Editorial: Investor rescue

OPINION: Thanks to a government guarantee, those people who invested in South Canterbury Finance, apart from shareholders, will not lose any money after the company collapsed this week.

Immediately after the company was placed in receivership, the Government bailed out investors for a total of $1.6 billion. Eventually, the Government will get some of this money back, but the bailout is certain to cost several hundred million dollars. Another way of looking at it is to say that all those who invested in the company, in order to take advantage of the higher interest it was paying and knowing the risk that involved, will get their money back, largely taken from the pockets of all taxpayers, the vast majority of whom chose not to chase the interest and take the risk. (The scheme is not free to entities that choose to join it but the fees last financial year amounted to just $74 million, not enough to cover the other failures it has paid out for.) Many taxpayers will be wondering whether the bailout is fair.

It is a question that was raised when the scheme was first introduced. Until two years ago, New Zealand did not have an explicit deposit guarantee scheme. This is unlike the United States, say, where depositors in retail banks have been insured since the 1930s. Even without one, however, it was widely recognised that there was an implicit guarantee. It was largely accepted that the government could not stand by if a major financial institution was in danger. This had, in fact, occurred several times during the 1970s and 1980s, most notably when the Bank of New Zealand became insolvent at the end of the 1980s.

The New Zealand scheme was introduced at the height of the global financial meltdown in October 2008. Only a year before, the British Government had been forced to intervene when the insolvency of a major lender, Northern Rock, had caused the first run on a financial institution since the 19th century in a panic that looked dangerously close to spreading to other concerns, both good and bad. In October 2008, with several giant uninsured American institutions collapsing, uncertainty about the safety of deposits was spreading around the world. Although no mainstream banks in New Zealand were in danger, the government was forced to guarantee deposits after first Ireland, then Britain, then (most importantly) Australia did so. The Australian move, under the then new Labor government of Kevin Rudd, took New Zealand by surprise. But after Australia acted, New Zealand had to follow in order to avoid a flood of cash away from banks domiciled here.

The New Zealand scheme was cobbled together by Treasury and Reserve Bank experts, more or less over a weekend. In a dubious move, the Labour government of Helen Clark kept the Opposition in the dark about it and, in a move of dubious propriety, announced it at the launch of the party's campaign for the general election. Because of the haste, the initial scheme was flawed and it has been tweaked a number of times since.

Guarantees of this kind are economically controversial. On the one hand, they can be seen as encouraging undesirably risky behaviour by banks. On the other hand, the failure of a large institution can have catastrophic ramifications, as the collapse of the uninsured Lehman Brothers concern in the United States in October 2008 dramatically demonstrated. That failure turned a moderately serious financial upset into a global economic calamity. Despite the urgency of the situation when the New Zealand scheme was introduced, some experts still had doubts about its risks. As the governor of the Reserve Bank, Allan Bollard, tells in a forthcoming book, neither his colleagues nor the bank's board were entirely happy with using taxpayers' money to guarantee bank deposits.

The scheme is due to run out in December 2011. At present 73 institutions with deposits of $133 billion are covered. But new Reserve Bank regulations about, among other things, the capitalisation of banks and other institutions and their reserve requirements have altered the financial landscape since the scheme was introduced. Although the economy is by no means robust yet, the financial world seems calmer. Whether the scheme will still be required after the end of next year must be open to debate.

- © Fairfax NZ News

Newest First

Oldest First

ds1   #1   08:41 am Sep 02 2010

Cut the scheme now and do what Labour would have done if returned to office - regulate finance companies.

Ad Feedback