Ritchie on gilts

This is an interesting little observation by our favourite retired accountant from Wandsworth.

Quantitative easing has indeed meant that gilts prices have risen (yields fallen, same thing). It\’s even possible that banks have been the major beneficaries of this. For the BoE buys the gilts from the banks, and old gilts will have been bought at above par values (for yields have gone down, prices on older yields must be above par).

It was in this way that the banks profited enormously from quantitative easing. Because the government was, effectively, forcing the price of gilts up by pushing the interest rate down in pursuit of its monetary policy the bank , without having to take any action or initiative  of their own, make a profit.

How much profit that was is hard to guess at. It would be invaluable if research was undertaken to establish this. But I suspect that a significant part of the £199 billion of spending on QE was turned, almost immediately into profit by UK based banks. It is this fact, and nothing else, that restored bank profitability and bank bonuses in 2009.

It\’s an interesting supposition, certainly.

I believe QE can work. But QE1 was captured by the banks.

That’s why QE2 has to be different.

So, is there in fact any research about what did happen?

Umm, yes, there is.

Over the 12 months to June 2009, banks increased their aggregate holdings in gilts from a slight negative holding to £120 billion. This is mainly due to additional requirements introduced by the FSA in 2009. UK banks are now required to strengthen their liquidity buffers by holding more assets that are high quality and have high liquidity.

Ah. So the banks have been net buyers of gilts then, not net sellers. So, no, QE hasn\’t all disappeared into the profits of UK based banks.

Another of Richard\’s suppositions destroyed by those pesky and inconvenient facts then.

Ritchie is, of course, writing a report on this. Be interesting to see if this misunderstanding still stands in it, won\’t it?

6 thoughts on “Ritchie on gilts”

  1. One of these days, someone is going to have to issue a book on “our favoured retired accountant”, giving a selection of his greatest hits, and Tim’s destruction of said. Get it out in time for Christmas!

  2. 1. A part of that £199 billion was easy profit made by the banks, but it was only a small per centage, so their net profit was maybe £1 billion or £2 billion.

    2. I find it highly unlikely that banks increased their holdings of ‘gilts’ in the narrow sense, they took that £199 billion QE money and deposited it straight back with the Bank of England. As at 31 December 2009, the combined balance sheets of the major UK banks showed over £200 billion on deposit with Bank of England (up from +- nothing a couple of years ago). Admittedly, these are just two different ways of the government borrowing money (hold gilts, have cash on deposit with BoE) but let’s be precise about which is which.

  3. as mark said, isn’t it easy to estimate? You just estimate how much higher you think bond prices were thanks to QE (say, 1%) and then apply that to the £200bn to estimate the gain the bond holders made from QE.

  4. Luis, on the day that QE was announced, the long gilt future jumped by about three per cent (it was even bigger in the USA), but from there on in, it is difficult to say whether long gilts would have been three per cent lower.

    So in theory, worst case, the loss to The Taxpayer was 3% x £200 billion = £6 billion, but we have to compare that with the interest saved, because the govt (via BoE) is now borrowing at 0.5% interest as against the 3% or 4% interest it was paying on the bonds before QE.

    Overall. the gain to the banks was probably only enough for two or three months’ bonuses, but this is good for house prices in Central London, which is what this is all about.

  5. Pingback: Green Quantitative Easing

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