This morning the Bank of England provided dramatic testimony to a parliamentary committee on how it had to act to prevent meltdowns of (at least) London credit markets in the last few days of September. Without, apparently, ever actually discussing financial derivatives contracts, the BoE acknowledged that a systemic financial crisis was beginning, triggered by interest rate derivatives, when on Sept. 28 the Bank announced a return to quantitative easing with more than $70 billion equivalent in commitments to buy longer-term British government bonds from big banks.
The testimony, as summarized by CNBC, described these stages of the crisis:
British government bonds suddenly plunged in value (their interest rates spiked) after completely incompetent energy-bailout and tax-cut announcements from the Truss government;
Large numbers of pension funds were “hours from collapse” late on Sept. 27;
Complete panic hit the near-$2 trillion so-called “liability-driven investment” (LDI) pension funds (more below);
“The Bank was informed by a number of LDI fund managers … that these funds would have to begin the process of winding up the following morning";
[A] large quantity of gilts [government bonds—ed.], held as collateral by banks that had lent to these LDI funds, was likely to be sold on the market, driving a potentially self-reinforcing spiral and threatening severe disruption of core funding markets and consequent widespread financial instability";
“Bank of England staff worked through the night on Tuesday, Sept. 27 … to avert this potential crisis, in close communication” with the UK Treasury.
