Will the UK Trigger the Meltdown of 2022?

The entire financial system was on the verge of blowing out when the Bank of England intervened on Sept. 28, to bail it out with an extraordinary injection of 65 billion sterling pounds, five billion a day for 13 days. On Oct. 10, the BoE intervened again, raising the daily purchases to ten billion, while at the same time activating special short-term and long-term repo facilities to provide banks with liquidity in exchange for junk assets. A return to QE (quantitative easing) in a big way…

What had happened is that the $500 trillion global interest rates derivatives pyramid was about to explode, ignited by the blowout of investments in UK pension funds derivatives. The BoE intervention temporarily defused the threat, but the collapse of the system, triggered by the increase of central bank rates, is already in motion.

The immediate cause of the British crisis was the effect on an already shaky financial system of the measures announced by the Liz Truss government (cf. SAS 39/22). A letter sent by the Bank of England to the House of Commons Oct. 5 describes the developments in terms as dramatic as a central banker can use.

On Sept. 23, the British government had announced a “mini-budget” of combined tax cuts and stimulus spending, which provoked a collapse of government bonds (gilts), whose yields had already risen as a result of monetary tightening. In the following days, “the speed and scale of the moves in gilt yields was unprecedented. That period saw two daily increases in 30 year gilt yields of more than 35 basis points.”

The BoE letter goes on: “The rise in yields caused the net asset value of LDI funds to fall significantly and their leverage to increase significantly (…) The fall in net asset value was reflected in margin calls, which the LDI funds had to meet.”

LDI, short for Liability Driven Investments, are those funds owned by pension funds. Reuters describes them as a “moneyspinner for asset managers”. The latter borrow money to invest in derivatives, using gilts as collateral. When the gilts lose value, more collateral has to be put up (margin calls). Usually, pension funds sell assets in order to do that, but what happened in the UK was that “in some LDI funds, the speed and scale of the moves in yield and consequent decline in net asset value far outpaced the ability of the DB [defined benefit] pension fund investors to provide new capital in the time available”, according to the BoE letter. This created panic on the market and forced the central bank to intervene in order to prevent a meltdown.

The BoE further insists that the “the resulting operations in the gilt market are designed to be temporary and targeted”, but further measures were announced only days later.

The British crisis shows once again how the abrogation of the Glass-Steagall regulations, along with the expansive monetary policy of the last decades, is at the root of the unsolved global financial crisis. Under the Glass-Steagall Act and similar laws in Europe, pension funds were not allowed to invest in high-risk instruments, such as derivatives. This, however, was in a world where they could reap a decent yield in fixed-income assets, such as government bonds. Due to central bank negative interest policies, there has been virtually no place to invest money without loss except equities and derivatives.

Now, the move by the most extreme war government in Europe, that of Prime Minister Liz Truss, has set off “instability” in a quadrillion-dollar global bubble of unpayable debt and derivatives. It has lit a match under the tinder that the Federal Reserve and European central banks have been piling up since the last global financial crash, in 2008.