Bank of England warns of material risk to financial stability

https://www.bbc.co.uk/news/business-63211743

by mellosouls • 4 years ago

42 16 4 years ago

bbc.co.uk

blagie3• 4 years ago

I feel like a lot of the West is living beyond its means, funded by debt.

England in particular, might be starting to unravel. England enjoyed a central stage in the world, due to the British Empire, and is used to being in that position. It's not quite clear what competitive advantage England brings to the table today, except remnants of that empire:

- Interest from colonial theft. A lot of places want their stuff back. That makes things a little bit brittle.

- Debt.

- Central role of the English language and ties to Commonwealth states.

I don't think any of that is permanent advantage.

sumedh• 4 years ago

It's not quite clear what competitive advantage England brings to the table today,

UK controls some of the biggest tax havens in the world.

blagie3• 4 years ago

Which ones?

Most of the ones I know are former colonies.

If you wanted a Double Irish With a Dutch Sandwich, that never hit any current UK country. Ditto for Caribbean nations.

UK is deep into sleazy financial schemes, but I didn't think it was a major player specifically here.

mint2• 4 years ago

When markets have confidence the debt can be serviced that’s not so much a problem.

The new government came in and destroyed that confidence with proposals for wild tax cuts for the wealthiest without showing any credible plan that leaves Britain able to pay debts and not tank their economy.

lotsofspots• 4 years ago

Removal of the 45p tax rate would cost around £2bn, which is peanuts compared to the amount spent on the COVID furlough scheme, for example. Calling it "wild tax cuts for the wealthiest" is political posturing.

uup2• 4 years ago

I don’t really see a good way out of this for the UK if pensions are in such a bad state that they can’t tolerate any change in interest rates. The era of free money is over, at least for now. The BoE can’t keep rates at 0 any longer. The government is going to need to borrow money to function (like all governments do). So the only option is going to be to sell bonds on the open market. That’s going to mean that bond prices will fall to the market rate, which is apparently higher than the pensions can tolerate.

iknowSFR• 4 years ago

This was an interesting read relating to your post. https://www.bloomberg.com/news/articles/2022-10-06/how-uk-pe...

The gist being that pension funds hedged with derivatives that are dependent on small movements of bond rates. However, since the rates increased quickly, the pensions needed to sell more bonds to fund their margin calls, which further caused a need to sell more bonds. They started their own death spiral.

FabHK2• 4 years ago

Matt Levine in his excellent Money Stuff newsletter had a neat summary of what happened there [0].

Basically:

1. A pension fund has to pay a $100 pension in 30 years (=liability) [1]. So, it buys a 30 year bond today (=asset) that pays $100 in 30 years. The asset and the liability are matched, and it is flat rates: long one bond (which it bought), and "short one bond", namely the pension it has to pay. +1 -1 = 0

2. However, rates have been quite low over the last two decades, making bonds expensive. So, the pension fond decides to try something new: mix bonds with stocks. They have higher expected returns, so it can get away with buying a bit less upfront, say half a bond and some shares. There will be a shortfall, but if the shares outperform the bond, as expected, it will sort itself out in 30 years.

3. Now the pension fund is long half a bond (which it bought), and "short one bond", namely the pension it has to pay, so in total not flat, but short half a bond: +0.5 -1 = -0.5. This means that the fund is unhappy when bonds rise in price, ie yields fall.

4. But even though rates were low two decades ago, they have fallen even lower after the GFC etc. [2] So, funds were unhappy, as they appeared to get worse shortfalls. So, they got the great idea of hedging, ie synthetically going long bonds: happy when bond prices go up, yields fall.

5. But recently, yields have shot up, bond prices fell. That's good, per se, for the pension funds - they're naturally short bonds, after all. Except that now they've hedged - and their hedges went massively against them.

6. Bonds are so cheap now, with high rates, the pension funds should be buying them. But instead they might be forced to sell to cover their margin calls, driving bond prices down even further, and ... we're in the spiral you mentioned.

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

[1] They actually have to pay a pension more or less every year over the next N years, but one can simplify this particular story by just picking one year.

[2] see e.g. https://fred.stlouisfed.org/series/DGS10 (click on "MAX" to see the full history)

janef0421• 4 years ago

A financial analysis is too abstract to reach the core of the issue. Materially, Britain has few natural resources, little remaining production capacity, particularly in heavy industry, and does not have a strong export sector for immaterial goods, such as software and music. Ultimately, this is a weak economic base that will inevitably lead to problems, both domestic and in international trade, regardless of financial manoeuvring.

Bank of England warns of material risk to financial stability

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