In today’s issue:
- Liz Truss, UK pension funds, Silvergate Bank and…you?
- On the cusp of mark to market mayhem
- Why interest rates are really coming down
A few years ago, I tried to play Wink Murder with all my Japanese in-laws. It didn’t go according to plan. I kept explaining the rules over and over again. And restarting the game again and again. But, try as I might, nobody would die.
After blaming my wife’s inability to translate properly, and getting ever more exasperated at the lack of any deaths, I discovered something shocking. I’ve married into a family incapable of winking. One of my children has inherited the faulty gene.
The mystery of the missing murderer quite ruined the game that day. Not to mention my mood. I’m still annoyed nobody told me about the flaw at the start of the game. Let alone before I married into a winkless clan. It’s typical Japanese to avoid the awkward until it’s too late.
Which brings us to the bond market. After several murders in 2022 and 2023, this year has been suspiciously quiet. Today, I ask why. And the answer may, once again, lie in the impossible mysteries of Japanese behaviour…
The first victim
It’s been almost two years since Liz Truss was blamed for blowing up the bond market. You can discover what actually happened here.
Since then, interest rates are up, bond prices haven’t recovered, the September bond panic is just a blip on a chart, and the new government is echoing all the “growth” rhetoric they lambasted two years ago.
Even Liz Truss’ reputation has undergone a restoration. More and more of the media are blaming the Bank of England for the September 2022 bond crash.
But they haven’t considered the implications of this accusation yet. If the Bank of England can unseat a government, what else might it be up to? Find out, here.
But there’s a lingering issue that still remains. Given that bond prices haven’t recovered, what happened to all those whopping losses pension funds faced back in 2022?
The gunpowder that blew up the Truss government is still there
The panic in 2022 was about whether pension funds would have to sell their bonds at dangerously large losses.
For a pension fund to be sitting on a loss is one thing. Realising it by actually selling the bond is quite another.
That’s what got several US banks into trouble in 2023. They were the second victims of Wink Murder in the bond market.
The banks’ depositors, US tech firms, wanted their money out. So the banks had to sell their bonds to meet the redemptions. But those bonds had since crashed in value. Selling them meant realising the loss. And those losses were simply too big.
Thus, a moderate amount of deposit flight triggered major bank failures. But only once the banks actually had to sell the bonds. And not all banks and pension funds did have to sell in 2022 and 2023.
The losses are still there according to calculations from the US’ FDIC, which insures bank deposits. Bond prices haven’t recovered much. The unrealised losses at deposit-insured institutions on government securities have fallen a little to around $500 billion from a high of $675 billion a year ago.
Either way, it’s big enough to cause a major banking crisis. And it’s almost certain to be the same story outside the US too.
So, who is sitting on those whopping losses, just waiting to be crystalised? Who else would fail in a liquidity crisis that requires they sell their bonds at a whopping loss?
When everyone’s got the Old Maid, it’s best to keep playing indefinitely
It’s not just me who has been wondering about the missing losses. Last week I had a back and forth with a reader about all this…
Nick,
I do like your work, and your analysis on trends etc is top notch. Your analysis always seems to be spot on, in terms of direction, but the timing is always so difficult, as I can imagine, because there are so many moving parts and big player with vested interests.
I am growing increasingly concerned regarding the DEBT, and the fact that so much is being held by pension funds/banks, which is probably not marked to market, and is therefore worth a lot less.
If we hit even a small bump in the road, there is little room to manoeuvre, as assets can only be sold at a true price, which ultimately will result in increasing liquidations, compounding the problem.
I have heard that the UK financial institutions have been buying Ukraine debt, which is seriously illiquid and if things get worse may crash completely.
I also hear that the government (us tax payers), are due the BOE up to 150 billion between now and 2030 to cover their losses on COVID debt.
What is your view on these matters and what risk are we running of another UK Bond crash.
Thanks R.
“Mark to market” refers to having to recognise the market price of an asset on your books. If you need to do this, you need to let everyone know you’re sitting on a whopping loss on your bond position. If not, you can pretend the bond is still worth a lot.
It’s like the difference between how an accountant and a fund manager sees the world. Do the market prices or the book prices matter more?
Here’s my response:
R., thanks for this Q.
Could I publish it, along with a response in Fortune & Freedom?
You’re right to be worried. I’m flummoxed it hasn’t been a bigger issue. Especially with those US banks failing in 2023. Why did the problem end there?
But it only becomes an issue if the institutions have to sell. As long as that can be prevented…
If interest rates fall in coming months, bond prices will recover and “fix” the problem.
What I don’t understand is how the unrealised capital losses aren’t destroying the performance of pension funds. They invested at very low returns, the bonds lost value and yet their internal accounting looks healthier…
Nick
R. followed up:
Yes, you may publish the question and I look forward to your reply.
I realise, if you do not have to sell you can hold till maturity. BUT that in itself must cause financial strain as you are holding a NON performing asset, which with inflation is losing purchasing power. Your other assets must be made to sweat harder (RISK) to make up the difference.
Who the hell thought it was a good idea to buy a 100 year Austrian Bond at an interest rate close to ZERO!!!!!
So are pension funds themselves starting to act like PONZI schemes? Getting new cash in to keep paying existing pensions, storing up problems for the future that cannot be fixed.
BONDS are a total write-off as the central banks will use financial repression. So, unless you are a top notch bond trader, you will be left holding the OLD MAID CARD.
We have a bigger problem because the TAXPAYER cannot pay the PUBLIC SECTOR PENSION LIABILITIES as we add more and more highly paid non-entity jobs in local/central government.
If an economy is based 61% on consumption, with the state accounting for a huge proportion of GDP, you tell me the likely outcome. I think we are getting closer to the Emperor’s clothes moment.
Thanks
R.
The general point here is that there remain whopping losses on balance sheets around the financial system. Bonds bought at interest rates near zero must have crashed in price, because their coupon payments are tiny.
A liquidity crisis that forces banks and pension funds to sell those bonds really could crystalise financial crisis-sized losses. Just like selling sub-prime CDOs in 2008 did.
It’s an accident waiting to happen
The hope is that bond prices recover as interest rates are cut in coming months. This should make the losses smaller. As your Global Intelligence Network member Daniel Lacalle put it on his exceptional X feed, “Now you know why there will be rate cuts despite persistent inflation.”
Re-investing money at higher interest rates should help paper over the losses in the meantime. But I still see crashed bond prices as an enormous drag on our pension funds and banks’ performance.
What has Japan got to do with any of this?
It’s the country that has demonstrated how to keep the status quo going, however calamitous it may look.
Nobody needs to die if nobody can wink. If everyone has the Old Maid in their hand and nobody passes them on, the game can continue forever. You just need to ensure there is no small crisis that triggers the need to sell bonds in a panic.
This is why the crashing yen caused such a sudden market panic earlier this year. And why the Japanese stock market remains so volatile. Everyone is sitting on gunpowder and the Old Maid is still the Old Maid.
The price we pay for this faux stability is economic stagnation. If bad investments aren’t liquidated, new ones are unlikely to be made. That’s why Japan’s economy is so stuck.
Unfortunately, whatever the central banks and governments might do, crises come along eventually. Just ask Liz Truss, Silvergate Bank, Silicon Valley Bank and UK pension funds.
Until next time,
Nick Hubble
Editor, Fortune & Freedom
