Yet again 'clever' financial engineering creates trouble
Discussion
In 2008 we learnt about financial institutions who bundled 'sub-prime' home loans into mortgage-backed securities, which were repackaged into collateralized debt obligations and then sold to investors. Many of the original mortgages were granted to people who had little hope of being able to maintain their payments, but that was unknown to the investirs who bought the CDOs.
That was one contributory factor, to what became known as the Global Financial Crisis.
Now we learn about another unexpected activity.
Defined pension fund managers had been encouraged by their regulator to hold 'safe'' government stock and commercial bond investments. When the historic low interest rate period began that presented a problem, because when rates start to rise again (which inevitably they would do with dates at 300 year lows), the values of those investments would fall.
A type of debt gearing was introduced to supposedly insure against unsatisfactory investment returns.
As is often the case with financial markets, when a change of direction takes place it can often be quite rapid. Raising interest rates has taken a very long time, but early in 2022 the change began. Many base rate increases have taken place and the pension world is now suffering.
It was so obvious that interest rates would rise at some point (when was of course unknown), but the pension fund managers thought they had found a miracle solution to the inverse characteristic of gilts and bonds.
I think it's easy to be critical but I recall US funds pay out 7% per year so with returns of 1.75%, they were in a difficult situation. 12 yrs of nominal 5.25% outflows would have been equally as bad.
I have often marvelled at how it seems pensioners and holders of these funds never allow themselves to think about the basic maths.
No one complained about the obvious leverage being used so long as it was working.
I have often marvelled at how it seems pensioners and holders of these funds never allow themselves to think about the basic maths.
No one complained about the obvious leverage being used so long as it was working.
Basically as I see it, even the safe and steady people/institutions have been forced into taking higher risk to get a return they 'needed'? Leverage is a word that always comes up when financial crises are discussed?
Low interest rates for years, meant money was easy to borrow for all purposes, including the questionable and not always 'value added' ones? So debt expanded but with less means to repay it, that gets less likely now as rates rise?
Money is crucially important to us, just to operate, but most of us are blissfully unaware of how the bigger picture stuff all works, very very few people know exactly all the in's and out's of the "system" and I'm certainly not convinced anyone knows all the ramifications and consequences (both intended and unintended - they didn't in 2008!) or what would be deemed a good 'fix' for the circumstances right now.
The average Joe is just getting on with life and knowingly or unknowingly runs to a budget, one that ebbs and flows, in simple terms, between savings and debt. The big picture stuff often doesn't materially affect them, but currency devaluations, high inflation, and therefore threats to pensions/savings will massively if they continue. Do we have the tools to fix it (the current government and Boe statements don't fill me with confidence?), is it in our control or are we just passengers at the mercy of the US/FED policy and (lack of) energy supply?
Low interest rates for years, meant money was easy to borrow for all purposes, including the questionable and not always 'value added' ones? So debt expanded but with less means to repay it, that gets less likely now as rates rise?
Money is crucially important to us, just to operate, but most of us are blissfully unaware of how the bigger picture stuff all works, very very few people know exactly all the in's and out's of the "system" and I'm certainly not convinced anyone knows all the ramifications and consequences (both intended and unintended - they didn't in 2008!) or what would be deemed a good 'fix' for the circumstances right now.
The average Joe is just getting on with life and knowingly or unknowingly runs to a budget, one that ebbs and flows, in simple terms, between savings and debt. The big picture stuff often doesn't materially affect them, but currency devaluations, high inflation, and therefore threats to pensions/savings will massively if they continue. Do we have the tools to fix it (the current government and Boe statements don't fill me with confidence?), is it in our control or are we just passengers at the mercy of the US/FED policy and (lack of) energy supply?
Scootersp said:
Basically as I see it, even the safe and steady people/institutions have been forced into taking higher risk to get a return they 'needed'? Leverage is a word that always comes up when financial crises are discussed?
Low interest rates for years, meant money was easy to borrow for all purposes, including the questionable and not always 'value added' ones? So debt expanded but with less means to repay it, that gets less likely now as rates rise?
Low interest rates for years, meant money was easy to borrow for all purposes, including the questionable and not always 'value added' ones? So debt expanded but with less means to repay it, that gets less likely now as rates rise?
Thank you.
Your apostrophes for needed, say it all.
I decided to post the topic because in this particular instance, it must have been so obvious to everyone, that at some point (the low rates did go on for a remarkably long time) interest rates would have to increase, possibly quite rapidly.
They could hardly say (when rates were the lowest they had been for 300 years), we did not anticipate interest rates rising.
So for something that eventually is going to be a certainty, they still took the risk of introducing debt, in an attempt to magnify their returns.
To make it worse, the scale of what has been going on must be enormous, otherwise we would not be hearing that some pension funds could fail completely.
Normally serious investors structure their funds, so that some disasters can be accommodated without bringing down the whole fund.
The regulator did encourage pension funds to hold more bonds, for supposed safety and a predictable outcome, but unless held to maturity (which you would have thought might be the core of a pension fund) gilts are of course the last thing you want during a rising interest rate environment.
I understand people with DB pensions in payment should be safe, because of the Protection Scheme (whether annual increases cease I don't know), but of course the rescue fund does become the burden of other people.
There is a lot I don't understand but you'd like to think the gilts and pension funds were in the safer end of the spectrum and yet here we are.
A contagion event that needed emergency measures (effectively bailed out?) to stop it, has it actually stopped it 100%, ie is the problem fixed and if so for how long.
The issues seem to always be that in extreme circumstances the market can break and so everything is ok for long benign periods or periods where the rate of change of circumstances is low and so people can adapt to it.
When something happens out of the ordinary, so robinhood/Citadel/Gamestop (too much shorting/short covering?), the nickel market blowing up, trading frozen and trades reversed, our Gilts, is gets messy and we have to step in?
" On January 22, 2021, approximately 140 percent of GameStop's public float had been sold short, meaning some shorted shares had been re-lent and shorted again" this is non sensical to any normal person!
Nickel "The story begins with Xiang Guangda and his company Tsingshan, the world’s largest producer of nickel. The Chinese billionaire industrialist took a position against its own commodity, deciding to take short positions." at what must have been excessive/irresponsible/greedy levels ie not a vanilla hedge?
Our gilts "Pension funds came under pressure to sell gilts to meet cash calls on leveraged bets amid the dramatic repricing, and could have become stuck in a reinforcing loop without the BoE's action to backstop the market."
It always seems to be leverage, what does leverage do? it allows you to make or lose money faster? You can lose more than you own? you can get margin called, you can get wiped out completely. The crisis is averted but do they learn their lesson?
Meanwhile, at home average Joe is just trying to get by and mortgage rates are on the rise, inflation too, cost of living ramping up and then those with enough left over to try and build up a good pension, in extremis, might never see it, and our PM and chancellor look clueless and/or helpless?
A contagion event that needed emergency measures (effectively bailed out?) to stop it, has it actually stopped it 100%, ie is the problem fixed and if so for how long.
The issues seem to always be that in extreme circumstances the market can break and so everything is ok for long benign periods or periods where the rate of change of circumstances is low and so people can adapt to it.
When something happens out of the ordinary, so robinhood/Citadel/Gamestop (too much shorting/short covering?), the nickel market blowing up, trading frozen and trades reversed, our Gilts, is gets messy and we have to step in?
" On January 22, 2021, approximately 140 percent of GameStop's public float had been sold short, meaning some shorted shares had been re-lent and shorted again" this is non sensical to any normal person!
Nickel "The story begins with Xiang Guangda and his company Tsingshan, the world’s largest producer of nickel. The Chinese billionaire industrialist took a position against its own commodity, deciding to take short positions." at what must have been excessive/irresponsible/greedy levels ie not a vanilla hedge?
Our gilts "Pension funds came under pressure to sell gilts to meet cash calls on leveraged bets amid the dramatic repricing, and could have become stuck in a reinforcing loop without the BoE's action to backstop the market."
It always seems to be leverage, what does leverage do? it allows you to make or lose money faster? You can lose more than you own? you can get margin called, you can get wiped out completely. The crisis is averted but do they learn their lesson?
Meanwhile, at home average Joe is just trying to get by and mortgage rates are on the rise, inflation too, cost of living ramping up and then those with enough left over to try and build up a good pension, in extremis, might never see it, and our PM and chancellor look clueless and/or helpless?
Scootersp said:
There is a lot I don't understand but you'd like to think the gilts and pension funds were in the safer end of the spectrum and yet here we are.
A contagion event that needed emergency measures (effectively bailed out?) to stop it, has it actually stopped it 100%, ie is the problem fixed and if so for how long.
The issues seem to always be that in extreme circumstances the market can break and so everything is ok for long benign periods or periods where the rate of change of circumstances is low and so people can adapt to it.
When something happens out of the ordinary, so robinhood/Citadel/Gamestop (too much shorting/short covering?), the nickel market blowing up, trading frozen and trades reversed, our Gilts, is gets messy and we have to step in?
" On January 22, 2021, approximately 140 percent of GameStop's public float had been sold short, meaning some shorted shares had been re-lent and shorted again" this is non sensical to any normal person!
Nickel "The story begins with Xiang Guangda and his company Tsingshan, the world’s largest producer of nickel. The Chinese billionaire industrialist took a position against its own commodity, deciding to take short positions." at what must have been excessive/irresponsible/greedy levels ie not a vanilla hedge?
Our gilts "Pension funds came under pressure to sell gilts to meet cash calls on leveraged bets amid the dramatic repricing, and could have become stuck in a reinforcing loop without the BoE's action to backstop the market."
It always seems to be leverage, what does leverage do? it allows you to make or lose money faster? You can lose more than you own? you can get margin called, you can get wiped out completely. The crisis is averted but do they learn their lesson?
Meanwhile, at home average Joe is just trying to get by and mortgage rates are on the rise, inflation too, cost of living ramping up and then those with enough left over to try and build up a good pension, in extremis, might never see it, and our PM and chancellor look clueless and/or helpless?
A contagion event that needed emergency measures (effectively bailed out?) to stop it, has it actually stopped it 100%, ie is the problem fixed and if so for how long.
The issues seem to always be that in extreme circumstances the market can break and so everything is ok for long benign periods or periods where the rate of change of circumstances is low and so people can adapt to it.
When something happens out of the ordinary, so robinhood/Citadel/Gamestop (too much shorting/short covering?), the nickel market blowing up, trading frozen and trades reversed, our Gilts, is gets messy and we have to step in?
" On January 22, 2021, approximately 140 percent of GameStop's public float had been sold short, meaning some shorted shares had been re-lent and shorted again" this is non sensical to any normal person!
Nickel "The story begins with Xiang Guangda and his company Tsingshan, the world’s largest producer of nickel. The Chinese billionaire industrialist took a position against its own commodity, deciding to take short positions." at what must have been excessive/irresponsible/greedy levels ie not a vanilla hedge?
Our gilts "Pension funds came under pressure to sell gilts to meet cash calls on leveraged bets amid the dramatic repricing, and could have become stuck in a reinforcing loop without the BoE's action to backstop the market."
It always seems to be leverage, what does leverage do? it allows you to make or lose money faster? You can lose more than you own? you can get margin called, you can get wiped out completely. The crisis is averted but do they learn their lesson?
Meanwhile, at home average Joe is just trying to get by and mortgage rates are on the rise, inflation too, cost of living ramping up and then those with enough left over to try and build up a good pension, in extremis, might never see it, and our PM and chancellor look clueless and/or helpless?
Thank you for your interesting contribution.
My investment activity has always been very conventional and I always try to remain within my own understanding. I know nothing about Robinhood/Citadel/Gamestop and nickel, so it sounds from your post, that I might have been fortunate not to have been involved.
Long-dated girls are fairly straight forward, whereby the current yield remains reasonably close to prevailing interest rates. Therefore when prevailing interest rates rise, gilt yields rise, but to do so the gilt prices have to fall. All fairly logical until we hear about debt and gearing being introduced.
I think the recent pensions crisis only involves Defined Benefit pensions. The Defined Contribution type do not have promises of after retirement payments, so no need to introduce any gearing risk.
The Bank of England recently boosted demand for gilts, but the (2022 steady) increase in Base Rates is still present, so their intervention might only be a temporary fix. Some DB pension funds refused to becime involved in Liability Driven Investments (LDIs). A while ago Lord Wolfson, CEO of Next, called LDIs a timebomb.
Edited by Jon39 on Friday 14th October 14:08
Jon39 said:
I think the recent pensions crisis only involves Defined Benefit pensions. The Defined Contribution type do not have promises of after retirement payments, so no need to introduce any gearing risk.
back to that need word again! Edited by Jon39 on Friday 14th October 14:08
Also schemes can be a mix and so it might not be as simple as DC fine DB not?
https://www.thepensionsregulator.gov.uk/en/busines...
Scootersp said:
Jon39 said:
I think the recent pensions crisis only involves Defined Benefit pensions. The Defined Contribution type do not have promises of after retirement payments, so no need to introduce any gearing risk.
back to that need word again! Edited by Jon39 on Friday 14th October 14:08
Also schemes can be a mix and so it might not be as simple as DC fine DB not?
https://www.thepensionsregulator.gov.uk/en/busines...
Oh dear.
Instances have arisen on occasions, where some fund managers have shown that they have responsibility for other peoples money, but prefer gambling to investing.
I hope there is never a serious pensions crisis, because the whole concept is so vital for a comfortable retirement.
Money does not produce happiness, but as someone once said, "I would rather be miserable in a Mercedes, than on a bus". -
Panamax said:
Jon39 said:
Long-dated girls are fairly straight forward
Where can I get me some of those? Sounds a much more inviting proposition than the financial markets!Well spotted Panamax.
If the predictive text makes a joke, it should at least add a smiley face.
I could say, I went to the wrong optician,
or, as Captain Mainwaring used to say, "I did wonder who would be the first to spot that".
Gassing Station | Finance | Top of Page | What's New | My Stuff