When Lehman Brothers collapsed in 2008, interest rates were lowered to the floor to keep money flowing. It was necessary to allow governments to print money. Interest rates would then increase once markets had recovered. 

But this was the worst financial crisis since the 1930s, and recovery took a while. In fact, interest rates didn’t rise significantly until 2022, in response to rising inflation post-pandemic. “In 2008, capitalism did not almost collapse, it collapsed,” says George Lagarias, Chief Economist for Mazars. “The only way to keep it going was to print a lot of money and throw it into the system. They tried at different intervals to raise interest rates and stop quantitative easing, but they never really got off the ground because the market was reeling. It took a generation to get over what happened in 2008.”

For pensions, this meant bond yields were either extremely low or negative yielding. Pension funds started investing in much riskier equities just to deliver a return. “We ended up with, at one point, over $20trn worth of negative-yielding bonds,” says Lagarias. “They started to invest in equities because, quite frankly, they had little alternative.”

Now that interest rates are increasing again, the yields on bonds are increasing, which is causing bond prices to crash. “Bond prices crashed because they move in the opposite direction to yields. Yields have risen to the point now where they are healthy, but that was an extremely painful adjustment. We saw the worst performance for bonds in over 50 years.” 

Bonds have never lost more than 3% or 4% per annum, Lagarias explains.But last year, US bonds lost 16%. This wrought havoc with the risk management process, as it’s so unprecedented, he says: “Even stress tests are based on real events. And generally, banks and other organisations don’t manage money under a stress scenario. They manage money under favourable scenarios. This has caused a series of problems.”

Regional banks that held a lot of long-term bonds saw their value collapse; big banks have a very large pool of unrealised losses. 

“If I keep giving you cheap money every year, you’re going to get used to it,” says Lagarias. “Now you have companies that took on debt assuming interest rates would be low for ever. Nobody expected inflation to make a comeback – at least not with a vengeance.” 

When you have piled up all that debt, raising interest rates is dangerous because you have to pay more for it, Lagarias explains: “Companies now have a problem with financing that [debt] because they took it on assuming it to be cheap for ever.”

Because of that short-termism, companies and governments have been destabilised by the abrupt crash in bonds and, while it’s not as bad as 2008, it’s still having a major impact: “In my humble opinion, it’s worse in some ways; 2008 was mostly about stocks collapsing – but bonds are the bedrock of portfolios. It was the sensitive part of the portfolio that collapsed almost as much as equities. And that in and of itself is dangerous.”

Pension funds now need to figure out what losses they might have incurred. In the longer term, however, there is some cause for hope, as funds will be buying bonds with higher yields, which will make pensions more predictable.

“If interest rates go down again, they could find themselves with a bond yielding 5% and an interest rate of 1% or 2%. This won’t happen until the end of 2024 at the earliest, however.”

At the moment, we have a short-term yield curve, with short-term bonds delivering higher yield rates than long-term ones. “We need to get credit flowing again, so that long-term credit has a better yield. This will start happening after we have stopped hiking interest rates.” 

In the UK, Lagarias says we’re likely to see at least three more interest rate hikes, particularly as inflation isn’t coming down fast enough. This is due to shortages in the labour market, which is pushing wages up. “That creates a vicious cycle. The UK has become entrenched and the Bank of England won’t stop until that breaks.”

Ultimately, despite the long tail of the financial crisis, this issue could have been mitigated if interest rates had been raised earlier, and in a more manageable way. But the fear that the end of quantitative easing would cause another shock to the financial system made governments cautious. 

“Now we’ve had to stop QE because of inflation, and the system endured,” says Lagarias. “It turns out we could have done it earlier.”