AIBU?
Can someone explain in laymans terms what is happening with the BOE/pension funds on Friday?
Silverin · 11/10/2022 21:38
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?
Jewel1968 · 12/10/2022 06:32
Thanks to all of you explaining this so well and simply. Professor Feynman would be pleased.
My question is - do you think it's a problem that so many of us don't really understand how all of this works? Do you think if we all had a better understanding of how capitalism and all the little mechanisms within worked it would influence anything?
lannistunut · 12/10/2022 06:32
emanresuymevas · 12/10/2022 06:25
Thanks for that explanation RedToothBrush.
It seems we're waiting for politicians to do the right thing.
Not sure I've ever felt so concerned about the future of the country.
I agree with this sentiment. We desperately need a general election now because Labour are mainstream, the Tories' are experimenting and we just need stability.
Andypandy799 · 12/10/2022 06:35
@Jewel1968 they make them so confusing that even NASA’s scientists couldn’t work out the subprime mortgage crisis when the banks were bailed out and bonuses capped in 1007 funny how only 15 years later another mortgage crisis for a different reason. Same old shit
YellowAndGreenToBeSeen · 12/10/2022 06:40
Bookclub99 · 11/10/2022 23:30
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.
This is brilliant, thank you.
I’d pretty much figured that money in pension schemes had been invested in ‘something’ (now know it’s gilts) and the value of those had dropped because The Market didn’t believe the recently announced ‘fiscal policy’ bollocks had legs, so started trying to offload all their gilts but because everyone was doing the same, noone wanted to buy (or rather, there were limited buyers as everyone was selling the same product). This saw the value crash., resulting in less money in the pension pots (so less money being paid out to pensioners). The BoE stepped in to buy all the gilts - stopping the crash (temporarily).
Your explanation really crystallised my understanding. Thank you.
daisychain01 · 12/10/2022 06:41
1jan2020 · 11/10/2022 23:04
Or should I wait longer to see if the market calms down?
My fwiw on this....
The only way you can play this re: fixing your mortgage, is to do a market survey, understand the %rate and what that means to you in terms of monthly affordability, and make your decision accordingly.
Yes, there is a risk that the rates come down but the reality to you needs to be solely about whether you can reasonably meet your monthly repayments. Fixing your rate is all about having certainty (and hence peace of mind) over a set number of years. If the rates go up, before they come down, you will have to try and afford the higher rate for however long that goes on for, and you may decide that peace of mind is more important (I certainly do).
The upside of fixed is greater certainty, the downside is that you lose flexibility eg making overpayments to bring down your borrowing (capital) which then reduces your interest on the lower capital. In the current volatile market, if your mortgage is high, certainty on monthly repayment is important.
FairyPrincess123 · 12/10/2022 06:43
Catonamountain · 11/10/2022 22:57
Nor do I, I keep reading and reading it but it's just like blah blah blah, I wish I understood
Idratherbepaddleboarding · 11/10/2022 22:54
I still don’t understand even with the lay mans explanations 🙈.
It's not a perfect analogy, but we all understand premium bonds which are a type of bond (obviously...). When you or I buy a premium bond we 'lend' the govenment a pound with the promise that we will get that pound back and we have the chance of winning a prize. With a 'normal' bond instead of a prize the government pays interest.
Pension funds like(d) them because, even though the interest rate is typically lower than you might get from investing elsewhere, up until now they have been regarded as safe, i.e. it's the government - they won't go bust and you'll get you money back.
Maybe where the 'premium bond' analogy fails is that there is a bond market, i.e. investment funds will buy and sell these bonds to each other.
A big part of the problem now is that, with inflation going up as it is, the interest that the bonds are paying is no longer large enough for the pension funds to be able to meet their obligations and no-one is interested in buying them, so like anything else that no-one want the value falls to its minimum and the value of the penison fund falls. Which is why the BoE stepped in and bought them.
User98866 · 12/10/2022 07:13
The bit I don’t understand is what’s going to happen in ‘real life’. Will people stop getting their pensions? How could they allow this to happen and what does that mean? That lots of people who planned to live of xxx for retirement will actually just have a state pension? They will presumably have to sell their homes & get used to a VERY different lifestyle to the one they planned. I just can’t see the Tory government doing this. UC applicants are fair game but to screw over their only voters?
travellingfamily · 12/10/2022 07:14
Some brilliant explanations on this thread, thank you.
I also think that in general, headlines like ‘BoE steps in to save pension funds’ aren’t terribly well understood because people understand ‘pension’ to mean their pension, when actually depending on what pension you have, they are affected in different ways.
If you have a government funded pension scheme (eg civil service) then these are backed by the government, and there isn’t a pot of money being invested to guarantee that pension. So that pension is not affected by the gilt market immediately, they are affected by how much money the government has and whether it may want to change the rules in the future, but what you have built up should be fairly secure, and is generally defined benefit.
If you have a defined benefit scheme set up by a company, these are affected. As explained very well by people up thread.
if you have a defined contribution scheme, the value of these is directly related to what you and your employer have contributed, and how that is invested. So the value is affected by the general market turmoil, but the ‘going bust’ issue is different, because your pension is directly related to the value of your pot, and if you are some way from retirement it is unlikely to be an immediate problem.
I am worried that the general impression people get is ‘pensions are risky’ when on the whole they should be an important part of everyone’s retirement planning.
I am less clear on how non-government schemes for employees who are effectively employed by the state are affected - teachers, firefighters, nhs, police etc. it is my understanding that there are actual funds backing those pensions, but that effectively the government provides the money to go into them. So I don’t know exactly how they are affected as I presume the government won’t let them go bust.
Jewel1968 · 12/10/2022 07:19
The person saying that people worrying about nuclear war are looking the wrong way. I can't help wondering at all the things we are encouraged to think about just so we don't think about this stuff. Anything that gets us fighting amongst ourselves is good for those that benefit from these capitalist games.
cakeorwine · 12/10/2022 07:28
Government borrowing, pension funds, etc - are all very complicated arrangements. I wonder how this was all set up in the first place many many years ago?
I did like the Big Short - and you could see how complicated the different things were with various derivatives etc
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