[presioneaqui]

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".

[mamonster]

This is the only correct answer I'm seeing so far here. Article clearly states BoE is avoiding rolling margin calls that could get triggered this week. Right now it is all about bailing out pension funds.

One other note: They could also be holding these bonds themselves on leverage. They could be asked to post cash as collateral for these bonds(which are now essentially risky assets).

[than3]

They were always risky assets the moment they started QE.

The main problem, its now almost impossible to avoid extreme hyper-inflation (which inevitably will cause a repeat event but much worse) and when the mechanics force it back there will be a deflationary cycle (that feeds on itself).

There have been a lot of policy mistakes over the past two years. Selling more bonds in an environment of rising interest rates is what a fool would do.

[ctrlmeta]

> 4) As the value of these bonds fall, these institutions are asked to post more collateral.

Why do the pension funds (and other institutional investors) need to post collateral? Where do the pension funds post their collateral to?

I guess I will understand why collateral is required if you can explain me what would go wrong if the pension funds were not made to post collateral.

[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.

[JumpCrisscross]

> why collateral is required if you can explain me what would go wrong if the pension funds were not made to post collateral

They're trading something everyone has to post collateral (a/k/a margin) on. This usually involves leverage, e.g. if they're buying futures [1].

The collateral is there for the broker and clearinghouse to sell if the pension fails to hold up its end of the deal. When the value of the collateral falls, the broker demands more to ensure they're covered.

[1] https://www.cmegroup.com/education/courses/introduction-to-f...

[mamonster]

Big banks. A bank lending any sort of investment vehicle money to essentially purchase assets on leverage is called a prime broker.

[mamonster]

They need to post collateral because they have leverage. And they need to have leverage because secure products like bonds don't earn a big enough return to meet pensions obligations. Yields were below 5% for the past I don't know how many years.

[naveen99]

government bonds are used for collateral allowing banks to go 10-20x leverage. When some of those 10 year bonds lose 25-50% of their value, banks get in big trouble. I bet pension funds are a small part of the problem but are being used to save face of the banks, money market funds, and other dealers of bonds.