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7/22/2016 In the shadow of quantitative easing, party like it is 1788- FT.com
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November 27, 2015 8:05 pm
In the shadow of quantitative easing, party like it
is 1788
John Dizard
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Quantitative easing is leading to the insolvency of insurers and pension plans,
says John Dizard
Atime traveller from 2010 to today's Europe would be
shocked by what they find.
The borderless Schengen area is now festooned with
immigration and customs barriers, and financial markets are
assuming ever-ballooning asset purchase programmes by the
European Central Bank that stretch into an indefinite future.
Oh, and a president of the European Commission who says
the single currency makes no sense when the Schengen agreement fails.
So then, in this world, what would be the "risk-free rate" that
institutional investors can use in their investment analyses? These problems are getting to the point
where they not only threaten life in Europe as we know it, but our very careers. America and Canada
can afford to make a lot of policy mistakes without social dissolution; Europe cannot.
Specifically, the ECB and its member banks' quantitative easing is leading to the insolvency of life
insurers and defined benefit pension plans. This is no longer a worst-case scenario, but the most
likely outcome of the present policy course.
Perhaps a couple of years ago this could have been dismissed as so much journalistic whingeing, but
now we are getting these projections from eurozone central banks.
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7/22/2016 In the shadow of quantitative easing, party like it is 1788- FT.com
Referring to last year's stress test of insurance companies by the European regulator, the Eesti Pank
of Estonia now says that "the low interest rate scenario used in the stress test has already arrived, and
the current yield curve is already lower than that used in the test. If companies do not take
appropriate measures or adjust their operations or strategy, they could face difficulties in meeting
their liabilities to policyholders earlier than was calculated."
The same problem applies to defined benefit pension plans, which are what most Europeans are
counting on for that part of their retirement income that is not covered by pay-as-you-go state plans.
As the promises to pension, life insurance and guaranteed investment contract beneficiaries are
discounted at very low or negative rates, they eat through any reserves or capital the institutions have
on hand. At the same time, the institutions earn less and less income from any new securities
purchases. This has happened slowly, and, with the curve bending downwards in working
populations, quickly.
Someone will have to explain to the pensioners and survivors that they are not getting what they are
promised. I would suggest not applying for that particular job opening. The compensation for
investment managers who are arithmetically certain to lose money will tend to decline over time.
When someone says I am not smart enough to understand persistent negative real rates (the
"persistent" is important), I have to agree. There is no way I could project all the dreadful
consequences. However, it would be difficult to match the stupidity of the excuses for the current
consensus on central bank policy.
Not that there will be a consensus for much longer. It does not take much reading between the lines of
statements such as President Obama's last note in the FT to see that the competitive devaluation
implicit in the ECB's policy path is making the leaders of a major currency zone rather cross. And just
before a US election year, to twist the knife.
But then it is always an election year somewhere, and it apparently is the job of macroeconomists to
come up with plausible stuff to fill out press releases, not to make actual policy.
To their credit, Federal Reserve staff seem quite guileless about the shortcomings of the long-term
projections generated by their central model.
Not that the market people are without their sins of oversimplification and formalism. They have
stretched VAR models for risk far beyond their real utility. The market's risk managers have the same
motivation as the macroeconomists: their bosses want a short answer that supports their
compensation plan or political platform.
Enough hard feelings; I am now confident that we in the developed world will succeed in our most
important goal. That is to get through the year end and the bonus calculation period without having to
put a complete financial disaster on the books. My concerns are about what comes after that.
Next year some of the seemingly endless European processes of regulation writing are coming to an
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7/22/2016 In the shadow of quantitative easing, party like it is 1788- FT.com
end. For example, Solvency II regulations for insurers are scheduled to come into force, which means
that the various national publics will have to be told that it will not be possible to pay them exactly
what they think they have coming.
Already there is right-to-left German national anger over the proposed eurozone deposit insurance
scheme, as if refugees were not enough. That the German distress is counterpointed by apparent
Italian government cynicism over budget policy does not help.
In the coming holidays, you should party like it is 1788.
Letter in response to this article:
The saving grace of negative interest rates / From Michael G Mimicopoulos
RELATED TOPICS European Central Bank, Central Banks, European banks, European Commission
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