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?

What I don't understand is the logic behind DB pensions. How can they guarantee a level of return in 20-30 years time? that's impossible to achieve. If if was that easy, why don't we all have a DB pension

Typically, they will buy 'linkers' or inflation linked gilts. So instead of buying gilts that pay a flat interest rate of say, 2%, they buy gilts that pay an inflation linked return. Essentially, the BoE have to get tough with the pension funds now, they were told they had a two week window to sort themselves out, the BOE have been in the market, daily, offering to buy up to £5bn. Yesterday they offered to buy £5bn 'normal' gilts and £5bn linkers, but the pension funds aren't taking up the offer. There have been some day in the last 10 days when the BoE have bought none - not because they don't want to, but the pension funds aren't selling. This is why Bailey needs to reiterate to them, it's a limited offer.

Just responding to a previous PP to say pension fund managers are not 'spivs'!
They use conservative investment strategies which is why they are invested heavily in gilts which until LT and KK came along were considered VERY low risk. US govt bonds btw were considered 'risk free' in the past. I'm not sure they are now though.
They have no option other than to leverage their investments because a lot of people take out more than they pay into their pot. That money has to come from somewhere.
Agree that pensions are basically a massive pyramid scheme 😳

Part of the issue is that the pension scheme might not actually have the gilts in hand to sell, I'd guess. They have exposure to gilt prices and interest rates via other instruments but don't necessarily have the assets to sell

I should add, in my personal experience, defined contribution ("stakeholder"/"personal") pensions let you choose what your pot is invested in.
Typically the default fund is a "lifestyle" one which moves to more gilts and bonds (as a pot %) than shares as you get closer to retirement.

That's kind of a throwback to when you had to buy an annuity with the pot when you retired. You don't now, you can pretty much just keep it all invested and sell bits when you want money to live on.

More or less you can choose what your DC pension pot is invested in, the same way you choose what your stocks and shares ISA is invested in.

A book that was recommended to me is Tim Hayle's "Smarter Investing", which goes through the different classes of asset, how they are related, how much they go up and down in price, how much they grow or produce money, and therefore how you might divide your own pot between them depending on your attitude to risk.

Thanks for this. Your finance posts are useful. What do you think will happen?

Just generally - financially / politically etc (no pressure just out of interest)

This is a great book for anyone wanting to grasp the basics. I recommend the paper version not Kindle (even if it's a secondhand copy) as the colour graphics are very helpful.

"How Money Works: The Facts Visually Explained (How Things Work) eBook : DK: Amazon.co.uk: Books" www.amazon.co.uk/How-Money-Works-Visually-Explained-ebook/dp/B0799FTV8G/ref=mp_s_a_1_1?crid=1VCTUX7LAVGN0&keywords=how+money+works+dk&qid=1665566019&qu=eyJxc2MiOiIxLjU1IiwicXNhIjoiMS4xOCIsInFzcCI6IjEuMjUifQ%3D%3D&sprefix=how+money+%2Caps%2C117&sr=8-1

The problem is when you try to lay it all on Truss it makes no sense.

The reason the pension funds are in this position is because they didn't just buy gilts. They bought them, then went through some financial wizardry in order to work them harder. I don't don't know for sure why they did this, but I suspect it has something to do with a) pension fund managers making bigger bonuses and b) funds trying to offer better value for their customers. How much of each I have no clue.

If you want to blame the government, sure there is some culpability. One is how they regulate the pension funds. However, it's hard to lay this blame on Truss since she's only been in power a few weeks. the other is how Truss spooked the markets by basically going for tax cuts without properly explaining and budgeting. This you can surely blame Truss for.

But the situation is a lot more nuanced than "everything is all Truss's fault". This is the problem with doing politically biased analysis. It doesn't get to the root of the problem so that blame can be laid at the door of the chosen one.

An interesting question to ask is, if the UK has debts of £2.5 trillion, why did announcing Truss's budget which borrows a mere £45 billion spook the markets so ?

Once you answer this question, you begin to realise that Truss's budget was merely a trigger for the markets to act on what has been the UK building itself into a long term unsustainable position regarding debt.

It also tells you something about the past and the future.

For example the following questions :

If the markets view our current debt position as bad, how would they view it now without "Tory austerity" during the 2010's ?

If the markets view the government debt rising by £45 billion a year as bad, how is any government going to raise future increases in spending through borrowing (irrespective of whether that spending is spent on tax cuts for the rich or benefits for the poor) and what consequences does that have for the manifestos of future governments ?

Not RTFT but this is a fantastic explanation, Thanks so much @Bookclub99 !

I gave a DB pension and a Career Average (currently paying into) pension with TPS (both very small).

I'm 59 and I was about to pay some (quite a bit) of money into an AVC (Prudential) to boost my retirement income. Would this now be unwise?

It’s a very good video but references the holocaust I assume as it’s a couple of years ago since I watched it but it opens your eyes to who controls money and inflation etc and who’s making the money

A previous poster mentioned that the IMF have said that our government have to sort this out or it could go global - what are the chances of the IMF or other external group/ power intervening in this to stop the havoc spreading to other economies?

I think it's less about the actual monetary value of the debt and more about what their decisions signal. Borrowing isn't inherently bad, but borrowing to fund tax cuts in an economy already heading for recession with spiralling inflation contradicts most economic rationale and has spooked the markets.

Many thanks. I shall take a look.

Sorry if I missed it, but is there an answer to this? Thanks

Thankyou to the great explanations on here. My brain is still aching though as I only understand some of it.

Genuine question which may help further. Can someone explain simply in football terms please?

@Pearmain sorry that comment was meant for you

It’s a very good video but references the holocaust I assume as it’s a couple of years ago since I watched it but it opens your eyes to who controls money and inflation etc and who’s making the money

There is a pension protection fund which provides a backstop in the even of scheme failure, but it doesn't generally give the full value and it may not be big enough if lots fail in which case it depends what the govt do

"If something happened to pension provider overseeing your money, you would generally be able to claim compensation from the FSCS.

The FSCS aims to make sure you get back 100% of any loss"

www.moneyhelper.org.uk/en/pensions-and-retirement/pensions-basics/how-safe-is-your-pension

Actually I am not sure whether that is for DC pensions rather than DB, sorry.

If you are offered an affordable fix which means you can stay in your home for the next 5 years, but if interest rates went up more you may not be able to stay, you need to take a view on whether you prefer

• the certainty that you are OK, but may be paying more than you had to, or
• want to take the risk that if rates jump up you will be in trouble, but if they stabilise you will be better off

Both decisions are valid and you should choose based on your appetite for risk and what the consequences would be for you personally if you chose the risky option.

DB is different, falls under the PPF

Statistcally thank you

so private pensions might be affected pretty badly. I'd imagine some people will pass on waiting for compensation.

I have never prioritised my pension because I felt immediate access savings were more important but I suppose the government will screw those up too.

my uncle was with Equitable life and didn't get anything back but I think he was confused and possibly didn't fill in the forms.

Now is actually the best time to invest in your pension I’ve actually suggested doubling down on your contributions you’re buying cheap

@MarshaBradyo my personal view, is that the BoE will have to extend the support - I can't see they have much choice, although this will dent their (already questionable), credibility Markets thrive on stability, and my personal view is that the Truss/Kwarteng policies in themselves, (with the exception of the 45% tax cut) did have some logic behind it. The issue (and what the markets detest) is the lack of communication.

The plan was presented a bit like a toddler's Christmas present 'wish' list, rather than a properly costed, grown up, plan. Markets go wild with speculation, in the absence of proper communication, and this is fundamentally where it's gone wrong - the markets are guessing what might/might not happen on 31st Oct.

Even today, the mixed signals flying around are incredibly unhelpful - two separate articles published on Reuters below.

1. Oct 12 (Reuters) - The Bank of England has signalled privately to lenders that it was prepared to extend its emergency bond-buying programme beyond Friday's deadline if market conditions demanded it, the Financial Times said, citing three sources.

Wednesday's report comes a day after the British central bank's governor, Andrew Bailey, said he had no intention of extending purchases of bonds beyond the deadline.

Sterling bounced 0.4% to $1.1008 after the report and was last up 0.28%.FRX/

"The risk is the pound quickly reverses the move if BoE officials deny the report," Commonwealth Bank of Australia said in a note.

"Either way, the pound is likely to remain volatile and is at risk of sudden drops because of uncertainty about government debt sustainability and the dislocation in UK pension (superannuation) funds that has spilled over into UK government bond market."

The central bank has made numerous attempts over the past two weeks to try and restore order in markets, after the surge in yields last month threatened to overwhelm pension schemes that had loaded up on leveraged derivatives.

Pension funds meanwhile have been trying to raise cash by selling off UK government, index-linked and corporate bonds.

The heavy selloff in gilts has pushed 10-year yields GB10YT=RR up by 100 basis points since Finance Minister Kwasi Kwarteng unveiled his economic plan and controversial tax proposals.

"They (representatives from the central bank) told us that they were watching the LDI managers closely to see whether they had managed to generate enough liquidity for their clients to cope with margin calls and would decide whether to extend the facility on Thursday or Friday,” the FT quoted one banker as saying.

The BoE on Tuesday expanded its programme of daily bond purchases to include inflation-linked debt, citing a "material risk" to British financial stability and "the prospect of self-reinforcing 'fire sale' dynamics".

By buying bonds, the BoE is seeking to reverse what it sees as "dysfunction" in the bond market. Specifically, the central bank is seeking to address problems facing pension funds. They were forced to stump up vast amounts of emergency collateral in liability-driven investments (LDI), which use derivatives to hedge against shortfalls in pension pots, after gilts dropped sharply in value.

2. LONDON, Oct 12 (Reuters) - The Bank of England re-iterated on Wednesday that its programme of temporary gilt purchases will end on Oct. 14

"As the Bank has made clear from the outset, its temporary and targeted purchases of gilts will end on 14 October," a spokesperson said in an emailed statement.

"The governor confirmed this position yesterday, and it has been made absolutely clear in contact with the banks at senior levels. Beyond 14 October, a number of facilities, including the new TECRF, are in place to ease liquidity pressures on LDIs."