Bond Buying Proves Poisonous for Pensions

Today's economic medicine carries harmful side effects.

Bond buying, known as quantitative easing, or QE, may have boosted growth and lowered corporate borrowing costs, according to a Bank of England analysis. But it is playing havoc with pension funds. Deficits have ballooned by £74 billion ($116 billion) as a direct result of the BOE's bond-buying program, estimates Pension Corp., an insurer.

The problem for pension funds is QE's design, not its rationale. The BOE's gilt purchases drive up prices and push yields down, a particular problem now that the scale of the BOE's bond buying is forcing it to buy longer-dated gilts of over 25 years in maturity, popular with pension funds. While quantitative easing boosts the value of pension assets, it lowers investment returns and increases estimates of future liabilities. Because typical defined-benefit plans are only 70% funded and face liabilities several years longer than their assets, that leads to wider deficits.

The BOE had hoped the bond-buying program would encourage pension funds to sell gilts and buy stocks and corporate bonds. Instead, many pension plans are doing the opposite: derisking and buying more gilts in the hope of closing shortfalls sooner. That isn't only exacerbating deficits but accelerating a move out of stocks, reducing a major source of long-term risk capital.

Some cash-strapped firms facing demands to plug QE-related deficits are petitioning the U.K. regulator to allow them more than 10 years to make up shortfalls. Another approach might be to discount liabilities at a higher rate than government or double-A corporate-bond yields. The Treasury uses a rate of 3% above consumer inflation for public-sector pensions.

But many trustees say the best response would be for the BOE to stop buying long-dated gilts and buy bank bonds instead. Not only would this ease bank funding difficulties, and thereby improve the supply of business loans, it would allow gilt yields to rise.

So far, the BOE has ruled this out, fearing credit risk and accusations it is subsidizing banks. But given the scale of the crisis, it may be time to take a less doctrinaire approach.

Source: http://online.wsj.com/article/SB10001424052970203686204577116573609854972.html?mod=WSJ_Heard_LEFTSecondNews