The need for the public to fund City disaster recurs with damning regularity: systemic collapse seems inseparable from the inventiveness of financial markets. Regulators may be motivated, but greed and fear always finds a way to screw things up.
Today, it’s the so-called ‘Liability-Driven Investment’ schemes your pension have bought which you are required to reach into your pockets to rescue. You can dress it up as a mysterious problem of derivatives if you like, but the underlying dodge is very obvious: if government bonds are yielding 1%, but your pension fund needs to pay out 6%, then why not take that call from Blackrock, Legal & General, or Schroders (said to be the leading pushers of these schemes) and leverage up your bond position six times?
In a world of near zero-interest rates and quantitative easing, why not? Of course, if bond yields go up to much, or too quickly, the salesmen will be back on the phone needing you to up your margin-payments and increase your collateral, but that will never happen, will it?
Let’s get on that tiger and ride!
So how much is involved in these LDI strategies? Reuters reports: ‘LDI was worth about 400 billion pounds ($453 billion) in 2011, quadrupling to 1.6 trillion pounds by 2021, according to the Investment Association.’
£1.6 trillion? Britain’s entire GDP in 2021 was £2.27 trillion.
Who let this happen? The Bank of England, which desperately hopes to avoid picking up too much of the tab, explains the regulatory tangle through which the LDI salesmen danced. From its latest Financial Stability Report: ‘Although the PRA (Prudential Regulation Authority) regulates bank counterparties of LDI funds, the Bank does not directly regulate pension schemes, LDI managers, or LDI funds. Pension schemes and LDI managers are regulated by TPR (The Pensions Regulator) and the FCA (Financial Conduct Authority). LDI funds themselves are typically based outside the UK. The Bank will work with TPR and the FCA domestically to ensure strengthened standards are put in place.’
In other words, it’s difficult even to find the right stable door to slam, now that the horse has bolted.
For its part, Bank of England initially set aside £65bn to stabilize the gilts market as the LDI schemes triggered forced sales. Little of that was used, and now the Bank says it will withdraw that stabilising support by Friday 14th. Rather touchingly, the FCA is urging ‘that everybody involved in the situation, the pension funds, the managers, the bank counterparties, really focus on the work they need to do in coming days to ensure there is resilience in the system.’
What should be truly alarming is that observation from BoE: ‘LDI funds themselves are typically based outside the UK.’ This suggests two thing: first, the problem is not confined to Britain - almost certainly pension funds throughout the developed world have played the same game; second, at this stage there’s very limited visibility about the scale and systemic threat these strategies now represent.
And there is a third observation: the LDI schemes are a direct product of the near-zero interest rate and quantitative easing responses to the last great financial crisis. Your pension is held hostage in that world of near-zero interest rates.
In another part of the woods, I am writing about chattel slavery in the West Indies. It’s a terrible passage of history which makes you ask: who were these monsters? After a couple of hundred years of abominable but very profitable activity, moral outrage finished Britain’s West Indian chattel slavery empire. But it ended with what seemed like a final shameless crime: 1837’s Slave Compensation Act compensated the slave owners for their loss, not the slaves for their slavery. It was a colossal handout, with some 40,000 plantation-investors together pocketing approximately £20mn, probably equivalent to around 2.5% of Britain’s GNP. In today’s money, about £60bn.
Why did it happen? Well, Britain’s West Indian sugar empire was financed by huge working capital loans (sugar production and shipping is a lengthy and risky business). And since chattel slaves typically accounted for about 38% of a plantation’s balance sheet assets, those same slaves would be mortgaged as collateral for the loans. That’s a unique aspect of chattel slavery. So when those slave were emancipated, the collateral was lost, and . . . you have potentially a City crisis. The Slave Compensation Act was, then, among other things, another City bailout.
It never ends.
How much more incompetence does the taxpayer have to underwrite Michael? The Greenspan put for capital has been extended into government debt puts over the past decade. How on earth the public is still underwriting tail risks for industry profiteers after 2008 is astonishing. All these six figured sinecures at the regulators won't be held accountable, they'll just wind up in some other highly paying bureaucracy, same as after 2008. I looked on the Pension Regulator website this morning. The only recent bulletin I saw was about a letter they wrote to pension funds taking them to task over their lack of planning for climate change! Not a peep about the chaos in their industry right now. Same as the muppets at OFGEM....such a horrible environment...take the profits in the good years and stuff the public with losses in the bad. That ain't my understanding of capitalism!
On a different note, I'd like someone to address the reasons why there has been a desperate yield grab. It's not just QE. In my less well educated mind, this compression of rates really began with the expansion of global trade, notably after China's accession to the WTO in 2001. The deflation that was unleashed is surely culpable? Especially recycling of trade balances into US Treasuries and other first world bond markets resulting in yield compression.
With ageing societies globally (global savings glut) everyone is desperate to lever up the pitiful yields we've had for years. Should protectionism be making a comeback?!