The Game of Consequences

I am guessing that Kwasi Kwarteng, now former UK Chancellor of the Exchequer, never played the children’s game of Consequences.  It is a pen-and-paper game that involves creating an imaginary scenario where each player writes something on a piece of paper.  They then fold the paper over, hiding what they have written and pass it to the next person to write something for the next step.  This continues until you have a series of folds hiding each of the steps of the scenario.

As an example, let’s say there are six players each with a piece of paper: step 1) they write down the name of A, fold and pass the paper on; step 2) the next person writes down the name of B, folds and passes it on; step 3) they add where A and B met, fold and pass on; step 4) what A said to B is added, before passing on; step 5) what B replied, fold and pass on; and step 6) they write down what happened next, fold and pass on.  Each player now has the piece of paper they started with.  In turn they unfold their ‘story’ and read out the complete scenario, often with hilarious results.  

Kwarteng’s mini budget on September 23rd led directly to the collapse of the pound, withdrawal of mortgage products and soaring interest rates/reduced prices for long-dated UK government bonds. The Bank of England also announced that, as an additional consequence of the Chancellor’s mini-budget, “a large number” of pension funds were in danger of going bust.

Manypension funds protect themselves from increasing bond prices, and the consequently lower yields, by hedging against such moves.  If they didn’t, they might find it hard to meet ever-increasing liabilities (what they need to pay out to pensioners).  These arrangements require the pension funds to post cash as collateral/security.  If bond prices then fall, the funds have to provide more cash as collateral/security to keep the arrangement in place.  

When bond prices tanked as a result of the mini budget on September 23rd, these pension funds were required to provide more cash, so they sold a lot of the bonds they had, which caused the price of bonds to fall still further meaning they got less and less for the next trancheof bonds they needed to sell.  It was the threat of such a doom loop that led the Bank of England to intervene with a promise to spend up to £65bn to shore up the situation by buying these bonds.

Any major decision to take action involves fully understanding the intended consequences of the action (and the risks that they might not be realised) and also fully understanding the risks of unintended second- and third- and even fourth-order consequences.  The children’s game has a structured approach to developing a scenario.  The Chancellor might have found it useful to adopt a similarly structured approach, and follow risk management principles at their most basic. 

Data Sources: tinkl.co.uk; The Guardian; The Financial Times.

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