Economic reforms may be too late

BY TRACY WATKINS

OPINION: So far the Treasury has used analogies including faulty toasters and a jar filled with sand, oil and water to explain the taxpayer bailout of South Canterbury investors.

With all due respect to the boffins, it's nothing like that. Toasters never go bung until the guarantee has expired.

A lotto ticket is a much better analogy.

Because that's exactly what the investors in South Canterbury Finance bought themselves when they chased big returns by ploughing their savings into Timaru millionaire Allan Hubbard's house of cards.

They've been rewarded for their risk- taking by a Government bail-out that not only preserves their nest eggs but pays out on the unreal 8.5 per cent interest rate the company had been offering.

For the tens of thousands of investors who saw $6 billion in finance company deposits wiped out before the deposit guarantee scheme came into effect, the memory of Hubbard supporters marching in Timaru streets in support of their hometown hero must stick in the craw.

To the many hundreds of thousands more mostly elderly New Zealanders, who saw what was coming and stashed their money in low risk-vehicles – the big trading banks in the main – it must stick in the craw just as much.

They have been penalised two and three times over for their caution; historically low interest rates have slashed the returns on their nest eggs, the big banks paid the bulk of the cost of the deposit guarantee scheme, and now as taxpayers they must help foot the bill to save SCF's investors from themselves.

So to describe the SCF mess as a headache for senior Government ministers is an understatement.

No wonder they harbour strong feelings over the flak they have copped from their rural heartland while trying to pick a way through the SCF minefield in recent weeks.

They may have chosen their words carefully in public in deference to the ageing Mr Hubbard's reputation and declining health – but in private they are furious over the messiah status accorded the South Island's richest man and the way he has rallied support against the Government as various agencies attempt to get to the bottom of his business dealings.

Finance Minister Bill English was unable to bite his lip before blurting out that it might be nice to see some gratitude from the South. Given the fiscal straitjacket Mr English has been forced to operate under as finance minister for the past two years, the news that he would have to fork out $1.6b to 30,000 SCF investors must have been hard to swallow.

The Government has clearly minimised the taxpayer's exposure by acting so swiftly to effectively seize control of the company once it became clear there was no saving SCF.

But a question mark remains over whether the Government should have tightened up the criteria surrounding the deposit guarantee scheme earlier (changes are due to take effect on October 12) and even whether the deposit guarantee scheme has been allowed to remain in place too long.

In a normal world, investors chasing high returns are expected to wear all the risk.

But in the post-GFC (global financial crisis) world, the normal incentives to avoid risk no longer apply. As long as the government guarantee remains intact, it is a perfectly rational decision of investors to chase high returns in high-risk ventures covered by the scheme.

Of course, in the turbulent days when the deposit guarantee scheme was designed against the backdrop of chaos and carnage in global financial markets, all this was known.

No-one was under any illusion that a gold-plated government guarantee on savings would create distortions in the market and incentivise risk-taking. The problem was that the alternative was so much worse it didn't bear thinking about.

Reserve Bank governor Alan Bollard, in a book that is due to hit bookshelves next week, describes the massive run on $100 notes in the leadup to the deposit guarantee scheme being put in place.

It wasn't difficult for the Labour government of the time, or its advisers, to join the dots. Panicked savers were cleaning out their bank accounts for fear of a banking collapse such as those seen in the United States and Europe.

Once Australia and other countries around the world moved to implement deposit guarantee schemes, New Zealand had no choice but to follow or risk a crippling flight of funds out of the country. That would have dealt a death blow to the economy.

This is where Treasury's toaster analogy comes in (forget the sand analogy, it's way too complicated). Having delivered a cast iron promise to protect savers' funds, the Government had no choice but to pay out to SCF investors, or trigger a massive loss of trust and confidence in the Crown.

Compared with the massive economic cost of such a loss of confidence, a $1.8b cheque looks small by comparison.

But Mr English and Prime Minister John Key are well aware of the potential for a backlash to what looks like favourable treatment of one group of investors over another – that is why they have been at pains to point out that they inherited the scheme from Labour.

And of course the Government would rather focus on the $600m figure it has calculated as the limit of the taxpayers' exposure once SCF's assets have been sold.

BUT IT could be years before taxpayers get a return on their investment, and in the current environment there are no guarantees that the assets will be sold for anything like their book value.

In the meantime, incentives remain for depositors to chase risky returns.

Mr English and Mr Key have said they won't be bringing forward the end date of the deposit guarantee scheme. They are banking on the revised criteria that kick in next month protecting taxpayers from any more big payouts between now and then.

They'd better be right, considering that taxpayers will probably balk at another big payout.

But the deposit guarantee scheme doesn't deserve their ire. It has worked as it was supposed to. The real problem is that it was forced to operate in an imperfect system.

The failure of successive governments to clean up a cowboy finance sector should be the real target of taxpayer fury.

The cost to the economy of the string of finance company failures since 2006 has been a massive destruction of wealth, matched only by a massive loss of confidence in the financial markets.

Commerce Minister Simon Power puts the value of deposits affected by finance company failures at $8b plus.

His efforts to clean up the sector come 20 years after a similar loss of confidence in the sharemarket, triggered by the loss of retirement nest eggs in the sharemarket crash.

In the two years since National took office, Mr Power has undertaken a huge programme of work to restore confidence in the financial markets through a series of sweeping reforms – the most significant in more than 30 years.

Seeing that the weakness of our capital markets has been identified as one of the biggest handbrakes on economic growth, the reforms are long overdue.

The tragedy is that they may also be too late.

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