UK pensions hit with margin calls as gilts and sterling slide

https://www.risk.net/derivatives/7954682/uk-pensions-hit-with-ps100m-margin-calls-as-gilts-and-sterling-slide

by MotherBruce • 4 years ago

243 304 4 years ago

The war strains of winter begin…

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)?

citizenkeen• 4 years ago

This is a lot of the UK’s first time in a D/s relationship, and it’s going to hurt.

sfvegandude• 4 years ago

Dom/Sub?

cjbgkagh• 4 years ago

I imagine people don’t think it’s maintainable and a reaction to it might be quite anti-business. I.e. it’s a drop in stability.

sp3322• 4 years ago

Yes, tax cuts that were to be funded by going into a lot of debt. [Deleted the vacation bit]

gonzo41• 4 years ago

I cannot imagine the King is happy with that. Not a good way to start.

retinaros• 4 years ago

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

mellosouls3• 4 years ago

On the other hand, if the rich want to leave the UK because of tax, I'll happily help them carry their bags to the airport.

thebradbain2• 4 years ago

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.

wyager5• 4 years ago

Are you trying to imply that those are straightforwardly causally related?

hanoz2• 4 years ago

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.

samizdis• 4 years ago

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.

[1] https://www.economist.com/leaders/2022/09/28/how-not-to-run-...

mihaaly2• 4 years ago

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.

NovemberWhiskey3• 4 years ago

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.

lossolo• 4 years ago

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.

switch0074• 4 years ago

£2bn is the government’s figure. Not everyone agrees. Plus there are the other tax changes

The IFS reckons the total tax changes will amount to £45bn/yr

https://ifs.org.uk/articles/mini-budget-response

sph3• 4 years ago

Yeah, it's only £2bn a year, the state can afford it. It's not bad PR, it's a bad idea on top of a massively catastrophic idea.

MattPalmer1086• 4 years ago

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.

switch0074• 4 years ago

The government announced their proposed budget. It hasn’t passed a Bill yet so it isn’t law

xupybd3• 4 years ago

Why are pension funds borrowing money?

twawaaay4• 4 years ago

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.

olladecarne• 4 years ago

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

sicp-enjoyer7• 4 years ago

Somehow I don't think you're giving the full picture.

wyager5• 4 years ago

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.

toomuchtodo• 4 years ago

It’s complicated. Matt Levine of Bloomberg explains very well, as always.

https://archive.ph/2022.09.29-165000/https://www.bloomberg.c...

omegalulw• 4 years ago

This blew my mind. Fantastic explanation.

sicp-enjoyer7• 4 years ago

Nobody lets large sums of money sit in cash. Full-filling their retirement obligations requires them to grow that money.

socialismisok8• 4 years ago

Why do they need to borrow to do that? Surely they could loan to do that?

xupybd3• 4 years ago

You can grow money without debt

missedthecue• 4 years ago

because they haven't been able to make money by holding government debt for years. This is a consequence of 0.25% rates on government debt.

NovemberWhiskey3• 4 years ago

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.

xupybd3• 4 years ago

That sounds a lot like borrowing money.

pyrrhotech• 4 years ago

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.

akimball2• 4 years ago

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.)

lmm5• 4 years ago

Levering up for higher returns, possibly encouraged by absurd accounting rules.

mFixman• 4 years ago

Because the government will bail them out if they go bankrupt.

Gambling is completely risk-free if it involves UK pensioners.

anm892• 4 years ago

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.

kasey_junk3• 4 years ago

The Bank of England has taken action since this was published.

Todays Money Stuff discusses: https://www.bloomberg.com/opinion/articles/2022-09-29/uk-pen...

LeoPanthera• 4 years ago

This is very out of date. The most recent developments: https://www.bbc.com/news/business-63065415

themitigating• 4 years ago

Very out of date?

twawaaay4• 4 years ago

Betting pensions on margin instruments?

orwin2• 4 years ago

Edging mostly.

ls6122• 4 years ago

I know you meant hedging but the typo is funnier.

twawaaay4• 4 years ago

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.

lvl1024• 4 years ago

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.

asdfasgasdgasdg2• 4 years ago

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?

djbusby4• 4 years ago

Why natural? Is it some effect of the "petro-dollar" thing?

lvl1024• 4 years ago

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.

snake_doc2• 4 years ago

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.

lvl1024• 4 years ago

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.

seer-zig• 4 years ago

Who in their right mind puts margin on pensions? Let's just keep building the house of cards higher and higher, that's a very good idea.

dboreham• 4 years ago

Something, something, defined benefit, it seems.

I had no idea defined benefit pensions were still a thing.

blockwriter• 4 years ago

They’re enshrined in the constitution of my home state, Illinois, for the public sector, I believe.

HarryHirsch• 4 years ago

You'd think that annuities were easy, they don't have many variables and have been studied for centuries.

Nursie2• 4 years ago

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.

shapefrog8• 4 years ago

Boomers - no contribution with a defined benefit out.

For some reason when they realised they were a bad idea they got rid of them for everyone else but themselves.

triceratops• 4 years ago

Matt Levine about this on today's Money Stuff:

"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."

boomboomsubban• 4 years ago

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.

iTradeWarez• 4 years ago

"aesthetically beautiful"

Jesus these people are sick

lvl1024• 4 years ago

Basically pensions used gilts as collateral because it was viewed as risk free. That changed overnight.

anonporridge• 4 years ago

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.

evandwight• 4 years ago

Selling derivatives looks great until it doesn't.

helloooooooo• 4 years ago

All funds use margin as a liquidity mechanism. If it takes a few days to settle funds and you need cash right away, you dip into your margin

anonuser1234562• 4 years ago

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.

skippyboxedhero• 4 years ago

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.

hn_go_brrrrr• 4 years ago

Got a link to the FT article? I'd enjoy reading those comments.

runeks3• 4 years ago

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.

midasuni• 4 years ago

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.

orwin2• 4 years ago

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).

jorvi• 4 years ago

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.

seper8• 4 years ago

3 months into financial tightening and pension funds already facing margin calls.

Very promising.

vasco• 4 years ago

This winter is going to be interesting.

isthisthingon99• 4 years ago

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.

NovemberWhiskey3• 4 years ago

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.

https://en.wikipedia.org/wiki/September_2022_United_Kingdom_...

pooper2• 4 years ago

» 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?

neilwilson4• 4 years ago

All government spending in the UK is funded by government borrowing. That's how the system has worked for 150 years or more.

Every penny spent is initially borrowed. Then as it bounces around the economy tax is raised by the induced spending flow.

It's only if people save rather than spend from that that the 'borrowing' shows up on the books.

Whether there will be any more borrowing show up depends how much people spend and how much people save.

The problem is the deliberate misunderstanding of what government borrowing is, put forward by those who want to see government spending stopped.

collegeburner11• 4 years ago

...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.

socialismisok8• 4 years ago

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.

throwyawayyyy2• 4 years ago

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...

socialismisok8• 4 years ago

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.

bergenty• 4 years ago

That’s populism for ya. Watch Italy, Hungary and Russia end up like this over the next year.

zimpenfish3• 4 years ago

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.

yyy888sss• 4 years ago

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.

obblekk• 4 years ago

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.

Unfortunately there’s no easy way out of this.

ColFrancis• 4 years ago

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.

nopenopenopeno• 4 years ago

They will go hungry, though. “Socialise the losses” means bailing out the banks, not the workers.

xadhominemx• 4 years ago

Well it’s completely wrong

dereg5• 4 years ago

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.

smallnamespace• 4 years ago

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).

xeromal• 4 years ago

Thanks for sharing this perspective.

deepGem• 4 years ago

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.

lmm5• 4 years ago

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.

runeks3• 4 years ago

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.

Aunche4• 4 years ago

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.

Scoundreller• 4 years ago

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.

jsmith99• 4 years ago

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).

collegeburner11• 4 years ago

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.

dereg5• 4 years ago

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.

ctchocula• 4 years ago

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."

mellosouls3• 4 years ago

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.

briartoon• 4 years ago

Why do they need to hedge against rates falling? The value of a mixed portfolio of stocks and bonds will also move with changes in rates.

dchftcs2• 4 years ago

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.

anm892• 4 years ago

Way off course here

cm21872• 4 years ago

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.

sofixa2• 4 years ago

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!!!"?) .

unity10013• 4 years ago

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.

graeme2• 4 years ago

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

unity10013• 4 years ago

To run a pension

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.

malermeister3• 4 years ago

I would add housing and infrastructure to that list.

mellavora2• 4 years ago

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.

zarriak• 4 years ago

New polling out of the UK is truly astonishing.

https://yougov.co.uk/topics/politics/articles-reports/2022/0...

lamontcg2• 4 years ago

Is there any way to force a vote before Jan 2025?

switch0074• 4 years ago

Vote of no confidence from the leader of the opposition (Labour) I believe.

Also the budget bill is seen as a confidence vote. That would be interesting because if it doesn’t pass. That would require a lot of Tory MPs to rebel

malermeister3• 4 years ago

The King could dissolve parliament.

benreesman• 4 years ago

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.

redanddead• 4 years ago

Would love to hear more of your thoughts on finance

csomar• 4 years ago

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.

barrkel• 4 years ago

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.

asdfasgasdgasdg2• 4 years ago

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.

boringg• 4 years ago

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.

btilly3• 4 years ago

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.

miohtama• 4 years ago

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.

dereg5• 4 years ago

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.

paganel• 4 years ago

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.

Aunche4• 4 years ago

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.

zimpenfish3• 4 years ago

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")?

cm21872• 4 years ago

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.

concinds• 4 years ago

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.

misja1112• 4 years ago

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.

zimpenfish3• 4 years ago

[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.

[1] https://newsletterhunt.com/emails/22524

betwixthewires• 4 years ago

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.

JonChesterfield• 4 years ago

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.

v-erne• 4 years ago

> 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.

dcminter• 4 years ago

Apropos of which I enjoyed this paragraph from Matt Levine's column yesterday:

(Edit: I missed that it was already mentioned elsewhere in the comments - https://news.ycombinator.com/item?id=33029162 )

"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."

https://www.bloomberg.com/opinion/articles/2022-09-29/uk-pen...

insomniacity• 4 years ago

Reminds me of this point by Matt Levine:

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.

https://www.bloomberg.com/opinion/articles/2022-09-29/uk-pen...

hackerlight2• 4 years ago

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.

bionsystem• 4 years ago

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.

andy_ppp• 4 years ago

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…

physicsguy2• 4 years ago

The strategy was nuts.

Pension funds were loaning gilts to banks, and then using the money to buy gilts which they then loan to banks, and then using the money to buy gilts…

jimnotgym3• 4 years ago

Is it nuts?

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.

physicsguy2• 4 years ago

Gilts are relatively risk free, in that they’re backed by government to pay some value out at a time in the future.

Derivative products based on the price of gilts where you might have to put up collateral are not.

mejutoco2• 4 years ago

Your description reminds me of Evergrande.

pfortuny• 4 years ago

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.

xtracto2• 4 years ago

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.

cbeach• 4 years ago

The mainstream media are still talking about the Pound sliding.

Ignoring the fact it’s grown strongly over the last week.

It’s clear to me why public trust in the U.K. media is down to just 34%.

https://pressgazette.co.uk/trust-in-news-uk/

malermeister3• 4 years ago

It still hasn't recovered from the catastrophic crash the week prior.

Overall, it's still a slide.

Blackstone4• 4 years ago

This refers to defined benefit persons not defined contribution pension. These pensions were overly generous…

_448• 4 years ago

Just putting it here so that we don't forget: https://www.bbc.co.uk/sounds/play/b06kgvcn

hoseja• 4 years ago

Time for Soros 2.0!

laylower• 4 years ago

How can we read the article on risk.net?

pjfin123• 4 years ago

I don't think defined benefit pensions are a very good idea.

UK pensions hit with margin calls as gilts and sterling slide

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