Pension Funds Tread into Danger Zone with Risk Taking: Economist

June 30, 2014 by Eva Taylor and Andreas Framke

Pension funds and other long-term investors are taking ever bigger risks and could be laying the ground for renewed turmoil when money gets more expensive, one of the world’s leading economists told Reuters.

As memories of the financial crisis fade and market confidence soars, policymakers have warned that investors desperate for any return on ultra-cheap money could be creating yet another bubble to go bust.

Now the chief economist of the body bringing together global central bankers has warned that while banks are still repairing the damage of the last crisis, pension funds have cast off their risk aversion in the hunt for profit.

“Things look and feel great but we are storing up a possibly more painful and more destructive reversal,” said Hyun Song Shin of the Bank for International Settlements (BIS).

“The one thing that is different between now and 2006/2007 is that the protagonists … are no longer … the banks. This risk taking is happening through other market players. Long-term investors are also joining in.”

This changing pattern of behavior carries “a potential source of danger”, he said. “We are going into somewhat unfamiliar territory.”

Central banks in the euro zone, Japan, Britain and the United States risk keeping the taps of cheap money open for too long after the financial crisis, he said.

Shin is the economic adviser to a group that brings together policymakers from across the globe, including European Central Bank President Mario Draghi and Federal Reserve Chief Janet Yellen.

He called on regulators to be alert to the new risks.

“As we have strengthened the regulation on banks, the risks have also changed,” he said. “We should not be blind to the fact that we have to address these new risks as they arise.”

Companies are turning increasingly to financial markets for funding, with gross issuance in the high-yield bond market alone soaring to $90 billion per quarter in 2013 from a pre-crisis quarterly average of $30 billion, the BIS annual report said.

Such offers found eager investors, including asset managers and pension funds, who were willing to take greater risk to meet return targets or pension obligations when interest rates, volatility and funding costs are all unusually low.

‘Catching Up’

Global equity markets have rallied and funding costs for lower-rated European governments have eased, helped also by stronger economic data and pledges by the ECB and the Fed to keep rates low well into the future.

Property markets are also heating up and the Bank of England sought to put the brakes on Britain’s surging housing market on Thursday by announcing a cap on home loans and tougher checks on whether borrowers can repay their mortgages.

Shin, who helped formulate Korea’s financial stability policy in 2010 when serving as a senior adviser to the Korean president, said advanced economies could learn a lesson from emerging markets in how to temper inflated asset prices.

Countries like Korea, Hong Kong and Singapore had successfully used macro-prudential tools, such as limits on loan-to-value or debt-service-to-income ratios, Shin said.

“There is some reluctance in advanced economies to use these macro-prudential tools and that’s because these tools are relatively untested in many cases there. There is some catching up to do, in terms of the familiarity,” he said.

Interest rates alone could be a very blunt tool to deal with soaring property prices, because they affected the economy as a whole, and combining rate policy with macro-prudential tools would make both more effective, Shin said.

(Editing by Ruth Pitchford)