A hidden cost of Osborne's pension reform?

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As you may remember me mentioning before, one of the big reasons why the US economy recovered faster than the UK and European economies after the 2008 crash is that America is much less dependent on banks for credit.

Only about 20% of loans come directly from banks in America, with the rest being supplied by investors who buy debt that is parcelled into bonds and sold to them.

In Europe, by contrast, 80% of loans come from banks.

So when the West's banks were hobbled in 2008 by the crisis, this was much more devastating to the supply of credit and the functioning of economies on this side of the Atlantic than on the other.

The flow of funds to companies and individuals recovered much faster in America than in Europe, because - spurred by unprecedented money creation by the US Federal Reserve - the credit tap was kept open by investors in the way it wasn't to the same extent by banks.

That is why quite a lot of the thrust of government policy here is not only to strengthen banks, so that they can supply precious loans needed by businesses and households, but also to encourage the establishment of other sources of credit, to reduce the potentially disastrous dependence of our economy on banks.

But here is the thing (as I am apparently wont to say).

The Treasury's proposed pension reforms could significantly reduce the supply of credit to companies and to the government from a source other than our banks - it could shrink what little competition there is to the banks in the UK in the business of credit creation.

Here's why.

Under the current rules, those who retire and have been saving in defined contribution pension schemes buy around £11bn of annuities every year.

Now of this £11bn, the vast majority is invested in bonds, and something like £7bn flows to companies through purchases of corporate bonds.

So if sales of annuities were to collapse after the government abolishes the requirement on retirees to invest in them, there would be a fall in the supply of credit from this source to companies - and a reduction in credit provided to the government, to infrastructure projects, to social housing and property.

That would be what economists would call the static effect. And, many would say, it would not be benign.

However there are many who believe that the flow of funds into defined contribution pension schemes could actually increase, as and when savers know they have more freedom over what they can do in retirement with their accumulated pot.

So the dynamic impact of the changes could be to increase the size of pension schemes, and some of this additional saving could be directed into credit for businesses and households.

That said, the dynamic and positive impact would be rather less certain than the static and negative impact.

And there's another thing.

There would be a much more serious and graver shrinkage in the supply of credit from pension funds - especially credit supplied to the government - if savers in final salary schemes were to convert their pension pots into defined contribution schemes, to take advantage of this new freedom to take the money and run on retirement.

For example, of the £1.1 trillion pounds of assets held by private-sector final salary schemes, some £290bn is held in government bonds and £200bn in corporate bonds. These holdings represent something like a quarter and a half respectively of the entire market for these bonds.

So as the government points out in a consultation paper, even relatively small numbers of savers saying they want out of final-salary pension schemes could could make huge waves in the market, if those funds were forced to cut their holdings of government and corporate bonds: the cost for the government and for companies of borrowing could rise pretty sharply, and could stay elevated, if pension funds' appetite and capacity to lend to them were permanently reduced.

Which is why in giving additional freedom to those in defined contribution schemes to do what they like with their money, the Chancellor is minded to give rather less freedom to those in defined benefit schemes - he has signalled he will probably ban members of final salary schemes from switching to defined contribution funds.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 82.

    SWEET!!! We're 280 quid better off a year as a family according to Auntie Beeb's calendar.

  • rate this

    Comment number 81.

    I'm going to cash my pension in and invest it all in beer and bingo.

  • rate this

    Comment number 80.

    46. SeeDubya

    I clearly meant 30 and that was obviously a typing error as even you must know. Are you trying to make a general point or are you just being gratuitously offensive?

  • rate this

    Comment number 79.

    Osbourne says 'trust people with their pensions' I wouldn't trust him with my piggy bank (its not even got anything in it)
    Problem with people is that they tend to do silly things. Plus if you start handing big chunks of lolly to the newly retired it probably will give a healthy boost to the boiler room industry as looking at that age group will provide a new clientele base...

  • rate this

    Comment number 78.

    But hey, it was all the banks fault and a nasty co-incidence"

    GB's "tax grab" is way overstated. There are many reasons for the "collapse" of pension funds: actuaries miscalculating life expectancy, pension "holidays" by employers, big reduction in returns from equities, collapse in annuity rates pre 2008 and worse since. GB's "tax grab" is small beer in comparison.

  • rate this

    Comment number 77.

    My prediction is that people retiring will take out cash from their funds and put it into the buy to let market so they can get income from it. That will put further upward pressure on house prices and make it hard for young people to get on the housing ladder.

    The one thing that might prevent this is that taking money out will be taxed, so there few will take it all out in one go.

  • rate this

    Comment number 76.

    60. FauxGeordie
    "The pension pots might well be so small because the UK financial services industry isn't very good."

    Funny how the UK financial services industry that wasn't very good had built Europe's best pensions until Gordon's tax grab.

    But hey, it was all the banks fault and a nasty co-incidence.

    Oh and remind me what Labour did to reform the "not very good" industry? Oh, yes NOTHING.

  • rate this

    Comment number 75.

    The natural balance of all things is no positives without negatives, or multiple & domino effect negatives.

  • rate this

    Comment number 74.

    On top of the 25% tax,one must remember that if they take all the money in there pot,or most, will any creditors be able to have priority over investing in a income for the future ie is tided up money being released to keep banks afloat rather than provide a future living in old age

  • rate this

    Comment number 73.

    Already hearing from people that they will invest in buy to lets for a bigger return. Once again not thought through

  • rate this

    Comment number 72.

    If it forces annuity companies to give better value to entice customers then its a really good thing. As the market currently is, you are much better off taking income direct from your pension fund.

  • rate this

    Comment number 71.

    58. aaron grant
    Well done George. More please to allow people to make their own decisions and take charge of their own lives.

    Yeah, that has worked so well in the past hasn't it? The average man in the street is easy meat to sharp suited tory con artists. "We conned you into transferring from final salary, we've ripped off your redundancy money and now we'll be coming for your pension pot."

  • rate this

    Comment number 70.

    Another hidden cost may be reform to the care system. If fewer retired people take out annuities there will be less income to cover their eventual care costs and the state will have a bigger bill which is likely to adversely affect any reform to the care system.

  • rate this

    Comment number 69.

    GO is plain wrong to assume we can all manage our finances sensibly. If we could, why has the government been pushing to get more people contributing to pensions in the first place.

    The reality is (and you can spin it how you like, depending on your politics), too many people will take the money and "blow" it (whether on cruises or investments makes no real odds).

    We are not all accountants.

  • rate this

    Comment number 68.

    What I believe should accompany this pensions overhaul should be an additional option viz: A Government assessed annuity based on strict life expectancy assumptions which are reassessed each year on revised life tables with an inflation element.If private annuity offerings are generating a very large profit, then this could be seen. It would go some way to deal with intergenerational fairness.

  • rate this

    Comment number 67.

    It doesn't seem that the ramifications have been thought through. Presumably if everyone draws their pension fund out if they become ill, there will not be the funds for annuities of people who live to very old age. This will surely transform the private pension industry and not necessarily for the better.

  • rate this

    Comment number 66.

    Two points if you have been lucky enough to be or have been in a final salary scheme, you will not bang out, believe me it's not worth it. Secondly people who save for pensions have a mental integrity which will stop them blowing the cash unless they have found out they have a illness. then they should.

  • rate this

    Comment number 65.

    US economic recovery???

    Robert Peston, are you completely oblivious to the situation over there. Incredibly ignorant. While some figures may be correct by your research, the analysis is incredibly poor.

    You used to write decent articles. What has happened to you?

  • rate this

    Comment number 64.

    Browns pension theft was one of the meanest, nastiest, most underhand acts ever perpetrated on ordinary people by a British government. But hey why should he care he's loaded, despite never ever having done anything good or worthwhile in his life.

  • rate this

    Comment number 63.

    Maybe a proper public bank could offer annuities to anyone who wants one. At least there would be democratic accountability and full transparency.


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