Sensemaker: The abyss

• The UK said more than 170,000 Russians had fled the country in the past seven days. 
• Malta pledged to enshrine press freedoms in its constitution. 
• Coolio, the rapper best known for the hip hop track Gangsta’s Paradise, died aged 59.

A scant 14 years after the crash, ministers faced bankers over a conference table in Downing Street yesterday to talk about an eleven-figure bailout. The euphemisms for printing money on a colossal scale are familiar. The root causes are different. 

2008: a US subprime mortgage crisis infects the global banking system.

2022: an ageing population, decades of industrial decline, an inventive pensions industry and an inexperienced and ideological government bring the UK financial sector to the edge of the abyss all by themselves. 

One analyst said but for the Bank of England’s intervention yesterday UK pension fund losses could have passed £1 trillion.

Liz Truss is not for turning or apologising today, defending last week’s mini-budget and its unfunded tax cuts as tough but necessary to get the UK economy moving; and denying they caused this week’s market meltdown. That leaves

• much of her parliamentary party in despair;
• UK taxpayers on the hook for £65 billion to add to £400 billion in extra borrowing already scheduled for the next five years; 
• Labour and global financial markets fixated on 13 October, when that £65 billion, pledged yesterday by the Bank of England to shore up bonds, runs out.

How did it come to this? A pyrotechnic analogy might help.

The fuel. Average UK life expectancy has risen from 68 to 81 years since 1950 (and from 73 since 1980), driving up pension liabilities as pay-as-you-go schemes funded by big industrial employers for their employees have been gradually wound up. The burden of those liabilities now falls overwhelmingly on pension funds and their insurers, including for defined benefit schemes with fixed outgoings regardless of market movements. Note also:

• UK public sector pension liabilities alone passed £2 trillion this year following a 16 per cent surge since 2019.
• Those insurers are heavily invested in UK bonds, but bond yields have been low and falling for most of the past two decades.

The fuse. In December 2003 Dawid Konotey-Ahulu, then a pensions specialist at Merrill Lynch in London, pioneered a new way of leveraging pension funds’ exposure to bond markets to help meet pension liabilities. Instead of simply buying bonds, he showed how a fund could harness their rising values by betting on their falling yields. The liability-driven investment (LDI) was born. It required lower capital allocations than traditional bond holdings, freeing up cash for more exotic investments in other markets. 

• LDIs worked well, protecting as well as growing savers’ holdings – as long as yields didn’t move too fast. 
• Last Friday they started moving fast and in the wrong direction – up – as investors spooked by the scale of Kwasi Kwarteng’s borrowing plans began offloading long-term UK gilts.
• As those bonds’ yields rose and prices fell, banks acting as counterparties to £1.5 trillion-worth of LDIs began asking for collateral – for cash. 
• For many pension funds the only way to produce that cash fast enough was to sell more long bonds, creating a downward spiral that by one assessment could have wiped out 90 per cent of UK pension funds without the Bank of England’s intervention.

The fire sale. The City’s first mayday went out to the bank on Tuesday. At first the bank failed to react. Some fund managers ran out of collateral and started dumping bonds at discounts of up to 80 per cent of their face value, according to one analyst. 

The fire fight. A change of heart at the bank yesterday morning produced a press release promising £65 billion-worth of long bond purchases at £5 billion a day for the next 13 days. It was enough to reverse the spike in yields, end the cash calls and stabilise the pension sector on which much of the UK economy depends. For now. An acute tension between what amounts to a new round of printing money and the bank’s now suspended goal of “quantitative tightening” remains unresolved.

No dots to join. Truss, Kwarteng and Chris Philp, chief secretary to the treasury, are of one mind this morning that the near-meltdown has nothing to do with Friday’s mini-budget or the decision to announce it without the usual forecasts and assurances from the Office for Budget Responsibility. Almost no one outside their silo is buying it.

Philp has meanwhile refused to confirm pensions will be uprated in line with inflation, as the “triple lock” requires. Instead he’s asked all Whitehall departments to be ready to make savings. Fewer than a third of Conservative MPs backed his boss for the leadership. A former senior minister noted this week that her first conference as PM, which starts on Sunday, will be “no coronation”. 

China stalls
The staggering price of Xi Jinping’s zero Covid strategy is coming into focus. For the first time since 1990 the World Bank expects China to grow slower than its neighbours. The bank’s average growth forecast for the 23-nation East Asia and Pacific region for 2022 is a healthy 5.3 per cent. For China it’s a miserable (by Chinese standards) 2.6. The Asian Development Bank is only marginally more optimistic. Zero covid – which entails regional lockdowns at the slightest hint of an outbreak – isn’t the only factor at play. China’s housing market is also imploding. But shutting down so much of what was the world’s manufacturing and exporting powerhouse, so often, is damaging Xi’s leadership credentials just when he wants to be confirmed as president for a third term. What if he’d swallowed his pride and licensed foreign-made mRNA Covid vaccines that actually work?

Gas leaks
Russian Navy support ships were seen near the site of gas pipeline leaks in the Baltic Sea, three sources told CNN, as a fourth leak was reported by the Swedish coastguard. It doesn’t prove Moscow’s involvement in the leaks – “we see them every week”, one source said – but it adds to strong suspicions that Moscow has the capability and motivation to disrupt energy supplies to Europe, even at the expense of their own pipelines (the Kremlin meanwhile has blamed the US). Seismologists reported explosions in the Baltic Sea before the leaks were discovered. The UN security council will discuss the damage on Friday and a site inspection could begin on Sunday once the remaining gas has left the pipes. Scientists have called it “catastrophic” for the climate: the leaks are equivalent to about a third of Denmark’s annual emissions. 

Alzheimer’s progress
Initial results for a new drug, lecanemab, showed cognitive decline reduced by 27 per cent in patients with early stage Alzheimer’s compared to a placebo. The drug, produced by Biogen and Eisai, also reduced levels of beta-amyloid plaque in the brain. For decades, Alzheimer’s research has been focused on anti-amyloid drugs on the theory that reducing the plaque lessens cognitive decline. But there has yet to be concrete clinical success supporting this theory. On the contrary, the FDA came under fire last year for approving the very expensive aducanumab, also from Biogen and Eisai, with scant evidence it worked. Earlier this year a whistleblower claimed a high-profile beta-amyloid researcher had manipulated images in a 2006 paper to prove a link with Alzheimer’s. But lecanemab is the first ever treatment for the disease that has had a positive effect on symptoms, and that’s worth celebrating. 

Florida, meet Ian
More than two million people have been plunged into darkness in Florida after Hurricane Ian wreaked “catastrophic” flooding across the state. It’s one of the strongest hurricanes ever to hit the United States, with 150mph winds when it made landfall on the state’s southwest coast. The storm has now dropped in strength but is expected to impact several million people across the state, as well as in Georgia and South Carolina. Camera footage showed streets turning into rivers. “This storm is doing a number on the state of Florida,” said Governor Ron DeSantis. US border authorities said 20 Cuban migrants were missing after their boat sank off the Florida coast as Ian approached; the storm is due to head into the Atlantic later today.

MBS named PM
Saudi Arabia’s crown prince Mohammed bin Salman has been named prime minister, a role usually held by the monarch. MBS has acted as the kingdom’s de facto ruler for several years because of his father King Salman’s ill health; this promotion makes his rule official. Conveniently for MBS, the PM title gives him the same immunity from international prosecution that other heads of government enjoy. He’s acquired it a week before the Biden administration was due to weigh in on whether he should be granted diplomatic immunity in a court case brought in the US related to his alleged role in the murder of the journalist Jamal Khashoggi. That decision was due on 3 October; it’s a moot point now. To note: Under MBS, dissidents, scholars and members of religious minorities have been tortured, forcibly disappeared and executed. March 2022 saw the largest mass execution in modern Saudi history: 81 people were killed.

Giles Whittell
@GWhittell

Additional reporting by Ella Hill, Phoebe Davis and Jessica Winch.

Photographs Getty Images, HM Treasury, Andrew Parson/ Number 10