Every financial crisis brings out concepts and investment instruments unknown to the public, and even to many experts, who have not heard of them until it is already too late. Things like subprime, those complex mortgage investment products with maximum solvency according to the banks that sold them. Or the CDS, insurance that shielded the previous ones and any other financial invention against any possible setback in the form of insolvency or falling prices. At the moment of truth, nothing was as sold and those cool inventions collapsed like a house of cards, revealing a bubble camouflaged by skillful conjurers.
In reality, it is always the same, mountains of unacknowledged debt, hidden, but which allow some to do business, collect commissions and raise profit margins. In 99.9% of cases, financial innovation is a euphemism that avoids clearly defining the new ways of placing debt.
In the storm that has shaken the treasury titles and the British currency in recent weeks, one of those words has already emerged that has all the numbers to be a new star of popular slang for crises. It is about the LDI (liability-driven investing) complex concept, of course, which could be translated as "investment aimed at dealing with liabilities or obligations". And that in recent years it has been one of the most demanded products of the financial boutique for pension funds.
The idea is that in addition to worrying about how to obtain income to pay the committed pensions, the funds should also insure themselves against an increase in their obligations, that is, their investors' retirement payment commitments. In the latter case, it is about factors such as the increase in life expectancy or inflation, in the event that the payments had to be updated according to the increase in prices. The scheme would look so much like a surreal still that it doesn't allow me to go into detail. The key is that the funds have been sovereignly indebted with the argument that they protected themselves in this way.
In the end, the moment of truth has arrived for the IDF, it always happens. It has been with the stampede of investors in the United Kingdom after the announcement of the fiscal plan of Liz Truss and her finance minister, Kwasi Kwarteng. But, later, once this was removed, the storm has continued and it is impossible to refill the tube with the toothpaste that has already come out. Faced with the evidence that the country faces a critical situation – on the way to recession, inflation, growing debt and interest rates climbing skyward – investors continue to flee.
And the pension funds, which manage 1.65 billion euros (one and a half times the Spanish gross domestic product, what it produces in a year) have been trapped in the race for liquidity, caught up in the scheme of the miraculous LDI . A real liquidity crisis.
And they have ended up begging the Bank of England (BOE) to extend its plan to purchase public debt and support the pound sterling.
In the great financial crisis of 2008 it was many investors' savings and home ownership that were at risk; now it is the pensions of many of the more than 30 million people who are, to a greater or lesser extent, in the wings and who have no idea what the managers of their savings are up to.
The problem of the British central bank, governed by Andrew Bailey, is that it has put its bow on inflation and its priority is to stop making debt purchases, which fuel price increases, and focus on raising interest rates, which aggravates the problems of these pension funds, which must sell assets to meet their commitments.
Some assets that are losing value after each hour that they go clockwise. If the BOE continued to buy gilts, British government bonds, interest rates would stop rising and their price would not fall, which would reduce the pressure to sell assets and offset losses with liquidity. At the moment, pressure from the sector and the City has imposed on the governor up to two extensions of his emergency program, which gives an idea of the extent to which the latter fears the consequences of an unleashed dynamic of sales, failures and defaults. Financial stability and that of the economy are always a concern of central bankers. What will be the final conclusion? Difficult to forecast.
Once again it is clear that the world, especially the most speculative banking sector and funds, is hooked on injections of free or subsidized money from central banks. When these withdraw them, even in an initial phase, the tide goes out and reveals a reality of chained debts and a domino of potential disasters. A true withdrawal syndrome.
The other evidence revealed by the serious British crisis is that investors' concern about the ability of states to meet their debts, or to simply pay interest on them, in a context of sharp rises in interest rates, continues to turn the wheel of history. Despite the magical intervention of central banks. The pressure on Italian debt (and also, although fortunately to a much lesser extent, on Spanish debt) is part of the same phenomenon. When central banks turn around and look the other way, investors are once again creditors.
