tag:blogger.com,1999:blog-582368152716771238.post5414580019437232550..comments2024-03-28T11:14:02.660-05:00Comments on The Grumpy Economist: More UK finance regulatory failureJohn H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.comBlogger14125tag:blogger.com,1999:blog-582368152716771238.post-24872809501724001612022-11-30T06:46:32.068-06:002022-11-30T06:46:32.068-06:00The finance regularity is totally fail, Taxes are ...The finance regularity is totally fail, <a href="https://accountants-inlondon.blogspot.com/2022/11/high-taxes-in-the-uk.html" rel="nofollow">Taxes are high in the UK</a> , Is there any permanent solution for this critical situation?Charted Accountantshttps://www.blogger.com/profile/01513500183131441679noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-45502740136247381942022-11-22T16:48:11.689-06:002022-11-22T16:48:11.689-06:00Long time reader first time poster; inspired to mo...Long time reader first time poster; inspired to move into UK LDI given your early work on structural term premium in sovereign bonds - your US sovereign conclusions are replicable to UK bonds. <br /><br />You are exactly right to suggest: ‘[pension schemes] buy bonds, borrow against bonds, and invest in stocks’. This has become the predominant strategy in the UK LDI market with schemes managing solvency interest rate (and inflation) risk while still being able to allocate to growth assets. Borrowing is predominantly provided by household named UK and US investment banks via gilt repo contracts. At the isolated LDI level, schemes agree to pay a cash rate in exchange for return on the gilts and collateralise these positions daily. The banks were ultimately at risk from pension scheme / LDI pooled fund default if the BoE had not stepped in. In this scenario banks are the forced seller of gilts and a bank run could have ensued.<br /><br />At an overall scheme level the bonds (including those on repo) are usually less than or equal to scheme assets so the leverage risk is minimised if schemes can get assets to their LDI managers sufficiently quickly. Some schemes/LDI Managers were well setup for this eventuality, others weren’t and the later therefore started the self reinforcing gilt selling.<br /><br />The pain points on bond prices of a shift to a high inflation environment were well known from your work but unfortunately ignored by a subset of those LDI managers who let their leverage levels drift up to unsafe levels and have given a bad name to US…Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-48496740273291898022022-10-24T12:36:10.335-05:002022-10-24T12:36:10.335-05:00A paper authored by Lionel Martinelli and publishe...A paper authored by Lionel Martinelli and published by EDHEC Risk and Asset Management Research Centre during 2006, provides a stochastic model, based on Ito's Lemma, to optimize the isoelastic utility of returns of a pension plan fund in an asset-liability management environment. The author, in a specific example, finds the optimal portfolio allocation for a cost function comprising the CRRA utility function of the asset:liability rato of a three-asset portfolio comprising (a) the risk-free asset, (b) the standard mean-variance portfolio and (c) the liability hedging portfolio. "[T]he proportions invested in these two funds [(b) and (c)] are constant in time." The paper consists of 13 pages. Twenty-seven references are cited.<br /><br />"Managing Pension Assets: from Surplus Optimization to Liability-Driven Investment", EDHEC RISK AND ASSET MANAGEMENT RESEARCH CENTRE, March 2006. Lionel Martellini, PhD (U.C. Berkeley), Professor of Finance, EDHEC Business School, Scientific Director, EDHEC Risk and Asset Management Research Centre. The paper is accessible by navigating to<br /><br />https://risk.edhec.edu/sites/risk/files/managing-pension-assets-surplus-optimization-liability-driven-investment.pdf<br /><br />Abstract<br />"In this paper, we consider an intertemporal portfolio problem in the presence of liability constraints. Using the value of the liability portfolio as a natural numeraire, we find that the solution to this problem involves a three-fund separation theorem that provides formal justification to some recent so-called liability-driven investment solutions offered by several investment banks and asset management firms, which are based on investment in two underlying building blocks (in addition to the risk-free asset), the standard optimal growth portfolio and a liability hedging portfolio."<br /><br />Justification:<br />"The aim of this paper is to provide an academic perspective on asset-liability management (ALM) strategies. In particular, we introduce a formal continuous-time model of intertemporal asset allocation decisions in the presence of liability constraints, and discuss how recent industry trends such as liability-driven investment fit with respect to the theoretical optimally designed strategies. The rest of the paper is organized as follows. In section 2, we provide a brief history of ALM techniques, outlining both the practitioner and the academic standpoints. In section 3, we introduce a formal model of asset-liability management. In section 4, we present a conclusion."<br /><br />The ultimate paragraph in section 3 contains this observation which is germane to the U.K. pension fund asset sell-off in September, 2022:<br />"Note also that, as outlined in the previous sections, several investment banks have suggested using customized derivatives to perform liability-matching, and use leverage so that full amount of asset portfolio is still invested in a risky asset. This strategy corresponds to -100% in cash, 100% in the liability-hedging portfolio and 100% in the market portfolio, which can be rationalized under a specific choice of the risk aversion coefficient. More risk-averse investors, on the other hand, will prefer solutions involving less or no leverage."<br /><br />Old Eagle Eyehttps://www.blogger.com/profile/05270080708077871311noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-92194666053091475692022-10-20T08:52:15.867-05:002022-10-20T08:52:15.867-05:00Thanks. And thanks for your many thoughtful commen...Thanks. And thanks for your many thoughtful comments here! John Cochranenoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-84033863488698543002022-10-20T07:23:23.922-05:002022-10-20T07:23:23.922-05:00John, I'd like to point out that I am not the ...John, I'd like to point out that I am not the source of the link to Craig Pirrong's blog page. "SRP" posted the link to "Streetwise Professor". His comment is no. 9 of 9 comments. My last comment was no. 8 of 9, and it referred to a quote from Mohamed A. El-Erian (on Twitter) that criticized the FRB's FOMC for policy failure. Old Eagle Eyehttps://www.blogger.com/profile/05270080708077871311noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-60428672518775853222022-10-18T20:37:25.123-05:002022-10-18T20:37:25.123-05:00The Streetwise Professor begs to differ on the rol...The Streetwise Professor begs to differ on the role of leverage in the British LDI turmoil.<br />https://streetwiseprofessor.com/clearing-is-not-a-harmless-bunny-i-told-you-that-i-told-you-that-i-told-you-ad-infinitum-that-i-told-you-so/SRPnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-22269707754093585852022-10-18T11:23:27.086-05:002022-10-18T11:23:27.086-05:00"An independent #FederalReserve is critical t..."An independent #FederalReserve is critical to the well-being of the US #economy. Having said that, it is getting harder to justify such independence when four big operational errors (of analysis, forecasts, actions and communication) are accompanied by a lack of accountability." -- Mohamed A. El-Erian (on Twitter).<br /><br />One is inclined to include the Bank of England in that ambit.Old Eagle Eyehttps://www.blogger.com/profile/05270080708077871311noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-91847385527070536752022-10-17T17:02:14.815-05:002022-10-17T17:02:14.815-05:00CATO Institute, Nov. 17, 2022: ESG and Financial ...CATO Institute, Nov. 17, 2022: ESG and Financial Regulation.Old Eagle Eyehttps://www.blogger.com/profile/05270080708077871311noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-21695685839821137032022-10-17T12:21:20.205-05:002022-10-17T12:21:20.205-05:00My remarks pertained to the U.K. financial markets...My remarks pertained to the U.K. financial markets in September 2022. The reference to Lehman Bros. 2008 was simply to make the point that the decline in bond prices in the U.K. did not set off a crisis in the U.K. financial market, though it might have been a close shave at that.<br /><br />You make some astonishing claims. Do you have public-domain references that support your assertions?<br /><br />One reading of your assertions, in toto, is that regulators are necessary and that their ability to create money is an essential element of the exercise of that regulatory power. Another reading of your remarks is that financial markets are incapable of managing on their own. This reading compels ever greater regulatory oversight even unto the regulation of who can participate in capital markets and which markets they can access. For a right-libertarian, that view might well be anathema to her life-philosophy.Old Eagle Eyehttps://www.blogger.com/profile/05270080708077871311noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-89186697515036062242022-10-17T12:07:42.977-05:002022-10-17T12:07:42.977-05:00My remarks above referred to "G.A.A.P." ...My remarks above referred to "G.A.A.P." It should have referred "G.A.S.B.", the American body that sets general accounting standards in the U.S.Old Eagle Eyehttps://www.blogger.com/profile/05270080708077871311noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-24800820060220245812022-10-17T00:56:25.987-05:002022-10-17T00:56:25.987-05:00The US government could never term out their rates...The US government could never term out their rates. They are not a price taker and their actions would have changed the price, their the biggest player by far.<br /><br />And more long rate issuance would have canceled out QE. And hence canceled out a lot of stimulus. The private sector never had that sort of 30 year rate demand.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-52316995985496554602022-10-16T09:16:28.214-05:002022-10-16T09:16:28.214-05:002020 required a larger bailout than 2008. You migh...2020 required a larger bailout than 2008. You might not realize it from your seat but the financial system was very close to a fatal margin call if the Fed didn't buy more than $1 Trillion of bonds in less than a week. The Fed then bought corporate bonds which never occurred in 2008. Now the Fed has more than $1 Trillion in unrealized losses, there is a structural $1 Trillion annual fiscal deficit, the US capital account is negative and inflation is far above target To say that we have not moved into more dangerous territory is being willfully blind.<br /><br />So the claim that regulating financial leverage does not work; is simply stating a fact at this point. To deny this fact is equivalent to being a flat earther.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-37091616673339044242022-10-14T22:47:01.910-05:002022-10-14T22:47:01.910-05:002018 was four years and 1.2 trillion U.K. pounds a...2018 was four years and 1.2 trillion U.K. pounds ago. One would expect that circumstances would change under the quadrupling of invested capital in that corner of the financial market. Most of this change was driven by change in financial reporting standards (I.F.R.S. in the U.K., and G.A.A.P. in the U.S.). You don't mention it, but that is the underlying cause. There are four generic LDI strategies that a company with a defined benefit pension can follow. I listed these in an earlier comment on an earlier blog post on the same subject. The "Overlay" strategy in LDI is the one that utilizes derivatives and leverage to gin up pension fund returns.<br /><br />Oddly enough, while much is being made of this development, the 'crisis' has yet to be proven fatal. There haven't been the spectacular failures such as Lehman Bros. in 2008. It's more like a wobble than a full-blown melt down. <br /><br />It might be useful to broaden the reading list. The WSJ is an o.k. news source, but its economics reporters are trying to cover too many bases at the same time to do the subject justice. The U.K. market advisory firms, and others such as Cambridge Associates provide better in depth analysis and commentary.<br /><br />I recognize that the point of the blog post is to slam regulatory bodies and financial regulations in particular, rather than to provide a clinic study of LDI strategies and associated risks to the markets. Not everyone has perfect foresight.Old Eagle Eyehttps://www.blogger.com/profile/05270080708077871311noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-8876113577061951502022-10-14T20:40:18.459-05:002022-10-14T20:40:18.459-05:00Throughout history human society has experienced e...Throughout history human society has experienced external crises such as plague and natural disasters. Supposedly, our technology is so much better now that we can cope with a lot of crises. But we can't change human nature and know-it-all bureaucrats. mortmainhttps://www.blogger.com/profile/04741056567111331885noreply@blogger.com