When the banking crash of 2008 almost brought the world to its knees, the accepted wisdom was that we’d been sleepwalking into disaster. All the signs were there but we either did not see them or chose to ignore them.
The same applies to pensions and 2022. For far too long we’ve been drifting along, enjoying economic stability and low interest rates. Then, along came Liz Truss and Kwasi Kwarteng and they unleashed a maelstrom.
Suddenly, things we took for granted were no more. Key to this was UK government debt or Treasury gilts. It was always regarded as the safest of the safe — indeed, schoolchildren were taught as much. Those studying economics were instructed that markets could go up and down but UK bonds, or gilts, would truck along nicely.
It was ingrained into us, embedded in our national DNA, that so dependable and strong was the British economy, so well-managed were our financial institutions, notably the Bank of England, that other, envious, nations looked on in admiration.
That attitude applied to pensions, too, so pension managers were encouraged to hold large amounts of low-risk gilts. Then, as I say, along came Liz and Kwasi, and in an instant, everything was turned upside down.
Investors took one look at what the new Prime Minister and Chancellor were proposing and stampeded for the exit. Ms Truss and Mr Kwarteng wanted to make unfunded tax cuts, in the middle of increasing global inflation and rising interest rates, with a war on and an ensuing energy crisis. So cavalier were they, that the dynamic duo wished to dispense with the services of the Office for Budget Responsibility, or OBR — they did not intend to open the books to others and have their work marked. There would be no objective analysis of the merits or otherwise of what they were planning.
Immediately, yields on gilts rose and their prices fell. Final salary pension funds that used gilts-based derivatives or Liability Driven Investments — LDIs — to top up their holdings, to help them achieve their investment goals, faced ruin. As gilts spiked, so the investment banks issued margin calls to the pension funds that were sitting on an incredible £1 trillion ($1.11tn) in LDIs.
Unless the LDI funds could meet the payments, which they couldn’t, the banks, which held gilts as collateral against lending to the LDI funds, would have no choice than to sell the gilts. This, into an open market, where there was little enthusiasm and the prices of gilts were falling. The massive £50bn offloading would only push gilts prices down further. It would become a death spiral.
Enter the Bank of England with a £65 billion emergency scheme to buy gilts. The measure produced the desired calm, but only to an extent — the shoring up could only be temporary and it ends on Friday.
Concerned that the Friday “cliff-edge” could prompt more chaos, the Bank has this week taken additional steps. The daily limit it imposed on the amount of bonds it could buy is raised, from £5bn to £10bn, and pension funds are also allowed to pledge UK company bonds as collateral.
All of this is sticking plaster, trying to control the bleeding. The underlying condition remains, nothing has improved — arguably, with the heightened conflict in Ukraine, it’s got worse.
After Friday, October 14, all eyes turn to Monday, October 31, which happens to be Halloween, when Mr Kwarteng reveals how he intends to fund his policies and the OBR gives its verdict. Humiliatingly, he had wanted to make it November 23 but has caved into pressure from his own MPs and will now make his announcement earlier.
The Chancellor has got to find more than £40bn — more, if the government pushes ahead with its declared aim of reducing national debt as a percentage of GDP over the next three years. Then he is looking at between £60bn and £70bn.
Mr Kwarteng has three options: make further U-turns and scrap more of his proposals; slash public spending; or increase government borrowing.
The first two will lead to political rows galore, while the third will undermine remaining financial markets' confidence in him and Britain.
He could push, as Charlie Bean, an ex-member of the OBR and former Bank of England deputy governor, has suggested, the lowering of national debt as a share of GDP from three to five years. This may be his least bad choice, buying himself more leeway as he insists that his tax cuts designed to spur economic growth will by then have come good.
The question is whether the OBR agrees and if the markets are also accepting. If not, the original “cliff-face” of Friday could appear like a slight incline and it will truly be a Halloween for Britain to remember.
In any event, what has occurred is a destabilisation, the like of which Britain has rarely encountered. The time-old notions of a reputation for safety and behaving responsibly have vanished. In the same way that banks were forced to accede to reforms, so too must pensions undergo a shake-up.
Gilts are not the secure haven we thought; pensions holding £1tn (who knew?) in LDIs as a means of being able to meet their final salary obligations must be examined, raising questions about the viability of final salary schemes; and, as with 2008, the watchdogs that were meant to be on top of the industry, flagging dangers, have been found wanting.
The irony is that the Truss administration is promoting “Big Bang 2.0”, a freeing of City red tape and regulation. After the lurching roller-coaster ride they’ve taken us on, where pensions are concerned, more not fewer restrictions are likely.