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

@TheFrendo just like the bail out in 2007 then

@TheFrendo just like the bail out in 2007 then

It's all bollocks. The upshot is the very wealthy (top 0.5% not 5%) will take more of our money. Our lives get gradually more shit while they have more money than they know what to do with.

How is this going to affect those of us still paying into DC workplace pensions? Should we request to switch our funds so that they don't keep pumping such a large proportion of each contribution into the rapidly failing gilts?

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.

Thanks to everyone for the incredible explanations on here.

One burning question is why did Truss/Kwarteng do this? Were they poorly advised? Did they not foresee that this might happen? Did they think it was a necessary "pain" we need to forge through to get to a better place?

Are they just very grandiose and out of touch with reality, psychologically? DId they think it would just all be alright?

Both are highly intelligent and educated people so just saying "they're tory bastards" doesn't really work as an explanation ...

@MarshaBradyo If it is we ran out of money / debt capacity a while ago

The growing government debt is our government's gift to our children. A gift that was not wanted or agreed to.

There may be trouble ahead...

Miceonabranch

Depends if you mean DB. Yes, some poorly managed smaller schemes could fail, there are protection systems in place though.

I am trying to understand but not quite getting how it might impact us on the ground.

We have a private pension we paid into but stopped contributions when things were tight. Is this a DC pension? What do I need to look for on our statements e.g if there are gilts mentioned, our pot could be in trouble? We are close-is

@MarshaBradyo If it is we ran out of money / debt capacity a while ago

The growing government debt is our government's gift to our children. A gift that was not wanted or agreed to.

There may be trouble ahead...

I haven't worked in UK finance for almost 30 years so forgive a dumb question - are DB pensions still available? I thought most employers had phased them out as being too expensive?

Pension funds have borrowed money and used Government bonds (aka gilts, basically chunks of debt) as security.
But, the bonds date from when interest rates were low. Interest rates and inflation are higher now, so buyers will pay less, now, for a bond that only pays (say) 1% interest.

The companies that lent the pension funds money have a bit in their agreement that says, "if the bonds you're using for security drop in value below such and such a price, you have to pay us money to make up for the fact that the 'security' is worth a lot less". Maybe the loan even gets called in in its entirety.

So where are the pension funds going to get that extra money from?

By selling some of the bonds they own...and so the prices of those bonds drop a bit more (the bond buyers know they NEED to sell, so will pay as little as they can).
So the remaining bonds they own drop a bit more in value and ooooohhhh look a nasty downward spiral right!there!

Bank of England goes, "whoa Nellie let's not see the Teachers' Pension Fund" (or whatevs) go bust" and starts buying bonds, which means the prices of those bonds go up, which puts a brake on that downward spiral.