Can someone explain in laymans terms what is happening with the BOE/pension funds on Friday?

[Silverin]

There seems to be a lot of panicked talk in the financial media about pension funds potentially collapsing and the BOE needing to step in to help them but this support being stopped on Friday.

As a layperson, I would like to understand what is going on - what are gilts, what did the BOE do/not do and what are the risks to pension funds that could cause a collapse on Friday?

[StatisticallyChallenged]

@citroenpresse

If the markets crashed so suddenly, is there any hope they could rise again suddenly? Would there be an even bigger downward spiral with a general election announcement or some glimmer of hope? Re Truss being removed, it wasn't the 1922 committee that did for any of her predecessors - all survived confidence votes. Seems more likely that if Tories can restrict to just two candidates it might be like the May/Leadsom leadership where Leadsom withdrew so only one candidate left (ie not having to ask membership).

Fast rebounds are possible; have a look at the chart of GBP vs USD around the time covid was really kicking off (March 2020) and you'll see a big drop followed by a really sharp uptick (although not back to previous levels). From memory, the big drop was around the time the big lockdown measures, school closures etc were being signalled, and the uptick was when the big support packages like furlough started being announced. So a policy change can make a big difference.

Whether it would here, with the same leadership, I'm not sure. If the Tories suddenly launched the pair of them off London Bridge <metaphorically> and put someone more mainstream like Sunak in - I think we'd see an improvement very rapidly. Whether it would hold would depend on the policy announcements which followed.

[citroenpresse]

The thing that the BoE have announced...the temporary expanded collateral repo facility. Is that seen (by BoE) as a more effective policy than buying/selling gilts but the objective is the same ie support pension fund instability? And if there's just been some market improvement, is that due to a coherent BoE action (ie at least one key institution is competent) or the indications that a mega mini-budget U-turn (huge Tory incompetence) is coming?

Someone earlier up this thread said they thought Julian Smith had been stepping out of line, but isn't he one of the sanest Tories going?

[walkingonsunshinekat]

@Notlabeled

You think a 45Bn budget tipped it over the edge, not the 400Bn on CoVid??? 100Bn on energy caps? No it was a couple of quid a month people could keep of their own money that disturbed the market.

Insanity.

The country is bankrupt

We are facing energy blackouts, failure of businesses due to energy costs, collapsing demographics, totally unfunded pension liabilities, nuclear war, economic failure in the EU and USA, a faltering Chinese economy, supply chains still in disarray, lack of spare parts to keep infrastructure and distribution functioning.

Put that 5p back on the top rate though.

Sorted.

You didn't read the "well, at least as much as it was pre mini budget"

The UK cannot go bankrupt, it has 100's of billions of various tax receipts coming in each year.

The energy subsidy is a bit like all the CV business support loans, a waste of money, not only is Truss handing billions to some very wealthy households, she is also handing it to many extremely profitable businesses, with no requirement for energy conservation.

Covid didn't cost 400 billion, its approx 320 billion.

The mini budget added 67billion to these amounts, none of it should have happened, there are 7m waiting for NHS treatment, many will be economically active, getting them back to work is good for everyone & that means billions of extra NHS spending.

Again, borrowing money to fund tax cuts or rather reversing them.

[Bookclub99]

@citroenpresse

The thing that the BoE have announced...the temporary expanded collateral repo facility. Is that seen (by BoE) as a more effective policy than buying/selling gilts but the objective is the same ie support pension fund instability? And if there's just been some market improvement, is that due to a coherent BoE action (ie at least one key institution is competent) or the indications that a mega mini-budget U-turn (huge Tory incompetence) is coming?

Someone earlier up this thread said they thought Julian Smith had been stepping out of line, but isn't he one of the sanest Tories going?

I don't think the market movements you're seeing today are the result of BoE actions (or at least not prednomiantly). I believe people are bottom fishing on the expectation of a u-turn on the tax cuts... who knows if it will happen, but people are willing to risk some money on the chance it might.

[StatisticallyChallenged]

@citroenpresse

The thing that the BoE have announced...the temporary expanded collateral repo facility. Is that seen (by BoE) as a more effective policy than buying/selling gilts but the objective is the same ie support pension fund instability? And if there's just been some market improvement, is that due to a coherent BoE action (ie at least one key institution is competent) or the indications that a mega mini-budget U-turn (huge Tory incompetence) is coming?

Someone earlier up this thread said they thought Julian Smith had been stepping out of line, but isn't he one of the sanest Tories going?

The repo vs buying gilts is quite different from the perspective of the pension companies - I put a long post further up which explains this (with the pawn shop analogy)

The pension companies can't just not have gilts, they need them - they're one of the only instruments which can match their long term liabilities (paying pensions). Repos let them still have exposure and ultimate ownership of the gilts, but with the cash freed up.


I'd say the gilt purchases from the BoE are about holding up gilt prices, which should in turn reduce the margin calls and need for liquidity that the pe sion schemes currently have. The repo scheme is more about helping the pensions to actually generate liquidity to pay what they need to.

None of that is absolute as each scheme is a bit different. But if you were to think of it in terms of a household; imagine someone has just lost their well paid job and the budget no longer balances. They might be able to get a good job in future but that'll take time. So you have a big shortfall. You'd tackle that from two sides - You'd try to cut your spending, and you'd try to get some income coming in even if it's lower and between the two you'd maybe keep afloat. The Gilt buying is to cut the spending, the repo scheme is to get some income.

[Bookclub99]

@Bookclub99

This is what is happening:

A Gilt is debt issued by the UK. When the Treasury needs to borrow money, it issues a Gilt (effectively an IOU note) to investors. For example, if the Treasury issued a £100 4% coupon 5-year Gilt, it would receive £100 from an investor and give them in exchange an IOU note in which it promised to repay the investor £100 in 5 years time and in the meantime pay them £4 of interest each year. The investor doesn't have to hold the IOU note until the Treasury repays the debt at the end of 5 years. It can sell the IOU note to other investors or buy more IOU notes from yet more investors if it wants to.

For reasons I won't go into here (because it will take ages to explain) defined benefit (aka final salary) pension schemes need to invest the money they will ultimately use to fund their members' pension payments in Gilts. Lots and lots of Gilts. So many, in fact, that they borrowed money to buy those Gilts. For example, if a pension scheme had £100, it went and borrowed an extra £200 and invested £300 in Gilts. Borrowing money to invest in something magnifies gains and losses. In the example given above, if you had invested just the original £100 and your Gilt investment lost 20% of its value you would have lost £20, leaving you with £80. However, if you borrowed £200 and invested £300, then you would have lost £60, leaving you with just £40 once you had paid back the £200 you borrowed.

For yet more reasons I won't go into (because I lack the skill to explain this in layman's terms), when interest rates rise, the price of Gilts falls.

The Bank of England sets interest rates and uses them to control inflation by increasing them when inflation threatens. Because of a mix of Brexit, Covid shutdowns in China and Russia's invasion of Ukraine, there have been supply shortages of certain things (e.g., oil/gas because of the Ukraine thing). This has led to inflation because when things are in short supply their prices increase.The Bank of England has raised interest rates to combat this inflation. This led to the price of Gilts falling. A lot.

Then old Truss/Kwarteng come along and announced a load of tax cuts. Tax cuts are inflationary because people have more money to spend, further driving up the price of those things in short supply.

This meant the Bank of England had to raise interest rates even more. The price of Gilts fell further. A lot further.

Now back to those pension schemes. They are making huge losses on their Gilt holdings. Because they borrowed money to invest in those Gilts, their losses have been magnified, and the people who lent them the money are now demanding they pay it back, so the pension schemes are having to sell Gilts to repay the money, further driving down the price of Gilts... it's a vicious cycle.

To help the pension schemes, the Bank of England offered to step in and buy Gilts. By buying Gilts, the Bank of England drives their price higher, thereby stemming the pension schemes' losses and arresting that vicious cycle. However, the Bank of England really doesn't want to do this. The reason why is because the Bank of England has to print money to buy the Gilts. Money printing is inflationary... so will ultimately drive interest rates higher (to control the inflation), which will force the price of Gilts lower, so the Bank of England has to print more money to buy more Gilts to save the pension schemes... and so on. Another doom loop. That is why the Bank of England put a time limit on buying Gilts - they wanted to do just enough to buy the pension schemes some time to stablise themselves - then stop to avoid the doom loop scenario. That time limit expires this Friday.

People thought the Bank of England might extend the time limit because the pension schemes are still in a huge mess, however the governor has just said that won't happen (presumably because he wants to avoid the doom loop scenario). So now everyone is shitting themselves.

It's all horribly messy. I don't know how this will be fixed, but the only realistic options are: 1) the Bank of England capitulates and starts buying Gilts again (this isn't a good answer because of the doom loop issue), or 2) Truss/Kwarteng reverse all their stupid tax cuts and resign.

If neither of those two things happens some pension schemes may make irrecoverable losses which would mean they wouldn't have enough money to fulfil the promises they made to their members. The only way to fix this would be for the pension scheme employer to put money into the scheme (some won't have enough), for the government to put money into failing schemes (i.e., a bailout) and/or the pension schemes break their promises to their members and don't pay them as much money as they said they would when the members retire - likely a combo of the three.

It's all horribly messy. I don't know how this will be fixed, but the only realistic options are: 1) the Bank of England capitulates and starts buying Gilts again (this isn't a good answer because of the doom loop issue), or 2) Truss/Kwarteng reverse all their stupid tax cuts and resign.

At the risk of sounding smug (but I can't help it, I am), I do so love being right. So glad the BoE held its ground and that 2) is coming to pass. The BoE was unlikely to capitulate for the reasons given, so it was always more likely that the Truss/Kwarteng resignation and reversal of their tax cuts was the only way out.

The only question now is: how long has Truss got?

I give her to the middle of next week. If you're a Tory MP you're likely to lose your job at the next General Election unless Liz goes. The MPs will strong arm her into falling on her sword, I think, and then have Rishi crowned as leader with no other contenders (to avoid a leadership race). That's the best chance they have at winning a GE and keeping their jobs. Everyone loves Rishi. He rode to the rescue with the furlough scheme and gave everyone free restaurant meals during Covid!

I must say, I do wonder why it took Truss/Kwarteng so long to act. It was sort of obvious that it needed to happen and every day they strung it out did more economic damage.

[MarshaBradyo]

Well good people of the thread Kwarteng gone, yes agree Book glad BoE didn’t fold but politics did

[RedToothBrush]

Kwanteng has gone

[StatisticallyChallenged]

Thought he'd be toast. Not convinced it will save her though

[RedToothBrush]

Nicholas Watt at nicholaswatt
A group of senior Tories have been holding discussions + have decided the following: the sacking of Kwasi Kwarteng will prompt them to come out publicly next week + call on truss to resign. My source: “These are serious people. The PM will find it difficult to survive.”

My source tells me Liz Truss has made a mistake if she thinks her (outgoing) friend Kwasi Kwarteng has no base in the parliamentary party. “People like Kwasi. He is friendly. He’s honest. Maybe a bit too honest. Maybe that’s his problem.”

[RedToothBrush]

Steven Swinford AT steven_swinford is apparently suggesting Jeremy Hunt has got the gig.

[citroenpresse]

Jeremy Hunt backed Sunak...Did Javid/Zahawi and Barclay ALL turn the job down?

[Faciadipasta]

As long as its not JRM. The Times have a list of possible candidates and he's ranked as number 4 or 5

[StatisticallyChallenged]

Christ, the thought of Mogg. That man is insufferable

[Bookclub99]

Maybe the failure to fill the role will be what prompts her resignation. I find it hard to imagine someone accepting it. Would you?

[Bookclub99]

@StatisticallyChallenged

Christ, the thought of Mogg. That man is insufferable

True dat. That interview he gave where he blamed "interest rate differentials" or some such blither for the movement in yields and Sterling made me rage.

[Notonthestairs]

@RedToothBrush

Steven Swinford AT steven_swinford is apparently suggesting Jeremy Hunt has got the gig.

They do need to unite the party so a Sunak supporter would fit that brief.

Then Truss can blame everything that goes wrong on him!

[StatisticallyChallenged]

They'd have to find a Sunak supporter willing to take the role. Given that it's very uncertain the Truss herself will survive I'd be surprised if any supporters of Sunak, Mordaunt, or even Gove would be willing to climb aboard this shoddy ship.

Which makes a very loyal and right wing, JRM-esque character maybe more likely

[Notonthestairs]

Hunt confirmed by the Times.

[Notonthestairs]

Does anyone else think that puts Hunt in pole position as caretaker PM when they get rid of Truss?
Why else would he do it? Duty?

[StatisticallyChallenged]

Hunt stood himself for leader didn't he - think he later supported Sunak but he's not a full on loyalist. He's a bit of a maverick and has gone for leader a couple of times without success so he maybe has little to lose

[the80sweregreat]

How long will Hunt last though?
If LT has to go, maybe the new leader might not want him.

[MarshaBradyo]

I’m at surprised Hunt but maybe last ditch attempt to choose from other side of party

If Truss goes wonder if he’ll be there long

[StatisticallyChallenged]

The letter from Truss with Kwasi's name at the bottom is a classic oops

[AuntSalli]

The report is at the end of the press conference aren’t you even going to say sorry absolute brilliantance