottery winners do not kick off dynasties, why children of moderately wealthy parents also tend to be moderately wealthy (not explainable by direct inheritance), etc.
The one domain where your model works better is perhaps for extremely wealthy families like the Rockefellers, but I'm hesitant to say that the model generalizes - that sort of thing might be a rare exception.
If you don't understand that the child of a lawyer will be encouraged or pressured into going into law, and therefore staying in the socioeconomic group, you'll overrate genetic factors.
The genetic factors estimates come only from adoption data, and there are studies that condition further on things like adoptive parent material conditions. The researchers are not dumb; they have put some thought into it.
One of the first results on google scholar that came up when I checked into your claims is a recent study that contradicts everything you wrote here. (Since you never cited anything I won't either.)
At a minimum, this topic is more complicated than you think, and you aren't using the correct statistical terminology when you discuss it.
As far as I see those making money (actually value behind it) are not getting rich but those who sit on top of the money flow do. Skimming it.
Also pension funds take over money from young or middle age, yes, but not giving it to anyone else than themselves on the end, when they became old. It is not given to boomers, are you sure you know what pension funds do and how it differs from traditional (social) pensions?
Not given to else eventually, except in the meantime when given into the care of financial professionals to hold it for them to keep its value - for a very generous fee, not for free of course, the fee of the professionals is determined by the professionals themselves - and indirectly to bad politicians to finance the everlasting popularity spending and consequential budget deficit through bonds (or sometimes for a good cause too, like in recent and ongoing turmoiled period in the form of social support, which might still strongly overlap with popularity runs, see current UK government).
The base problem is that people have expected pensions to pay out like they always did in the past, before the ZIRP era. When real interest rates were positive (like they were for most of history until circa 2010-present), it was very easy to pay out the expected results by just buy and hold treasuries or gilts. When central bankers decided to cure the last recession by artificially holding real interest rates at negative levels for over a decade, pensions had to move out on the risk curve. This led to the everything bubble we have today, with the market overvalued somewhere around 100-300% compared to its historic norms. Once inflation came back, the central bankers ZIRP plans were cancelled, bonds and stocks start crashing and pension accounting no longer balances.
The are lending money, by buying British bonds. The bonds are risk-free but only when held to maturity. (The market price for bonds before that time will vary dramatically with interest rates, but the value at maturity is perfectly stable as is the coupon stream.)
Certainly true. But the textbook advice is broad market stocks and leveraged long bonds. Aren't they being less risky by using the tried and true strategy?
They aren't really borrowing money. They're having to post collateral against derivatives (probably interest-rate swaps) that have moved against them.
Those swaps are supposed to be a hedge against falling interest rates: they lose money in a rising rate environment, and the colossal bungling of the UK economy by the current government has resulted in such large and rapid rises in gilt rates that the collateral calls exceeded cash available to meet them.
That is very good question. These guys probably think they can predict the future, and we all know that's just not possible.
Personally, I think it is hard enough to invest long term in stock issued by reputable companies. At least with companies you can try to understand their situation and whether they are likely to succeed and worth their share price.
People's well being should not be left to 'the market'. Anything like people's retirement, health, education should not even be entangled with private actors and their whims, less, sold to such private actors.
To run a pension you need assets. You buy those on the market.
But wait. Why buy private assets. Why not have the government make its own assets. Like….a govt bond. Well, those are substantial portions of pension assets.
You could fund pensions from general tax revenue. But, then what happens if tax revenues are low one year….do you just not pay out the pensions?
At a certain point you’re on the market whether you like it or not. Even communist countries own assets
Taxes. You need taxes. Just like how you run the military.
> then what happens if tax revenues are low one year
You tax the top iter of the society to make up for it. Just like how it is done for the military.
> Even communist countries own assets
In no communist country, the well being of their people or societal infrastructure ranging from transportation to military to police or education, was tied to the market. Even today there are many capitalist countries that dont do that.
Taxes fund current military expenses. Pensions are designed to fund tomorrow’s expenses with today’s money. You need some sort of instrument to do that.
If you don’t save current resources for future expenses, then you risk needing a very large future amount of the tax base for pensions. If, for example, more people retire.
Even for the military they used war bonds and took on debt in wars when the wars demanded outsized current expenses. They didn’t just raise taxes really high in WWII to pay for everything. They paid for it over time with bonds. The Soviets did the same in agreeing to repay lend lease bonds.
uhhhh no? i don't think most countries levy extra random taxes on the super-rich until their military budgets are met. also i get really fed up with people pretending that military spending is anywhere close to entitlement spending these days. yeah it's too high but please don't both-sides it.
it's unfortunate but usually when there's a downturn, revenues drop. yes including from the super-rich, whose net worths are usually more not less volatile. so now what?
> i don't think most countries levy extra random taxes on the super-rich until their military budgets are met
Most countries don't do that because the funding for military is never excluded from budget calculations. But when such a need arises, like in wartime or emergencies, they do.
> i get really fed up with people pretending that military spending is anywhere close to entitlement spending these days
Only in the US, where military has been made into a teat from which the military-industry sector sucks as hard as it can. That way you end up with gigantic flops like F-35 that go on forever. They are flops for defense, but they are major successes for channeling public money to the industry...
if it helps, 3.329 / 1.035 = 3.22. that number means we spent over 3 times as much on handouts.
so no, military spending is nowhere close to our handout spending. yeah it's inefficient and wasteful and i favor cutting it at least somewhat combined with efficiency improvements and focusing on spreading defense $ to make the market more competitive. but i get really fed up with people trying to "both sides" our handout and military spending every time someone brings up the cost of the former because they just aren't close.
funny enough, lots of pensions are getting into the real estate game. Owning housing give a long-term stable source of revenue (rents), making it a really good investment from a pension policy point of view.
If everyone believes that gilts are essentially risk free (certainly what I was taught as a trainee accountant) then it seems a fair strategy. One doesn't normally expect a government to deliberately devalue its own bonds, and drive its own debt prices higher (I say deliberately because Truss its intimating that, I don't really believe it. I think they made a spectacular misjudgement and are doubling down).
This strategy only looks risky if you believe that there was a risk to the assett price. Otherwise it looks smart.
By the way, once again I'm impressed with the BoE reaction. They got burned some 30 years ago, and since then they reacted correctly and fast enough to each crisis, while the Fed and ECB do slip up sometime (keeping policies too long or not reacting fast enough).
What's troubling is that for the first time, they do not react to an external crisis or a bubble bursting, but to their own government fucking up.
I do not care about UK politics as much as I did when i wanted to emigrate there, so i follow it loosely at best, but the Tories choose the worst time to have an internal campaign. Because it wasn't followed by a national campaign where the internal promises have to be dilluted for the national interest (and swing vote).
> while the Fed and ECB do slip up sometime (keeping policies too long or not reacting fast enough).
The ECB is perpetually paralyzed by needing to acquiesce to the demand of born financially solid, and financially shaky members (of which there are a lot).
It is not incompetence but inability that binds the ECB.
Don't worry, once global sovereign credit markets freeze, itll just be a mild recession. A slow quarter or two and right back to line goes up and yoloing on dog coins.
No systemic risk here! We killed that in 2008 according to every wall street analyst on cnbc.
Hedging... funny. It sounds important and smart until you realise, in simple words, what it means. I hate those kinds of words because they obscure the simple reality.
When you invest in something you basically say that out of all possible options that were available to you, you predict the one you invest in will most likely (according to your risk assessment) bring profits.
If this was your best choice, WHY IN THE WORLD would you invest in something that is doing the opposite?
And there are other reasons not to play with borrowed money... Common sense says any kind of borrowed money costs.
Hedging is used in short term situations, where you want to insulate yourself from market fluctuations. Say you are Lufthansa and you have tight budget and you don't want your budget ruined by changes in fuel prices. Knowing how much fuel you will need and at what time, you hedge against those changes. It will cost you but you treat this cost like insurance against disruptions of your business.
> If this was your best choice, WHY IN THE WORLD would you invest in something that is doing the opposite?
This is trivially answered via the oldest financial instrument in the world, agriculture futures. A producer trades potential upside in the future to lock in a price now, splitting the risk between themselves and the futures contract holder.
If they couldn’t do that risk split most producers wouldn’t produce at all.
A pension has a similar problem, they need to produce returns in the future, so splitting the risk now allows them to do that.
It doesn’t matter if you are producing corn that takes 5 months to deliver, cattle which takes 2 years, timber that takes 15 or pension returns that take 30. Future production risk needs to be hedged to even engage in the activity.
So there are two types of enterprises that are trading.
Those who invest and are after the price changes -- their entire goal is to buy things that will increase in value.
And there are those who for some reason have to trade but the price changes are nuisance for them. Like agriculture farmers. They know they will have to sell their produce at some point in the future, but they would very much prefer to know the price in advance because that makes it easier for them to plan and make better choices. Do I plant this or that?
When we are talking pensions, this is definitely the first scenario. The large part of the reason to trade is investing (the other is improving supply of money and also helping your businesses have easier time getting funding they need).
The about only reason I can come up with is fund managers sabotaging long term returns just to ensure small, steady, more predictable return every year. So that they can their bonuses every year.
Maybe another reason is people who do not understand trading? Then more steady returns create the illusion their managers are doing good job.
"This is trivially answered via the oldest financial instrument in the world, agriculture futures."
No, I think your parent has an interesting point ...
People don't start farming soybeans because they have a free weekend here and there ... it's a long-term, sometimes generational undertaking that has one locked into these activities and investments.
So, in that case, it makes sense you would use derivatives to hedge the activity you have no choice but to undertake.
On the other hand, if you're just a trader-bro ... you do, indeed, have full autonomy and can buy or sell anything you like. You could just as easily afford equivalent protection by buying less of the underlying asset or buying another asset entirely.
Unless, of course, there is a relative price mismatch between the underlying asset and the derivative - in which case it would make sense to pick up the protection cheaply ...
... but I still think your parent has a point that isn't so easily dismissed ...
I'm not sure how many trader-bros are allowed to make major decisions in pension funds, or why a trader-bro would want to work at a pension fund vs some other type of market participant which could reward their genius^H^H^H^H^H^H crazy risk taking.
One reason why you would opt to use options to hedge rather than sell your position (and be delta neutral) is due to materialising profits and incurring taxes just because you were being prudent about volatility
because people have different risk tolerances? derivatives let you pick a "middle way" instead of having to pick the best of a few options. you can customize your risk/reward tradeoff to whatever you want and that's generally a good thing.
Heres what happened: The Bank of England (BoE) suppressed interest rates for 2 decades, driving government bonds from 6% to 2%. Pension funds typically had a high percentage of bonds, so they decided to borrow money (again, made artificially cheap by the BoE) to buy 2-3x the amount of bonds on leverage to be able to pay out the same as one 6% bond. Now the BoE is slowly raising rates to 'fight' the inflation it created over the past 20 years, which is causing these house of cards pension funds to start to tremble. The fund directors are relaxed though as have already paid themselves large bonuses every year, and after 2008 they realised they could rely on the government to come in and socialise the loses stemming from their financial recklessness.
No, this explanation is not correct. These pensions were generally not trying to juice yield by buying gilts with leverage (they would not be able to borrow cheaply enough to make this work, and leverage would be better used to buy stocks).
The margin calls are coming from interest rate swaps they did to mitigate accounting risk on their long term liabilities.
When rates fall, pensions take huge paper losses because the present value of liabilities moves inversely with interest rates. To hedge this risk, you enter into a swap with a bank to essentially pay current floating interest rates (in return for receiving a fixed rate). This swap's value moves in the opposite direction of the liabilities.
Unfortunately because rates moved up so quickly, these swap trades are deep in the red. Even so, the funds should not be going bankrupt from these trades, because the losses net against enormous accounting gains from their liabilities being worth less.
Anyway, this is a complicated and technical story about the interaction between bond math, accounting, and liquidity risk. There is a lot to criticize, but the moralizing version of 'greedy pension fund managers borrowed to juice yields' is not quite accurate, and Matt Levine's article is a good source (although he doesn't get into the nitty gritty of interest rate swaps).
I read Levine's take but I'm not convinced. The accounting rules are like that because they reflect the real liabilities that the pension (eventually) has. Lower interest rates for a pension that needs to pay out a fixed amount in the future aren't just a "paper loss", they're a genuine asset deficiency.
This kind of swap wasn't just about protecting against the downside (otherwise they could've bought an option), it was about doing it as cheaply as possible by selling off the upside. They took on extra liabilities in order to pay as little as possible for their protection - or, equivalently, to boost their returns - and they missed, or failed to properly cover, an edge case in the liability they were taking on.
You can certainly make a case that it's well and good for pension providers to try to make as large a return as possible. But the "greed" shoe fits.
When rates fall, pensions take huge paper losses because the present value of liabilities moves inversely with interest rates
Lets say my liabilities are 1000 at interest rate 10
Now interest rate is 5 so my liabilities value is 2000
Now I don't look good, so what do I do.
I buy a swap ( which I equate to a put option) which is valued at 100 on the basis of my liability being at 2000
If my liability drops to 1000, the swap goes to 200 (thereby I'm screwed)
Now the interest rate is 20
So my liability is 500 and the swap is at 400. I am really screwed. However, my liabilities are also proportionally down, so I am basically at break even.
Is this the correct math ? If so, then there shouldn't be any reason to panic.
The problem is you're getting margin called on your swap. You've got to put up more collateral, not when your liability comes due but now, and that probably means selling some assets for far less than they're worth.
Specifically, the problem is that a lot of these pension fund investments are in long-duration government gilts of a kind which are mostly useful to pension funds like them, and when the margin calls in and they had to sell there was not enough of a market for them and prices collapsed, which would have lead to more margin calls and prices collapsing until a substantial proportion of their investments had been transferred to bankers and speculators for much, much less than the actual value. Supposedly there were literally no bids for some of the gilts at some points.
I don't think there's much moral hazard in the Bank of England stepping in here; the duration structure of available gilts is a government creation anyway, a big reason no-one else wanted to touch them was because of uncertainty from the Bank's aggressive interest rate increases lately, and if government gilts aren't a safe, liquid investment we're all in deep trouble.
When rates fall, liabilities increase, but so does the value of the bonds that the fund holds, so if they are properly funded and invest solely in bonds they are perfectly even.
But bonds have had very low yields for decades, which makes funding future pensions solely with them very expensive, so pension funds started investing in stocks- this makes sense, as pension funds are long term investors which can earmark funds as "not to be withdrawn for the next 30 years".
Now THIS creates the paper loss problem: yields fall, liabilities rise, but funds don't have enough bonds raising in value to match that loss. So they use derivatives to hedge the risk.
When rates fall the value of outstanding bonds raises.
You can think about it this way:
Yesterday's bonds yield 10%.
Yesterday I bought a 10% yield bond brand new, at a 100 cents on the dollar.
Rates fall, today's bonds yield 1%. If you want to buy a bond, you can buy a new 1% yield one at 100 cents on the dollar, or you can buy my used one, which yields 10%. How is mine not more valuable than 1$?
> When rates fall, pensions take huge paper losses because the present value of liabilities moves inversely with interest rates. To hedge this risk, you enter into a swap with a bank to essentially pay current floating interest rates (in return for receiving a fixed rate).
Honest question: why is the devaluation of bonds from a rise in the interest rate considered a risk to a pension fund? It doesn't impact the ability of the pension fund to fulfill its purpose: deliver an income stream to pensioners.
Sure, the market value of the bonds decrease when rates rise, but the bonds still provide exactly the same income stream as they did before.
That's a good question. Many companies want to get to as close to fully funded as possible so that they can offload the pension from their balance sheet and transfer the risk to an insurance company.
This is demonstrably untrue and yet you proffer it as fact. The pensions benefit from rates rising, because higher rates decrease their liabilities more than it decrements the value of their bonds. The pensions have, as a result, entered swap positions go hedge themselves against rates falling. The only issue is that the sudden drop in the gilt has created a feedback loop in the gilt sell off.
There is a reason why explanations of what went on are so complicated… It’s because pension math is extremely boring. However, you cannot understand the situation, even intuitively, without going into the nitty-gritty to try to learn the plumbing.
Your mistruth is incredibly corrosive to discussion on this site. @dang please keep an eye out.
Edit: I’m reading through the comments here and virtually everyone has it wrong. The pensions made what should have been a good decision to hedge their liabilities. They made a bad decision in terms of forecasting their liquidity needs in a high-stress rate scenario.
Don't look at the word "margin call" and assume they did something wrong. Simplistically, if you're getting called on a hedge, you're probably making money, just less of it. On a position like this, the fund faces a "margin call" every day. It's called variation margin, and all that means is the position's PNL is settled on a cash basis, daily. You may be thinking of a margin call in terms of a retail investor naked shorting a stock that has subsequently tripled in value. It's nothing like that. Variation margin "calls" are part of the structure of the instrument.
I've consulted pensions. Saying that pension fund managers did this to "pay themself large bonuses" is laughable – pension fund managers aren't compensated like other areas of finance so the incentive is always to be more risk averse because they want to keep their jobs.
Edit edit: I don’t mean to say these pension mgrs don’t deserve criticism. It’s just that what I see is so off mark.
I agree with the spirit of this post, but I think you are going a bit too far in the other direction by stating that "the pensions would have been fine without the policy". From Matt Levine's article today, it was a more dangerous situation than you are making it out to be:
> "At some point this morning I was worried this was the beginning of the end," said a senior London-based banker, adding that at one point on Wednesday morning there were no buyers of long-dated UK gilts. "It was not quite a Lehman moment. But it got close." ...
> "If there was no intervention today, gilt yields could have gone up to 7-8 per cent from 4.5 per cent this morning and in that situation around 90 per cent of UK pension funds would have run out of collateral," said Kerrin Rosenberg, Cardano Investment chief executive. "They would have been wiped out."
Agree, I edited it out. I was so annoyed that I went too far with that statement. While they wouldn’t necessarily have been wiped out, they would have needed to make a LOT of calls.
On financial topics there are many emotions thrown around based on very little understanding. Unfortunately my upvotes to comments like this can only affect so little.
Why should you trust me on this? I've consulted pensions in the past.
To be fair, that may give you insight into the technicalities of the machinations, but with you having profited from and contributed to the financial system -that ordinary people have spent the past decade paying for the venality, stupidity and corruption of - that when you dismiss as corrosive with calls to mods to suppress counter-narratives, your investment doesn't necessarily mean we should trust you.
this isn't a "counter narrative" any more than "bill gates put microchips in my vaccine" is a "counter narrative". and i'm not being an asshole here, this is just a factual misstatement of LDI and what transactions are taking place. maybe the peak of the dunning-kruger curve shouldn't be sitting at the top of the thread for the first thing people read? i think asking @dang to at least pin a better explanation is fair.
I mostly agree with your take on the facts. But I don't think you need to call for moderation quite so much. People are wrong on the internet all the time.
yeah true and i'm not asking for anyone to remove stuff, nothing wrong with being wrong (though i wish this person did it less confidently). when i commented though this was the top comment on the thread (still #2) and i was more hoping dang could pin a better explanation to the top. reading something egregiously wrong that's written very confidently first thing can screw up a thread imo.
uhhhhhhh what? it says pretty clearly this is interest rate derivatives (makes sense). i think what you're trying to talk about is repo leverage: buy a bond, repo it out, use cash to buy another bond and repo it ad infinitum until counterparty risk measures start blinking.
remember a repo is me selling you my bond at a haircut and buying it back later for a little more, so basically a secured loan. the repo margin (the amount more than the loan value i have to give you as a premium) depends on creditworthiness and bond prices blah blah blah but the gist is there's some margin where, if the value of the collateral i gave you (the bonds) falls too much (like now) you margin call me and say "give me more stuff because your collateral lost too much value". this is what happened to the pension funds: they buy bonds (safe asset), sell via repo (cheap loan to invest in interest rate swaps for hedging) and now they get margin called because the "safe" gilt just shit the bed. some are using gilts as collateral for swaps, so their collateral fell so much that their hedges are getting called.
now think about if you've leveraged the repo market to double or triple up on bonds, whatever your counterparties will put up with... you don't have to cover the fall in the gilt, you have to cover 2-3x (or more) the fall. so it's not really "borrowing to buy more" because that wouldn't make sense it's diluting your collateral in a way that tbh counterparties should account for better. same thing happens in real estate if you do it right.
the big concern here is a death spiral: funds have to sell gilts, value of gilt drops more, more funds have to sell gilts. BOE doesn't want this so it's now back to QE because the exchequer is a bozo.
The rest of your comment has already been discussed, but this part:
> Now the BoE is slowly raising rates to 'fight' the inflation it created over the past 20 years
Is wrong. Inflation is the result of a pandemic and policies to combat it's results, and a war impacting critical raw materials. It is not a purely monetary phenomenon like so many people prefer to pretend (I never got why - is it a "I have been saying these policies will result in inflation for 20 years, and I was right!!!"?) .
No it's not about the level of interest rate, it's about the duration. I think they go long/short a short term and long term bond, creating some duration exposure to manage the discount risk of their pension liabilities.
You can't really create the arbitrage you are describing. Whatever the gilt yields is pretty much what you would pay to borrow against it.
This is actually the clearest, simplest explanation I’ve read (including Matt Levine’s).
I think this is the first time moral hazard made sense to me from an operational perspective. The fund manager who in old days would feel bad about risking retirees money, now legitimately feels okay knowing there’s no way they’ll go hungry.
It’s a completely incorrect explanation. There’s no moral hazard here, they weren’t risking pension or funds through the swap agreement. The reason why the answer isn’t clear is because pension math is boring. The thing is, you can’t fully grasp the truth unless you’re willing to engage in it.
Sure, punish the recklessness to remove the moral hazard. You can both make sure people don't starve and align the incentives. If you don't then next time it will be worse.
So if this interpretation is correct, what should the fund directors have done instead? If you can only get 2% safely, but you need 6% or else the pension becomes insolvent, you're going to have to take some risks. UK stocks have been stagnant overall and plummeted during the pandemic, so that's not a much better option.
UK defined benefit pension fund trustees have been quite risk averse actually. The main purpose of these investments was to avoid a mismatch between the funds assets and its liabilities (which can fluctuate wildly as actuaries make small changes to their assumptions). Their actual investment strategy is often very risk averse though, heavy on bonds and on buying insurance.
Any deficit has to be covered by the original employers but trustees don't seem to have taken the temptation to chase returns. A recent report from the regulator showed most funds with deficits has less than 40% of funds in what they called 'return seeking assets' (ie things like shares as opposed to boring (usually!) things like public sector bonds).
Usually pension fund solvency calculations are based on returns being related to the long bond interest rate, so as the long term bond rate goes up, your liabilities decrease.
Your liabilities only decrease in the interest exceeds the payouts, but I doubt that's happening even as they're raising interest rates. What are they supposed to do in the meantime? Pray for the central bank to raise interest rates while your liabilities accrue?
If there are margin calls for pension funds, the managers are doing things with other people’s money which these people do jot understand and would probably not consent to.
From my 10000 feet view, it looks VERY similar to what Celcius and other Crypto scams happened: People put their assets in this place as an "investment". But the fund managers get greedy and start playing all kind of lotteries with the money. Then they lose it and shrug. The difference is that these guys get bailed out by the taxpayers, while the people that invested in crypto scams get shafted.
I worked for a pension fund and they are absolutely not taking risks; gilts from a country like the UK are super safe because nobody would ever elect disaster capitalists to run the economy, so things like a complete rearrangement of their economy during a massive economic downturn cannot happen…
It was actually funny to read the comments in the FT from people who work in the sector...everyone was doing it, this was a perfectly sound strategy, you have to hedge (the irony of losing £60bn in four days from hedging apparently not correlated to whether the hedges worked)...there was a guy who is CEO of a clothing company who actually wrote to the BoE about these strategies, the response was not just anger that he was right, it was rage (it also didn't help that this CEO was a big supporter of leaving the EU).
Either way, this is something that has been warned about since QE started, the BoE repeatedly denied this was an issue, it was obvious, multiple books have mentioned this, I have heard it a million times from market participants, I talked about this with other people...and the BoE are trying to shift the blame feverishly.
The chances that this doesn't happen in other countries is close to zero. The buildup in risk due to QE has been massive, and DB pension funds are patient zero.
> The FT has the best comments section on the internet, IMO.
Mostly yes, but depends on the topic.
Anything where Brexit can be involved (anything about an EU or EU country problem, or UK issue), there's a bunch of stupid comments, mostly empty pro-Brexit ones.
Anything tech is usually mostly technically oblivious financial people (oh VMware have a great position, numbers looking good, tech is amazing).
Anything where Russia is involved, there's at least a few (idiots|Russian trolls|etc.) getting eviscerated.
Why not? The government will bail out the funds. Meanwhile, there are bonuses to be made on a quarterly basis. Heads the fund managers win. Tails the taxpayer looses.
What else can you do when your task is to deliver a fixed income stream to pensioners and interest rates are 5% one year and 0% the next?
The fundamental problem of our current monetary system is unstable interest rates. Pension funds can't fulfill their purpose under these circumstances. Not without taking risks, at least.
Internet rates have been more stable over the last 14 years than at any point in recent history. Even with the combined problems of covid recovery shocks and the Ukraine war it wasn’t going terribly until the inexplicable budget last week.
Any financial professional who holds space in their belief system for "risk free" gains should be immediately fired and barred from managing anyone's money ever again.
It is risk free, held to maturity. 50 year bond market prices however, vary strongly in response to interest rate changes. Since these bonds are issued by the bank of England and since interest rates are set by the bank of England this is a crisis entirely & predictably created by the bank of England.
Definitely not the pension funds who chose to diversify from gilts into riskier securities and then took out margin to buy more gilts as a hedge thereby destroying the long term durability AND THE ENTIRE PURPOSE of a pension…
I don't really understand the financial situation here, but my guess would be, if this were actually risk free money then there wouldn't be an issue here.
The bonds are risk-free when held to maturity which is what every textbook will tell you if you actually read them.
What is not risk-free is the value of those bonds before reaching maturity. That price is decided by the market (i.e. you need to find someone to buy them from you, therefore there is a price to be negotiated). Why? Because when the government issues new bonds at higher interest rates why would anyone still buy the old bonds at the same price? If you want to sell those bonds on the market you will have to sell them at a discount. OR you can hold them to maturity and get paid in full.
What went from here is that those pension funds used those bonds as collateral (the value of which is decided by the market). Since the market value of those bonds is falling now due to rising rates, the value of the collateral is decreasing thus margin calls.
Everyone knows this and no one seriously thought this was risk free. The simple fact is that all these pension schemes are underfunded yet there is the expectation that they still pay out pensions like they did 50 years ago. How to solve this? You take on risk!
Im not saying that the bankers are all nice guys here but it’s not solely their fault. There is some context here. People just prefer to sweep away problems until there is no more place to hide them. That’s the real issue here.
Decreases in the market price of these bonds due to interest rates rising is not, as I understand it, actually a problem for these defined benefit pension funds because they actually have to pay out a specific income to people in the plan and higher interest rates also decrease the present-day cost of meeting that liability. The actual problem was that there was no functioning market for certain gilts they held at all - as in, supposedly there were literally no bids at all to buy them at several points in time, and even when there were the prices were terrible. A few people posted graphs of the yield curve and that part of it was obviously just outright broken.
Indeed because under normal circumstances I would assume these bonds are mostly held to maturity. But why do they have to sell them now? I was under the impression it was to cover some margin calls.
And to your point about broken yield curve… to some extend I agree that governments should step in when there are technical liquidity issues (i.e there is temporarily not enough money to go around but all business is sound) but at some point you have to wonder if there is no liquidity simply because no one wishes to buy these assets in the current market.
We may not remember but interest rates have been above 10% before, and with inflation where it is at now, it might simply be that the market expects yield to go up significantly in the near future thus it would make sense for the yield curve to invert. Is it then that BoE is solving liquidity issues or again bailing out failing pension schemes? I don’t know of course it’s just a bit smelly.
These gilts or bonds work exactly as you’ve described. So how do you get margin called? You mix in 5-10% high risk, high reward securities to try to make a profit and buy, on margin, extra gilts/bonds to try to hedge the risk.
You’ve now gone from a durable bond as long as it’s held to maturity to a derivative based house of cards vulnerable to bank runs.
The issue is not whether gilts are risk free (they are for any country that controls its own fiat currency). The issue is that 1) they are only risk free if held to maturity and 2) they used this risk free asset as collateral so that they could lever up, and leverage is never risk free.
In order for pensions to meet mandates, central banks forced them to take on ever increasing risks as part of a 15 year period of relentless QE. The end of this story has been foretold by many people over the past decade, but as always the response was "it's different this time". It turns out it wasn't
You can blame the pension managers for taking on excessive risk, but if they didn't then their returns would not have met mandated targets and granny's pension would suffer. Instead blame central banks and electorate which applauded their moves. Most people did not complain as equity markets surged higher for a decade, and borrowing costs dropped to zero on a real basis driving their housing equity higher. Average people gobbled up stimmy checks and even now look to the government to cap utility bills and shield them from the realities of the world.
We have coddled ourselves into thinking that we can only have good times. But that's not how economies and markets work. They are cyclical: boom and bust. We have gotten better at smoothing some things out, but you can't prevent downturns in aggregate, which is what we've tried to do since 2008. All you do is compound the issues in the future, which will eventually come home to roost. This is what is happening now.
"I know this is bad but I find something aesthetically beautiful about it. If you have a pot of money [pensions] that is immune to bank runs, over time, modern finance will find a way to make it vulnerable to bank runs. That is an emergent property of modern finance. No one sits down and says “let’s make pension funds vulnerable to bank runs!” Finance, as an abstract entity, just sort of does that on its own."
Surely nobody in the world of finance has been making money off of these pensions becoming vulnerable to bank runs. And even if there were someone profiting, they wouldn't have done so by choice, it just happened.
From my read of Levine's explanation, it was really the promise of a greater pension outcome for a given amount of contribution. Whether the contribution was smaller or the outcome larger is kinda immaterial -- the managers were chasing yield.
I am not an expert but if someone managing a pension fund makes it less underfunded by using some of these instruments/techniques they might get a bonus for good performance, don't they? Or am I misunderstanding something.
There are a lot of retired people in the UK who are living off them at the moment, they were only really phased out for new entrants about 20 years ago, and for a lot of people they were able to continue to build them if they were already part of one.
So it's going to be a long time before all those people, both retired and not, are dead.
Plus the public sector in the UK still offers them.
Either feds take over this obligation, or Illinois will go bankrupt, legally disolve, and the land will be absorbed by neighboring States.
This is why I expect a federal UBI.
> Either feds take over this obligation or Illinois will go bankrupt, legally dissolve, and the land will be absorbed by neighboring States.
US States cannot go bankrupt (They are not only not covered by bankruptcy law, but there is a reasonably strong argument that state bankruptcy would violate the contracts clause. (And the public entities that can go bankrupt via municipal bankruptcy in US law do not legally dissolve when they do.)
why th should i be paying for illinois underfunding its pension obligations. this is not some natural disaster where the government couldn't predict it, so screw that. i hope all the other 49 states vote against any of that nonsense.
I find it ridiculous that the strong USD, which is the main cause of pending global financial crisis, was directly brought on by Federal Reserve’s head in the sand moments: (1) not raising rates or even stopping QE prematurely when inflation was flashing bright neon red, then (2) ignoring all the data points to overcompensate for its gross negligence in (1). UK is not isolated here. We are on the cusp of an avalanche across developing countries and EU.
As far as I understand, weakening the USD for the benefit of parties foreign is not part of the federal reserve's mandate. Maybe it should be but it isn't. I'm also not sure how continuing with inflationary policy could strengthen the USD. Surely any delay in raising rates should weaken it relatively speaking?
Also, it is natural for the USD to appreciate given the energy crisis and knock on effects from that, isn't it?
The problem is really that they are doing it extremely fast while ignoring the very financial plumbing they made everyone around the world rely on for two decades. It’s quite shortsighted to keep USD at extremes to soften inflationary pressures in the US while letting the RoW and developing countries burn. It’s 2022 and everything is connected. There’s no such thing as a decoupled economy.
so you are saying we should sit through 15, 20% inflation for the sake of other countries? that's not the fed's mandate and you will never, ever get domestic support for that. nor should you tbh, we should not suffer for the sake of everyone else. we don't want the dollar quite this strong but it's better than the alterantive.
regardless it's not all our choice. people will keep fleeing to the dollar for stability and that will strengthen it relative to other currencies. believe me this is not all fed policy or even mostly fed policy, we still have a lot of inflation so domestic winds aren't making it that strong. this is a "relative basis" thing. besides, what do you think the RoW impact would be if there was no safe currency to flee to?
and lastly petrodollar go brrrrr, energy crunch means we will have a strong dollar like it or not.
U.S sells a lot of oil and gas and as it happens Europe needs both. A lot of capital is fleeing from Europe and other risky markets(China) to safe havens( the U.S). All this in addition to the fed rate cuts.
Are you positing that had the Fed raised rates earlier that the dollar wouldn’t have strengthened?
The US dollar strengthens when (1) the world goes into downturn, and/or (2) when US interest rates rise.
In what scenario would the US dollar not have strengthened? It was inevitable regardless of what the Fed does because of the greenback’s dominance in world reserves and trade. It’s a currency of last resort in times of busts and booms. The dollar smiles.
I am saying that if they cut the bullsh_t back in March 2021, when all the excesses from crypto, meme stocks and SPACs were blatant, we would not be here today. They made a very public choice to let that play out. Heck, even China was hitting the breaks at that point. A 200-250 hike cycle would have more than sufficed. This is gross negligence. The worst monetary policy decision that they are now compounding.
I’m not sure what world you were living through in March 2021, but no one was cutting back fiscally at that point. Had you forgotten the US then passed ARP in 3/2021?
The Fed’s only instruments are interest rate and signaling, QE is controlling long tail of the curve. You wanted the Fed to raise rates at the same time when fiscal policy added another $2T in spending?
The more logical argument is perhaps the US shouldn’t have passed ARP and poured gas on the fire.
To oversimplify a bit, there seems to be a crowd saying: “these pension fund managers gambled with my retirement to enrich themselves”.
There seems to be another crowd saying: “if you examine the details of these transactions you’ll find that it’s neither that simple nor fundamentally even true”.
I’d like to submit that the latter group, which I suspect is probably technically correct (the best kind) should possibly examine the possibility that while any isolated derivatives transaction probably makes sense and is governed by deep and sophisticated mathematics, it does seem to be the case that in sum total we see, decade after decade, a cumulatively destabilizing effect on both financial markets and the financial security of everyday folks: somehow the emergent system either is or really, really fucking appears to be privatizing profits while socializing losses while simultaneously driving up the swings of the business cycle.
I love the financial mathematics stuff intellectually and this is certainty a forum that welcomes experts discussing details, but at some point we need to acknowledge that it’s high finance’s job to convince the public that they’re actually helping, not the public’s job to learn high finance.
Elites that forget this for too long have historically come to very bad ends.