A problem with pension funds in Britain?

Stock market sayings are often quite accurate and quite funny.

One of them applies particularly well to the current situation: the markets take the stairs to go up and the lift to go down

We just had a wonderful example.

Please consider the chart below.

From 2014 to the end of 2021, UK 10-year interest rates (Gilts) drop from 3% in 2014 to 0.2% during the Covid panic.

Suddenly, someone who had invested £ 100 in a 10-year, constant-term bond saw his capital increase from 100 to 134 in eight years.

And in 8 months our investor is less than 100 (97.8), having not been able to get out “in time”.

We actually just had the bloodiest bear market since 1971 in government bond markets in nearly every developed country at the same time.

The attentive reader of the IDL will recognize that I have been saying for at least three years that I have no long ties in either the United States, France, Germany, or Great Britain.

Maybe I was pessimistic a little too soon, but I don’t regret anything, because the decline has been heavy, brutal, and it may not be over.

Which, at this point in the argument, leads to some observations.

  • From 2014 to 2022, the long rates on bonds of all developed countries had seen their prices constantly manipulated by local central banks, to the point that the crazy budget deficits created during this period were fully financed by the said central banks operating the press. of money in overdrive.
  • This means that the interest rates paid on these bonds were not “the price of time” determined in a free market between buyers and sellers, but a false price imposed by central banks for the benefit of local states, which simply amounted to 100 percent tax. on savings if the rates were equal to zero.
  • Buying bonds at this false price meant making sure that as soon as the “central bank” buyer disappeared, the markets would very quickly revert to the real price, which involved a considerable and very rapid fall in capital, and that’s exactly what it is. success.

So what happened in Britain last week is perfectly normal and everything will be fine very quickly?

I’m not so sure, and here’s why.

  • Imagine you are the manager of a British pension fund that has to pay retirement index-linked pensions in Great Britain.
  • Also imagine that the regulations force you to have at least 40% UK government bonds.
  • How do you meet the obligation to pay an inflation-linked pension if the 10-year rates are zero and inflation is 2 or 3 percent?

Answer, you can’t!

And this is where your true friends, the investment bankers, come into play.

What do they offer you?

Something very simple: thanks to their deep technicality and their knowledge of the markets, they have built structured products “that will allow you to earn two or three percent more, without significantly increasing the risk of your portfolio. And the poor manager rushes to these extraordinarily complicated products that no one, and especially not even his manager or board of directors, understands anything.

And I’ll make a revelation to all readers.

Great financial crises destroy stock markets, but they rarely originate there.

In fact, all the major financial crises I have suffered or studied in my career begin with a frantic search for greater profitability in the bond market, very often because the central bank has set rates too low.

Let’s go back to the great crisis of 2008 2009.

Mr. Bernanke keeps interest rates too low to “stimulate growth” which has never worked in history.

The interest rates on AAA, ie high quality, or government bonds are too low for insurance and pension funds.

It does not matter. Wall Street gets to work and, from rotten bonds, builds pyramids of instruments whose tops will receive AAA ratings. How do they do it? They take several junk bonds and claim that the first 10 percent of the payments will go on a new bond, which is then rated AAA and can be purchased by insurance companies.

Of course, when the recession comes, the underlying debtors don’t even pay 10 percent and default on the new instrument and we have a massive financial crisis that we haven’t finished paying for.

For those interested, I have described these manipulations in my book “Liberal But Not Guilty Suddenly” which you can order on the site.

What happened this time in Great Britain?

I simplify.

Investment bankers came to pension funds and said: interest rates are zero. You sell call options on 10-year bonds that would force you to buy the bonds if rates fell to 3 percent, for example, and we would buy those options. There is little risk for you because rates will take a long time to reach 3 percent and you will have plenty of time to dissolve your positions.

What has been done.

Unfortunately, a new prime minister (Liz Truss) is appointed in Britain along with a new finance minister and the two decide that interest rates must return to market levels and suddenly the 10th year goes from 2 per cent to 4 per cent. a hundred in a few days.

Pension funds are forced to buy bonds at 3 percent, and they don’t have a cent.

They then sell what they can sell, stocks, bonds etc… whose prices collapse and the markets enter a hellish cycle in which the decline becomes unstoppable as the exchange rate collapses.

Panic at the Bank of England, which was unaware of the existence of these extraordinarily speculative positions.

But where were the supervisory authorities, the auditors, the rating agencies?

To absent subscribers, I guess

And suddenly, the Bank of England has to buy 70 billion British government bonds in a disaster, otherwise the Crash was inevitable.

But redeeming this $ 70 billion, once again, means managing the printing press, which risks bouncing inflation faster and faster.

Let’s go back to the previous problem.

In summary, the cycle-to-cycle scenario is always the same:

  1. The central bank is setting rates too low.
  2. Long-term savings are no longer remunerated
  3. Managers of this long-term savings are offered miracle products by investment banks trying to help them
  4. These products are exploding and pension and insurance systems are on the verge of bankruptcy.
  5. Investment bankers are getting richer.
  6. The central bank intervenes, lowers rates and we once again have a false market price on interest rates, which allows investment banks to offer new miraculous products to poor managers, who have also been replaced to be taken over.

And at the end of the process, the long asset manager hires the central banker at the end of the latter’s mandate, to ensure a peaceful retirement.

  • So Bernanke rescued the greatest American manager of the time in 2009 by buying all of his junk bonds from him, only to find himself on the board of this same manager when his term expired.
  • Mr. Draghi was thus appointed to the board of one of the most prestigious investment banks, after having “saved” the euro in 2012.

To win back our democracies, we need to remove interest rate and exchange rate control from central banks and perhaps control central bank operations during periods of financial crises.

The results would be interesting.

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