Hard Times For Pension Funds

Following the Great Recession, interest rates has been at historically low levels. This is partly related to the almost zero interest rate policies implemented by the major central banks and the quantitative easing measures which aim at lowering nominal rates below levels that would otherwise prevail. Moreover, the emerging economies are keen on investing in the developed economies (f.e. US T-Bonds) to prevent their currencies from appreciating. In most of the industrial world real interest rates have turned negative.

The large role for non-market forces in the determination of interest rates which is a key feature of what Carmen M. Reinhart calls financial repression1. Financial repression includes directed lending to the government by captive domestic audiences such as pension funds or domestic banks. It takes many forms such as
the explicit caps on interest rates, regulation of cross-border capital flows, and relatively high reserve requirements.

When financial repression results in negative interest rates, it works as a transfer from creditors to borrowers. This facilitates the servicing of the high public sector debt in the industrialised world. Hence, Mrs Reinhart calls this transfer a financial repression tax. As this tax operates in a rather opaque way, often justified by prudential regulations, this result is a more palatable solution for deficit reduction than outright tax hikes or expenditure reductions.




Forced on a sovereign debt diet
Encouraged by new pension regulations such as the introduction of mark to market accounting, pension funds, particularly defined benefit plans, have steadily reduced the risk on their portfolio in recent years by increasing the share of fixed income products in their portfolio (chart 1). This movement was accelerated by disappointing returns on equity investment after the bursting of the dotcom bubble and the 2008 credit crisis.

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