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.
It is risk free, held to maturity. 50 year bond market prices however, vary strongly in response to interest rate changes. Since these bonds are issued by the bank of England and since interest rates are set by the bank of England this is a crisis entirely & predictably created by the bank of England.
Definitely not the pension funds who chose to diversify from gilts into riskier securities and then took out margin to buy more gilts as a hedge thereby destroying the long term durability AND THE ENTIRE PURPOSE of a pension…
I don't really understand the financial situation here, but my guess would be, if this were actually risk free money then there wouldn't be an issue here.
The bonds are risk-free when held to maturity which is what every textbook will tell you if you actually read them.
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.
Decreases in the market price of these bonds due to interest rates rising is not, as I understand it, actually a problem for these defined benefit pension funds because they actually have to pay out a specific income to people in the plan and higher interest rates also decrease the present-day cost of meeting that liability. The actual problem was that there was no functioning market for certain gilts they held at all - as in, supposedly there were literally no bids at all to buy them at several points in time, and even when there were the prices were terrible. A few people posted graphs of the yield curve and that part of it was obviously just outright broken.
Indeed because under normal circumstances I would assume these bonds are mostly held to maturity. But why do they have to sell them now? I was under the impression it was to cover some margin calls.
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.
These gilts or bonds work exactly as you’ve described. So how do you get margin called? You mix in 5-10% high risk, high reward securities to try to make a profit and buy, on margin, extra gilts/bonds to try to hedge the risk.
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.
The issue is not whether gilts are risk free (they are for any country that controls its own fiat currency). The issue is that 1) they are only risk free if held to maturity and 2) they used this risk free asset as collateral so that they could lever up, and leverage is never risk free.
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.
