presioneaqui

Fundamentally, pensions are a FUTURE liability on CURRENT assets. So the primary goal of the fund managers at these pension funds is to ensure that size and mix of current assets can meet future liabilities. One of the biggest risks to this objective is inflation which will eat away at the value of current assets. To hedge against this risk, a fund may purchase inflation/interest rate risk protection (usually complex swap products from derivatives desks at big banks) and pay for this protection with some combination of cash or collateral.

Now it looks like while these products work in a low interest rate - low inflation environment, in this environment this "protection" is pretty worthless at best and actually harmful even.

That's why the current UK gov is under fire, because their tax-cut proposal has been perceived to have precipitated this crisis.

1) Pension funds (and other institutional investors) own government bonds. 2) They have also purchased risk/hedging products and posted these bonds as collateral. 3) As interest rates rise, the value of these bonds fall. 4) As the value of these bonds fall, these institutions are asked to post more collateral. 5) To come up with more collateral, they sell more of their bonds, dropping the price even more. 6) They are asked to post more collateral....death spiral.

The BoE buying these bonds applies the brakes on bond prices and "restores financial stability".