Morning:
8°c
It has been an article of faith in the pensions industry that it needs to buy more long-term Government bonds so that it can time these assets to mature just when the funds will need money to pay the pensions of its members - perhaps 20 or 30 years hence.
However, it has also been a continuing gripe in the industry that the Government's reluctance to issue long-term bonds, in the face of the industry's desperate need for them, has created an artificial shortage. As happens when there is a shortage, this has pushed up the price, which means the effective rate of interest on the bonds is reduced.
Pension deficits are calculated by using long-term interest rates to discount the cost of these future liabilities. The lower the interest rate used, the more money you need to invest now to deliver a given sum in 20 years' time, and that is why lower interest rates translate into higher estimates for pension-fund deficits.
Despite the vast sums the Government will need to borrow because of the collapse in its revenues and the unanticipated costs of the banking bailouts, it has generally been assumed the pension funds will absorb all the debt the Government cares to throw at them provided it is suitably long-term, and obviously priced appropriately.
This is doubly the case now the Bank of England has begun buying Government bonds as part of its policy of quantitative easing - an action that can only add to the shortage. Yet, contrary to what one would expect, comes news that the Government's debt management office (DMO) is in trouble. Last week's Government debt auction showed the weakest demand for 10 years.
Separately, at the weekend the Item Club, the forecasting group that uses the Treasury's model for the economy, forecast a significantly higher Government deficit and borrowing requirement than anything the Government has yet admitted. Figures of £180 billion were being bandied about.
The DMO said last Wednesday that it was expecting to have to issue £147.9 billion in bonds in the financial year beginning on 5 April. This is a mixture of additional and replacement debt, so does not compare directly with the Item Club number, but it is nevertheless three times higher than the sum raised in 2007-8.
There is obviously no need to be alarmed at this stage about the Government's ability to finance its debt. But, that said, the DMO's performance in judging the market does not inspire confidence. There is supposed to be huge demand out there, and yet auctions are failing. Given how much more debt there is still to come, it needs to be a bit more sure-footed than it currently seems to be in its understanding of what the market wants and in its willingness to tailor its issuance to meet that need. Otherwise, it is going to be a difficult year.
A message from banking old guard
One of the more exciting of the pre-Christmas parties a few months ago was a day organised by Lombard Street Research at which politicians and bankers of yesteryear — including some, like Paul Volcker and Jacques de la Rosière, who refuse to be pensioned off — talked about crises of the past and the lessons that might be learned from them.
Today, the Centre for the Study of Financial Innovation (CSFI) takes this idea a step further with the publication of a collection of essays under the title Grumpy Old Bankers: Wisdom from Crises Past. Henry Kaufman, Sir Jeremy Morse, Andrew Crockett, Brian Quinn, Eugene Rotberg, Toyoo Gyohten, John Reed, Stanislas Yassukovich and many more have in their reminiscences shown what has happened in the past and used this experience to draw lessons on how to address the current challenges to the system. Most of the authors were highly influential not very long ago. They too lived through their shares of crises. They have something to say.
The fact that many of these names may mean little in the current City is exactly to the point. As CSFI director Andrew Hilton writes in his foreword, a generation in the City is often as little as a decade.
The result is that there is almost no one around who remembers what happened last time, and why this time it is unlikely to be different.
More to the point, even those in authority are unlikely to have seen such turbulent market conditions, or remember how the problems were resolved last time. Instead we have to reinvent the wheel before we can begin to go anywhere. Hence, he says, this is probably the most important CSFI publication in 16 years.
He may well be right.
