A run on finance companies – but not in the direction you’d expect

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So investors are “rushing” to finance companies to invest money.  One of my economist friends just told me he tried to invest money in a finance company, just to be told that they were “over-subscribed”.

I have two concerns stemming from this:

  1. Moral hazard:  Finance companies will invest in higher risk ventures to get the return – knowing that there downside is covered by the government.
  2. Bank funding:  Given suggestions that banks may face a funding crisis, a movement of funds from banks to finance companies can’t be a good thing :P

I suspect that Bank’s decision to charge a premium based on the quality of investments will have some impact – however, is the premium high enough to solve these problems?  I guess we will know once we see the new set of deposit rates that finance companies come out with.

Posted in New Zealand Economics

About Matt Nolan

Matt Nolan is an economist at Infometrics (although the opinions expressed are independent of the organisation) . Email: matt@tvhe.co.nz; nolan.matt@gmail.com; matt@infometrics.co.nz. Work phone: 04-496-5290

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  • gomango

    Property mezz loans were 16 to 25% 18 months ago by the time you accounted for all the charges, PIK etc. Even with a 300 bp insurance cost there is still a significant margin if finance coys go crazy and pay 10 or 11% on deposits. Which they won’t do because they’ll argue the guarantee makes them as a good as bank, they’ll advertise at 8.5% and the grey rinsers will go mad for it.

    I just dont see why treasury/rbnz had to allow finance companies potentially in. All of them except the 3 that would survive anyway have already gone and artificially raising them from the dead is poor use of resources and a bad signalling mechanism. Their “assets” are generally worth zero by the time the the banks get back their first mortgage so essentially the insurance scheme is just allowing them to start a new business using exactly the same failed business model.

    We are seeing developers walk away from their failed projects and buying it back from the bank at 30 cents. Now we are gonna see finance companies reflate their businesses courtesy of the taxpayer – its a rort. There is just no way the rules will stop finance company shareholders stripping subsidised money out of the companies no matter how tight the rules are. Good time to be a finance partner at rmv.

  • John

    “We are seeing developers walk away from their failed projects and buying it back from the bank at 30 cents. Now we are gonna see finance companies reflate their businesses courtesy of the taxpayer – its a rort”

    Where’s the news media?

  • http://tvhe.wordpress.com Matt Nolan

    “There is just no way the rules will stop finance company shareholders stripping subsidised money out of the companies no matter how tight the rules are”

    In that case there is either an agency problem in the firm, or the the firm itself is only a short-run entity. In either case it doesn’t really matter – unless the government commits itself to always saving finance companies.

    If insurance was offered at the market rate and finance companies pick it up then there is no issue – as they would have to pay for the riskiness associated with there market structure.

    The issue that we might have is that lenders don’t realise the risk associated with the finance company – in this case we need better information, which is a role of government, and which is something the Bank is working on.