UK pensions hit with margin calls as gilts and sterling slide
risk.net
risk.net
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.
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.
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.
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.
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.
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.
Those who modelled the risk did not think Tories would do anything that stupid and risk the UK economy.
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.
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'm going to have to very emphatically disagree!
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.
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.
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".
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.
That’s what the margin calls are, no?
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.
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")?
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.
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.
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.
It's a fundamental law of investing that return is positively correlated with risk. Unfortunately you can't have your cake and eat it too.
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.
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.
(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...
> 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...
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.
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.
Todays Money Stuff discusses: https://www.bloomberg.com/opinion/articles/2022-09-29/uk-pen...
Very promising.
https://en.wikipedia.org/wiki/September_2022_United_Kingdom_...
» 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?
If that is correct then they should hold on through market wobbles and some heat in the media as economic growth will ultimately pay for it.
Im not defending the specific implementation and timing, but the theory is sound.
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.
What the government has done is cut corporate taxes and left it to the Bank of England to raise the Mortgage tax.
Those paying for the government's investment idea will be those paying mortgages and those selling houses.
There's no difference here to cutting corporation tax and putting up income tax to compensate.
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.
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.
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.
https://www.bbc.com/news/business-63089222
(I'm not sure if that's the same tax as e.g. Germany has recently announced, or a separate one.)
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.
Maybe the word is bathos. She wants to be Thatcher but is cursed with a modicum of humanity.
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.
https://yougov.co.uk/topics/politics/articles-reports/2022/0...
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
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.
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.
Edit:
https://en.wikipedia.org/wiki/Dissolution_and_Calling_of_Par...
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.
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.
[1] https://en.wikipedia.org/wiki/Fixed-term_Parliaments_Act_201... [2] https://en.wikipedia.org/wiki/Early_Parliamentary_General_El...
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.
A necklace with an o on the front is a signal to some folks.
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!"
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.
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-...
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.
There are already companies doing this. A crash will accelerate it. Eg https://slate.com/business/2021/06/blackrock-invitation-hous...
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.
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 IFS reckons the total tax changes will amount to £45bn/yr
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.
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.
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.
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.
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.
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.
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?
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.
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.
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.
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.
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.
For example: The child of a doctor or lawyer is much more likely to be pressured or encouraged to go into law or medicine.
They have, of course, tested this as well.
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.
At a minimum, this topic is more complicated than you think, and you aren't using the correct statistical terminology when you discuss 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).
https://archive.ph/2022.09.29-165000/https://www.bloomberg.c...
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.
Gambling is completely risk-free if it involves UK pensioners.
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.
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?
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...
entitlements were $1.18T (social security) + $697B (medicare) + $537B (welfare) + $396B (unemployment) = $3.329T
military was $1.035T.
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.
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.
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…
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.
Derivative products based on the price of gilts where you might have to put up collateral are not.
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).
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.
No systemic risk here! We killed that in 2008 according to every wall street analyst on cnbc.
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.
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.
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 ...
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.
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.
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).
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.
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.
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.
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$?
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.
What was this edge case? Rates rising quickly?
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.
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).
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.
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.
> "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."
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.
Because the value of their present liability goes up more than the value of their bond assets, meaning they become more underfunded.
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.
> 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!!!"?) .
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%.
Overall, it's still a slide.
I had no idea defined benefit pensions were still a thing.
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.)
> This is why I expect a federal UBI.
That seems…unrelated.
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.
For some reason when they realised they were a bad idea they got rid of them for everyone else but themselves.
"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."
Jesus these people are sick
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.
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.
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.
We have seriously degraded the world stability the last 2 years.
Edit: see sibling comment for clarification.
They should not be allowed to manage money backstopped by the public. But letting them lose private capital is fine.
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.
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.
https://www.ft.com/content/5802c53b-3130-462c-8fb3-e3e6203f1...
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.
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.
Also, it is natural for the USD to appreciate given the energy crisis and knock on effects from that, isn't it?
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.
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.
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.