What caused the LDI crisis?

Gabor Pinter, Emil Siriwardane and Danny Walker

In September 2022 the interest rate on UK gilts rose by over 100 basis points in four days. These unprecedent market movements are generally attributed to two key factors: the 23 September announcement of expansionary fiscal policy – the so-called ‘mini-budget’ – which was then amplified by forced sales by liability-driven investment funds (LDI funds). We estimate that LDI selling accounted for half of the decline in gilt prices during this period, with fiscal policy likely accounting for the other half. Balance sheet segmentation and operational issues slowed capital injections into LDI funds by well-capitalised pension schemes, leading LDI funds to instead sell gilts. Our analysis shows that these frictions were most pronounced for pooled LDI funds. There are further details in an associated working paper.

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Unto us a lender of last resort is born: Overend Gurney goes bust in 1866

John Lewis.

The 1866 collapse of Overend Gurney sparked widespread panic as investors flocked to banks and other institutions demanding their money back. Failure to provide substantial liquidity threatened to bring down the entire financial system. The Governors of the Bank of England asked the Chancellor to relax the constraints of the 1844 Bank Charter Act, by granting an indemnity to allow the issue of unbacked currency. The Chancellor’s reply, and the policy response it initiated, would save the day, and go down in central banking history as pivotal in the foundation of the “lender of last resort”, a function which has been fundamental to central banking practice ever since.

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The ghost of crises past, present and future: The Bank Charter Act goes on trial in 1847

Huaxiang Huang and Ryland Thomas.

The financial crisis of 1847 has often been dubbed “The trial of the Bank Charter Act of 1844 (Morgan (1952)). The Act sought to remedy the errors of crises past by trying to prevent the overissue of banknotes that many had felt was the major cause of previous crises in 1825 and 1837. The Act gave the Bank of England an effective monopoly in the issue of new bank notes and those additional notes had to be backed one for one with gold. But this had a crucial unintended consequence: it made it difficult for the Bank to act as a lender of last resort. When the crisis struck, the limits imposed by the Act effectively had to be suspended.

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