[12] As I will explain, that could relate to wrong way, risk, market dynamics, the behaviour of other market players, even operational details. I think further progress on both these fronts is needed if we are to be confident the counterparty channel is fully managed. Are these risks unique to non-banks? I think it’s helpful at this stage to ask whether these issues are unique, or if we’ve tackled them before in other contexts. And with that in mind, I’ll draw a very brief comparison to a market which has already been widely studied and embedded in the macroprudential toolkit: the mortgage market. Banks manage their exposures to mortgagors, through affordability testing, leverage limits and collateral. And that’s important from a financial stability perspective, given the feedback and amplification mechanisms that have been seen during stresses in the past. For example, stress test scenarios cover house prices falling and borrowers defaulting, and so can capture the potential for amplified price moves and a self-reinforcing price dynamic, as a result of forced sales by bank lenders into a falling housing market. Perhaps correlated falls in asset prices and leverage can create amplifying price dynamics in non-bank financial institutions as well as with households. In addition, in our financial stability analysis of the mortgage market, we recognise that reductions in spending by highly indebted mortgage borrowers as they keep up with debt repayments can create negative spillover effects to the rest of the economy.
And so pooled LDI funds became forced sellers of gilts at a rate that would not have been absorbed in normal gilt trading conditions, never mind in the conditions that prevailed during the stressed period. Other LDI funds, with segregated mandates, were more easily able to raise funds from their individual pension scheme clients. However, given their scale, at 85-90% of the market, some of these funds were also contributing to selling pressure, making the task at hand for pooled LDI funds even harder. And of course if the pooled funds had defaulted, the large quantity of gilts held as collateral by those that had lent to the funds would potentially be sold on the market too. With the gilt market unable to absorb such forced sales, yields would have been pushed even higher, making the scale of the selling need even larger still. This is the self-reinforcing spiral that the Bank intervened to prevent. The Bank’s 13 day and £ billion intervention was made on financial stability grounds. It was the first example of us acting to deliver our financial stability objective through a temporary, targeted intervention in the gilt market. But let me emphasise: the asset purchases were a means to an end. They were designed to create the right conditions in the right part of the gilt market for long enough so that the LDI funds could build resilience so that their leverage would be well managed once the asset purchases had ceased and should gilt market instability return.