Kwasi Kwarteng’s quasi-Budget of 23 September will be remembered in many ways: as the least successful fiscal event in the UK for at least a decade, as a template for how not to manage the economy, as perhaps the last gasp of a long Tory era drawing to a close. But among financial decision-makers, his calamitous speech will be remembered as something more startling – the day a chancellor nearly brought down Britain’s pensions industry.
In the days after Kwarteng’s statement, investors rapidly lost faith in the British government. The interest rate on bonds for UK government borrowing (or “gilts”) rose by 1.3 percentage points for 30-year bonds. This was an unprecedented rise, more than twice as great as any other since 2000. That added £25bn a year to the government’s annual debt interest bill – twice the size of the international aid budget.
The rise in yields had another, more devastating effect: it created a “dash for cash” among debt-laden UK pension funds. The spike in bond yields forced these funds to “come up with cash” to meet margin calls (the minimum collateral on their investments), as Mervyn King, the former governor of the Bank of England, explained to me when we met in his book-panelled home office in Holland Park, west London.
After the 2008 financial crisis, as interest rates stayed low, pensions became increasingly expensive. In response, many major pension funds “decided to take more risk by borrowing”, King said. “Now, that risk was very obvious, and indeed it was identified by the Bank of England four years ago, but no one did anything about it.”
In the rush for cash, a “doom loop” was created as pension funds sold gilts to raise funds, driving yields higher. On 28 September the Bank of England stepped in, buying UK government debt in order “to restore core market functioning”. It had bailed out over-leveraged pension funds, just as, under King, it bailed out the banks in 2008. Nothing, King told me, has been done to correct the moral hazards in financial markets.
[See also: How Brexit broke the UK’s fiscal credibility]
“Financially sophisticated organisations get bailed out, but ordinary people do not. Families won’t get bailed out when they have to pay higher mortgage payments. Although this is a smaller issue than the financial crisis, the issues are the same. It’s another example of something being too big to fail.”
King believes the pensions crisis proves the urgent need for a new model of emergency Bank of England (BoE) support, one he advanced in his book The End of Alchemy (2016). At present, the Bank acts as a “lender of last resort”, bailing out essential financial companies. King wants a system that forces banks and pension funds to provide collateral to the Bank, which would only lend against that collateral. It would be “like an insurance policy, where you pay upfront. There’s got to be a penalty,” King emphasised, “to going to the Bank of England and taking cash from them.”
If King has the solution to moral hazard, why didn’t he enact it when he ran the Bank? After a career in academia, he became the BoE’s chief economist in 1991, a deputy governor in 1998, and was made governor five years later. But King did not, he pointed out, gain oversight of the City until the final three months of his decade in office in 2013.
Yet King was in charge when the tsunami hit in 2008, and he has been criticised by some for failing to see it coming. His response is that governors are not paid to spot crises but to react adroitly when they happen. He also did arguably predict the crisis. Credit, he warned in 2007, was more available than ever, and “excessive leverage is the common theme of many financial crises”. His old speeches are full of scepticism that banks had, as they claimed, spread the risks of leverage by collateralising debt. “Are we really so much cleverer,” King asked in 2007, “than the financiers of the past?”
Could the Bank have acted? It did not directly regulate the City, but King has suggested that the political climate would not have allowed it to act regardless. “Politicians worshipped at the altar of finance,” he wrote of the 2000s in The End of Alchemy. “Regulators were under pressure not to impede the expansion of the sector.”
King, 74, the son of a railway porter and teacher, speaks with formidable fluency. He can translate the concepts of high finance into what they really are: political choices. And as the former head of an elite institution, he is caustic about political amateurism.
“To go around announcing large tax cuts and say, ‘Well maybe next year we’ll tell you how debt-to-GDP will come down’ is asking for trouble,” he said of Kwarteng’s statement. “To say ‘I’ve got a Budget here, but I’ve got no idea how much it costs or how it will be paid for – it beggars belief anyone would think this was a sensible thing to do.”
Treasury civil servants will have advised Kwarteng against this course of action, King said. The Chancellor has now, ironically, made himself “the prisoner” of the Office for Budget Responsibility (OBR), having made the OBR’s assessment of his plans more significant by delaying it. A wiser chancellor would have used the OBR’s forecasts as cover for his tax cuts. But King doesn’t believe such cuts will solve any of Britain’s economic ills. “The idea that we were all sitting there on the edge of our seats, ready to unleash a technological revolution if only the basic rate fell from 20 per cent to 19 per cent is not credible.”
For a decade, King’s mandate at the Bank was to control inflation – something his successor Andrew Bailey has failed to do. King partly blames the Bank and the US Federal Reserve for resorting to quantitative easing (QE) during the Covid pandemic in 2020. Central banks, he said, “got into a mindset of just doing QE whenever there was bad news. It was a way of telling the world, ‘Don’t worry, we’re here’.” They came to believe that, “QE is about signalling things. This was a terrible mistake. They lost track of the fact that QE was simply printing money.”
That has an inherent downside: QE drives up asset prices by design, exacerbating wealth inequality. And in 2020 it had no upside, King said. Supply was constrained by government lockdowns. Printing money was the last thing the Bank should have done. “How do you get inflation? It’s too much money chasing too few goods. You couldn’t have a better example [than 2020].”
For a decade, King’s words had the power to move markets. Now he has returned to writing and teaching. He is sanguine about criticisms of his tenure. Some think he allowed himself to be co-opted by the Conservative-led coalition government as a proponent of austerity. But he argues that he never endorsed spending cuts and any government could just as well have raised taxes to cut the budget deficit. He is also defiant about his most unexpected belief: support for leaving the EU.
In his view, Brexit “isn’t really an economic issue: it’s a political issue”. King does not share the free-market utopianism of the Tory right (“the idea that we’re suddenly going to be like Singapore because we’ve left is nonsense”), but rather emphasises the importance of “being in control of our laws, which we clearly were not”, and of the EU’s ever-greater integration, which he believes the UK had become powerless to prevent.
He dismissed the OBR’s claim that Brexit will reduce GDP by 4 per cent in the long run. “They can’t possibly know that. They just make it up.”
Mervyn King’s focus is on debt, however. “There’s a lot of other embedded leverage out there in the financial sector” and the UK is awash with “zombie companies which can’t repay debt”. Financial markets, he fears, “may move very sharply” if their tolerance for Western debt changes in the coming years. The UK’s pension funds, he warned, “are the tip of the iceberg”.
[See also: Zombie capitalism is unravelling]
This article appears in the 12 Oct 2022 issue of the New Statesman, Will Putin go Nuclear?