The UK LDI Gilts blow up rhymes with GFC 2008 and AFC 1998

Mark Twain once said that “History never repeats itself, but it does often rhyme.” This is certainly true of financial cycles.

What all have in common is an attempt to use derivatives and leverage to make something risky appear safe.

If you understand the above you are all set and can skip to the end for the conclusion. If not, read on while I break it down.

UK Gilts market = UK sovereign bonds – like treasury bonds for American readers. Ok nothing esoteric there. For my story on how I first learned about Gilts please click here.

LDI = Liability Driven Liability Driven Investment. This is a bit esoteric. My super simple explanation is that LDI is a derivative instrument mostly used by defined-benefit pension plans to insure their liabilities, so that they can improve returns via leveraged fixed income trading.  For my story on who taught me enough about derivative instruments please click here

GFC 2008 = Global Financial Crisis. This is well known. Although American in origin it was Global because America is such a big/important market.

AFC 1998 = Asian Financial Crisis. This is less well known. It was mostly limited to Asia, so it was traumatic locally but not globally.

First, these 3 crashes are different in two obvious ways location & market:

  • Location. Gilts LDI = UK, GFC = USA, AFC = Asia
  • Market. Gilts LDI = leveraged fixed income trading, GFC = Consumer Real Estate, AFC = Currencies

What all three have in common is dressing up something inherently high risk –  leveraged fixed income trading,  consumer real estate, currencies – to make it look safe. The old age is “if it looks too good to be true it probably is”.

Gilts LDI is in the news at the moment. I believe it will be more like AFC than GFC – traumatic locally (in UK) but not globally.

Image source.