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 502.

    "our soul
    shall not always
    be without an object"

    Robert's 'hidden cost' might bring disturbance no more unwelcome than that inflicted on the youth of Europe, any boost to 'habit' of gainful employ 'worth it' even if only toward subsistence for all in Grounder's eventual Brave New World, realisation of JfH doom not really from money excess or low rates, but from crippling inequality.

  • rate this

    Comment number 501.

    @500 All for All "so dependent on greed for food enough (to go around) in the world"

    One should speak the truth as one sees it, not as one would wish it to be. As true of global inequalities as centenarian penury or dependency encouraged by politicians desperate to reduce the deficit for electoral advantage.

    Good night.

  • rate this

    Comment number 500.

    "noble and true"

    And not as @479 really so dependent on greed for food enough (to go around) in the world, or on fear (of injustice, of loss of place) as if vital not destructive of our co-operative motion, as you imply (with different mischief) on trickle-down pension-pot liberation or drawdown.

    Grateful to our Moderators, so thorough pursuit here of hidden costs. Goodnight!

  • rate this

    Comment number 499.

    "6.12 It is unlikely that the proposals set out in this document would have a significant impact on the composition of defined contribution investments in the accumulation phase."


    Standard advice is progressively to align funds to their target, so there should be an impact.

  • rate this

    Comment number 498.

    @494 All for All "Wondrous the return of the wise steersman"

    Bless all those with an initial G for what is noble and true in their intentions!

    VAT receipts, tax-year to date, are up 4.7% with a surprising uptick in February. That's the sort of statistic that's hard to "fiddle" or mis-estimate. Consumer demand continues, shored up, now, by two years of pension one-offs... Brave New World!

  • rate this

    Comment number 497.

    @496 The J Hoovers Witnesses
    He's only 82. Seems he's been around for much, much longer
    It was his father that left on his bike, I think.

  • rate this

    Comment number 496.

    Ah well. We've always got the likes of Tebbit to cheer us all up:


    He's only 82. Seems he's been around for much, much longer.

  • rate this

    Comment number 495.

    @492 Blackbag2003 "It's a life insurance policy, the insurer always gains."

    Not so. Insurance companies often lose money on individual policies or whole books of business. Sometimes a whole company is in danger of going bust and their peers take on their obligations.

    Good companies will generally make a profit from annuities, as will the majority of annuitants (at the expense of the minority).

  • rate this

    Comment number 494.

    Grounder @488
    "£20K to £12K to NIL"

    Wondrous the return of the wise steersman, as if in George amongst us again Gordon, eye on the horizon, tiller held against all currents and all cries amidships, to be upset again I fear by US submarine manoeuvres, the EU without steerage, our own carriers flightless, stable aggregate demand forsworn, Dad's Army mobilising, a mini buy-to-let in Brittany?

  • rate this

    Comment number 493.

    @485 All for All
    caring for that old soul through seeing
    I think I expressed that in @486 which I think you would not have seen when you were composing @ 485
    Goethe puts it well I think,
    "A bright day is like a dim one, if we look at it unmoved; and what can move us but some silent hope that the inborn inclination of our soul shall not always be without an object?" (Meister)

  • Comment number 492.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 491.

    @489 JfH
    Fortunately for so many, I gave up economics in 1979... My diagnosis differs from yours as a chicken from an egg. The banks were allowed to create too much money and states then created still more to ease the economic fallout!

    Either way, there's too much around now and the over-supply naturally drives down the cost. As the economy creates more demand, so the price of money will rise.

  • rate this

    Comment number 490.

    @487 John
    I think I must have been thinking of birdwatching when I used "crepuscular" or perhaps Romantic poetry.
    I broadly agree with your economic solution

  • rate this

    Comment number 489.

    488.G "we transform our ...economist into the "wise ruler""

    1. No. The whole teaching of economics has been twisted by the money of the bankers - who have lost all of their own and ours. The must re-learn from history and not try to reinterpret it to justify the current corruption. Any economist educated in the last 30 years is NOT an economist!

    2. Your solution = die on the streets?

  • rate this

    Comment number 488.

    @482 All for All "do whatever necessary"

    Now we transform our technocratic mechanical economist into the "wise ruler". It is puzzling that the transitional measures reduce the minimum guaranteed income from £20,000 to £12,000 while the ultimate proposals do not even require the equivalent of the full state pension. Why not halve it and align it to the personal allowance (guaranteeing some tax)?

  • rate this

    Comment number 487.

    476.pah! Corpuscular has some meaning.

    The reality is that the mechanism has been broken by the BoE & Fed. They know they have broken one of the essential capitalist mechanisms but they haven't a clue how to fix it as all possible solutions result in more severely breaking the mechanism that would have happened in 2008 if they hadn't made the wrong choice!

    Bank bankruptcy is the ONLY answer!

  • rate this

    Comment number 486.

    @484 All for All
    I am with you when you say that our caring for others is founded on "their real existence".
    And I think this is at the heart of morality.
    Love thy neighbour as thyself.
    In the 17th century the idea of extension was of course founded on geometric advances which were contemporaneously being made.
    Analogously, in voluntary action we extend our intention toward our object.

  • rate this

    Comment number 485.

    plotinus @483
    no sense
    if the cause
    is MERELY a reaction
    to external stimulus"

    That 'merely' the problem. You won't help that old soul across the road unless you SEE her, even then not unless you CARE about her fate, the seeing & the caring (however represented in the philosopher's cave) in 'you' utterly dependent on your corporeal being, your democratic entitlement to 'defined benefit'

  • rate this

    Comment number 484.

    plotinus @480

    Annuity or not, what profit to pursue irresponsible comfort in neglect of human inquiry into the non-physical 'substance of consciousness', the 'corporeal exension' of thoughts whether 'ours' or God's, and the inescapability of both existence & caring, the 'real' existence of others supplying all we need of volition & (shareable) morality beyond instinct and appetite?

  • rate this

    Comment number 483.

    @482 All for All
    Our free will is a subjective reality.
    Easily provided for - well only if within a suitable framework.
    Cogs and gears, are perhaps to rigid a format.
    I prefer your earlier comment where you refer to being "seated atop".
    If the cause of our actions is merely a reaction to external stimulus then morality makes no sense.


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