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ZorbaTHut  2yr ago (text post)   35667 thread views

Culture War Roundup for the week of September 26, 2022

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Let me get this straight: Managers want to make equity returns with bond risks. Banks come up with a miracle product that promises just that. They both profit for a few years. Then of course it all goes tits up, and the state 'has no choice' but to bail them out again. They're not illiquid, they're stupid or reckless.

You could say the banks delivered exactly what they promised. Only there was a secret ingredient, the fool who magically takes the risk away from them for free.

That's not quite right. They're saying that bond yields temporarily rose due to illiquidity in the market and were expected to fall shortly, which they did. The Bank of England didn't transfer wealth to the pension fund. They acted as the lender of last resort to tide them over.

Now, if the increase in interest rates had been more permanent, the strategy could have actually failed to the point of insolvency without an actual wealth transfer. Buy that didn't happen.

If my friend acts as a lender of last resort every time I am in danger of getting margin called, that is a valuable service, worth money, even though no money needs to be transferred from his account to mine.

Illiquidity is a red herring, a euphemism for the fact that the yield of those gilts is lower than it should be, propped up by overleverage. Bond yields are rising everywhere. Which is a problem, since they've successfully "hedged" themselves against falling interest rates by making themselves vulnerable to rising interest rates through leverage. Now they're getting margin called, and the state has bought bonds above market rate to keep the charade going, rather than liquidate their positions to let the market find the true, higher, yield.

Sure, but in exchange for this additional risk, they make it dramatically cheaper to fund pensions. I think to make a principled policy argument against this sort of arrangement, one would have to claim that the NPV of stochastic future government bailouts is less than the NPV of making the pensions much cheaper to fund.

I think I want pension funds to be stodgy, conservative, no-fun, reliable old plodding donkeys, not flashy exciting high-risk high-yield racehorses. 'Way cheaper now' has to be paid for eventually, and it can go sideways just like this did.

That doesn’t exists in the real world of being “stodgy conservative”. Transferring money from today to the future is always going to have a lot of risks.

There’s no risks free way of transferring consumption today into consumption tomorrow. It involves some part of society investing surplus today into capital investments that are fruitful tomorrow.

You could say just buy government bonds. But if everyone does that then government bond yields go down (potentially even negative) and someone needs to a credible borrower today that will pay you your capital tomorrow when your pensioners want to consume.

The US government of course does this with social security but that even runs into issues of population pyramids and whether social security will give much real spending power when their are more retirees than young caregivers/workers.

How much should society be willing to pay for that preference? I don't think your opinion is able to graduate from irritable mental gesture to serious policy preference unless you have some inkling of the relative costs involved.

You mean it’s a legit government subvention of pension funds in the form of an unofficial put, and everyone knows but don’t say. So you agree the claims of illiquidity and 'no choice' are bunk, missing the forest for the trees.

I have a few objections:

Moral hazard: encourages risk-seeking behaviour, causing greater problems than anticipated, currency crisis etc. The best thing for them would be to flip for the money repeatedly, get the most out of that put.

Leakage: the most reckless banks and managers take a larger cut of the profits in good years, sucking up the subvention.

Lack of transparency/uncertainty: Taxpayers are unaware the subvention was in place until the crash. Since it’s an unofficial guarantee, Market participants can never be sure of the bailout, leading to uncertainty and malinvestment .

Unfairness: The simple and honest worker-investor who decided to accept the risk of equities for his pension, did everything right, saw through the lies of bankers, doesn't cause systemic risk, has a cheap pension fund. As a reward, he is outcompeted by this chimera of governement subventions and banks.

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