Mike Clark
Consulting Actuary
In one of my all-time favorite films, Frank Capra’s holiday classic It’s a Wonderful Life, the protagonist George Bailey (iconically played by Jimmy Stewart) is about to escape small-town life once and for all to live his dream. Finally, after years of crises that kept him nailed down at home, he was about to see the world on a honeymoon with his new bride Mary (played by Donna Reed) and a wad of cash. (“We’re gonna shoot the works ... the richest caviar and the hottest music and the prettiest wife!”)
But a funny thing happened on the rainy drive to the airport. Nervous crowds gathered outside Bedford Falls’ financial institutions. Just as it seemed worry had taken a holiday, Ernie the cab driver pulled over and declared, “Don't look now but there's something funny going on over there at the bank, George. I've never really seen one, but that's got all the earmarks of being a run!”
Just like that, an unanticipated event suddenly appeared to dash George’s plans. He never does leave Bedford Falls. (The movie is 77 years old so I feel no spoiler guilt!)
At least it’s dry
A modern version of this scene played out on March 10 when the FDIC took receivership of Silicon Valley Bank (SVB). Phone apps and laptops took the place of umbrella-toting citizens queued up on sidewalks (at least any soakings won’t be literal) but the effect was about the same. Panicked withdrawals overwhelmed liquid assets, forcing the sale of long-term securities at depressed prices to satisfy cash calls. (Kind of like Mary Bailey handing out their honeymoon bankroll in It’s a Wonderful Life, though she ended the day with $2 left.)
The emergency liquidation forced recognition of losses from selling bonds for less than they were purchased, which hurled the bank into a rapid spiral of failure. All in all, a surprisingly simple catastrophe compared to some prior, more complex credit-based crises—and one that unfortunately appears to be spreading to European banks as this goes to print.
Not on the bingo card
Localized shocks like the SVB collapse often fall outside the field of vision of those managing risk for defined benefit (DB) pension plans. Most attention recently has been focused on macro questions like the Federal Reserve’s plans for interest rates and whether the economy can be cooled without triggering a recession. “Bank failure” simply wasn’t on many bingo cards.
Either way, when the invisible hand unexpectedly pulled the “bank failure” ball out of the cage, a flight to quality quickly ensued—the worst-case scenario for DB plan funding ratios. [See previous blog Double Dutch.] Flights to quality are marked by simultaneous asset losses and liability increases—much different than 2022 where both declined steadily with little effect on net positions.
Stocks have shed almost 5% since the initial SVG announcement but falling bond rates have generally done the real damage. Longer duration rates used to measure pension liabilities fell over 50 basis points in just a few days, which increases a typical market value pension liability by 5% to 8%.
Bank on uncertainty
Most diversely allocated portfolios quickly lost several percentage points on their funding ratios, which can cause balance sheet and glide path discomfort. Positions are still better than a year ago, so hopefully the current problem is relatively contained and the negative impact is short-lived.
But the SVB failure is a good reminder that the only thing certain about life is its inherent uncertainty. (That’s why we use the word “risk”.) The sad truth is that there is no guarantee any of us will ever get out of Bedford Falls.
While making grander honeymoon plans, though, fiduciaries can improve pension risk mitigation through liability-driven investment (LDI) strategies to help against sudden interest rate movements no matter where they originate. Somewhere between this market shock and the next, an increased commitment to LDI may be enough to allow pension fiduciaries to relax a bit and get on with living their Wonderful Lives.
