The Bank, bonds and risks for the UK

 

                 I agree with the Bank’s warning that if government bond prices fall there will be problems for some EU banks. The curious thing is why have the Bank and other EU financial regulators supported the idea that government bonds are very low risk? Why did they make them core assets for banks, if now they are so worried about them?

                  This generation of bank regulators, Central banks and pension fund advisers have kept telling us government bonds are low risk and should therefore be the pillars of our banks and pension funds. Now they tell us some governments may not pay all the interest or repay all the capital. Meanwhile, setting very low official interest rates and buying up government bonds themselves, central banks have created a bubble in government bonds that could be damaging and painful if deflated.

                    The Bank’s comments may prove all too accurate, but not helpful. The central banks and governments  which have inflated the bond bubble and told us to rely on them have a duty now to get us out of the mess they have created.

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12 Comments

  1. Tim Carpenter, LPUK
    Posted December 17, 2010 at 7:19 am | Permalink

    I am wondering how it can be anything other than the Governments/Central Banks deciding how we (the taxpayers) are to get them out of trouble using our money.

    Governments do not have a penny that was not nor will not be taken from us by force. Dilution, easing or other mechanisms are just the same via the back door ( harming savers and rewarding debtors).

    It does rather seem the bubble was formed due to denial caused by a determination that the Euro must succeed at any cost. If it was not that, then incompetence is my second choice.

  2. lifelogic
    Posted December 17, 2010 at 7:53 am | Permalink

    “The central banks and governments which have inflated the bond bubble and told us to rely on them have a duty now to get us out of the mess they have created.” indeed but I do not imagine they will.

    They have after all still not been able to get any sensible bank lending to small businesses going yet.

  3. Brian Tomkinson
    Posted December 17, 2010 at 8:36 am | Permalink

    This situation conjures up the picture of someone finding a bulging bubble in a sealed rubber tube. Fearing the bubble will burst, they grasp the bubble and squeeze. Whilst congratulating themselves on how clever they have been they suddenly realise (surprise, surprise) that the bubble has now reappeared further along the tube. How much longer will this process continue before a proper analysis of the problem and the necessary solutions are performed by governments and the banks?

  4. Gary
    Posted December 17, 2010 at 9:53 am | Permalink

    Our Dear Bankers, facilitated by our Dear Politicians , have taken the world to the brink of the greatest collapse, not since the Great Depression, but since that of 1345 :

  5. Iain Gill
    Posted December 17, 2010 at 12:04 pm | Permalink

    and if house prices crash there maybe problems for some banks

  6. Denis Cooper
    Posted December 17, 2010 at 3:02 pm | Permalink

    The level of risk with bonds (government or corporate) partly depends on whether the investor intends to hold them to maturity and is sure that he’ll be able to do so.

    If you buy gilts in the market then you can precisely calculate the return you will get if you hold them to redemption, assuming the UK government doesn’t default on its promise – which is still extremely unlikely.

    But if you buy gilts in the market and then have to sell them in the market before redemption there’s always a risk that market prices will fall during the period that you hold them. Of course there’s also the possibility that market prices will rise, but that looks less likely at present.

    With corporate bonds there’s the additional risk that the company may default, as it can’t use the courts to extract money from taxpayers to guarantee repayment.

    And then there are government bonds and government bonds; one of the massive errors which has been made was to assume that eg the Greek government was no more likely to default on its bonds than eg the German government.

    The best thing is to be a large and powerful private international investor, and then you can bully governments into guaranteeing not only their own bonds which you hold, but also the bonds issued by private banks which you also hold and on which you’re reluctant to take any losses, and the taxpayers can then be forced to cough up to protect your investments.

    • Mark
      Posted December 18, 2010 at 1:49 pm | Permalink

      With corporate bonds there’s the additional risk that the company may default, as it can’t use the courts to extract money from taxpayers to guarantee repayment.

      That is exactly what the banks are managing to do via the Court of the BoE. Default risk from well managed corporates is of course rather lower than from badly managed governments and banks.

  7. BobE
    Posted December 17, 2010 at 5:18 pm | Permalink

    Just spreading the love….

    David Cameron plays down prospect of Conservative byelection wi – Guardian http://aggbot.com/link.php?id=11865592&r=tw&t=co

    (Copy/past the above line into your browser)

  8. Javelin
    Posted December 17, 2010 at 6:17 pm | Permalink

    Its not just Government Bonds but Mortgage backed bonds that have been allowed by banks to be used as ‘core’ assets – as you call them.

    The reason Central Banks / Regulators have increased the quantity of assets is that they have wanted to make more credit available – and to do that they needed more assets to back the loans with. Hence expanding from cash to gold to Government Bonds to Corporate Bonds to Mortgages.

    The Central Banks need to stress test the banks by simply getting them to state what assets at what tiers they have to back how much lending and in enough detail to value the assets – they should be publishing this anyway. By “enough” detail – I mean in the case of mortgage backed securities to have a realistic value for retail or commerical properties – not just the mortgages on them as they are at the moment.

    We can then all see on a simple spreadsheet what would happen if the price of housing or bonds fell. This information should be published with the accounts every quarter. The public can then decide whether they are assuming too much of their assets.

  9. StevenL
    Posted December 17, 2010 at 9:42 pm | Permalink

    What about all the people that are cashing in their life savings (buying annuities) in this bond bubble? If it was me I’d be more than a little bit cheesed off with Mr Bernanke and Mr King.

    During the house price bubble everyone used to say “my house is my pension”, now their house price bubble is eating their pensions!

  10. Mark
    Posted December 18, 2010 at 1:22 am | Permalink

    The moving finger writes, and having writ moves on: not all thy piety or wit shall cancel half a line (of credit)…

    The BoE Stability Review as usual reveals some interesting insights (some unintentional). Table 3B shows that banks now consider the biggest systemic threat they face is from an economic downturn (83%),up from 67% at the time of the election. They regard funding and liquidity problems as the next biggest systemic threat at only 45% (albeit up from 33% in May), equal with regulation and taxes on banks. Falling property prices have moved up as a concern from 18% in May 2009 (when prices were just about bottoming before rising under the Brown/Darling bubble reinflation measures) to 41%. Sovereign risk is now only regarded as important by 36%, down from 69% as recently as May 2010: such a decline either implies that banks were alarmingly unaware a few weeks ago of the impending Irish crisis and its threat of contagion, or that they understood that there would be a bailout that would kick the risk down the road – or that they magically managed to get credit default swaps at cheap prices to cover their risks (somehow I think not). Interestingly, household and business customer default risk is now seen as much less of a threat than it was previously. Perhaps the survey smacks more of posturing for public view rather than the genuine thoughts around bank boardrooms.

    Among other interesting revelations was that the BoE estimate the effective subsidy caused by its rigging of interest rate markets was worth over £100bn to banks in 2009 (Chart 5.9). Without that subsidy, the banks would all have been loss making if not insolvent, and certainly would not have had funds to pour into bonus pots. Large chunks of that subsidy pass through to mortgage holders, while the rest goes to bonuses and repair of bank balance sheets.

    UK banks’ tier 1 capital is just 4% of assets on a non risk weighted basis: however, apply those magic zero weightings to sovereign bonds and the risk weighted tier 1 ratio floats up to 11.4% (Chart 4.18). Zero weighting does seem to be a bit light given recent experiences.

    The real sting in the tail remains the refinancing programme the banks face. Of the £800bn they need to address over 2010-2012, they have raised just £130bn in the past 12 months. There is about £220bn of refinancing still to do to replace the SLS and CGS operated by the BoE. The current report glosses over the full £800bn figure that June’s report revealed, by not adding together the wholesale funding and BoE funding required.

    It would seem that we are at risk of a downturn because banks will not be in a position to offer new loans because of their funding problems – perhaps exacerbated if there is a sovereign bond market crisis, rather than a downturn being the cause of problems for banks.

  11. Ralph Musgrave
    Posted December 18, 2010 at 4:27 pm | Permalink

    John Redwood starts “I agree with the Bank’s warning that if government bond prices fall there will be problems for some EU banks.” On the other hand, the only circumstance in which a central bank sells bonds back to the market is where inflation looms because some alternative source of demand appears (e.g. more exports or “irrational exuberance”). And that additional demand provides the banks with extra business.

    Problems solved? Well, partially solved, at least.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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