Thoughts on South Canterbury Finance saga

The receivers are in, and the government is throwing in $1.7bn in order to buy assets they expect to get a return of $700m from.  Sounds like a typical New Zealand investment to me 😉

There are a few points to come out of this.  In some sort of order these are:

  1. The government had to pay the money when the receivers came in – they had no real choice, after all SCF was guaranteed by government.
  2. However, it does show you the type of cost that can be associated with such a scheme – and raises the question of whether putting finance companies in the scheme was a good idea (both Agnitio and myself were skeptical).
  3. It is apparent that the scheme may have led to some dodgy lending in that sector.  I am genuinely concerned about what other moral hazard issues will appear over the coming year – is this just the tip of the iceberg from a poorly designed scheme, or is it just one unfortunate failure.
  4. Questions have to be raised regarding the price placed on risk by the guarantee – was it really high enough?
  5. Why is anyone defending Alan Hubbard when he used other peoples money to make risky bets that made people like him – just to fail and have the rest of New Zealand paying for it?  Running a company under a government guarantee and not following best practice is immoral – no matter who you are.
  6. This can’t be compared to TARP, and the lack of insurance would not have made this like Lehman Brothers.  The scope for contagion from a finance company failure like this is small – which implies absent the scheme the government should have just let this company fail.
  7. Another nail in the credit rating coffin?  What credit rating did SCF have at the start of the deposit guarantee scheme?

Another point is that this statement:

Furthermore, being in control of the receivership process takes the pressure off the receiver to quickly sell any assets

Is actually a good one, if they feel the assets would be shot off at fire sale prices.  This is one of the main lessons from TARP.  However, the sad thing is that the government is stuck buying them at an inflated price instead 🙁

Surely this tells us that it is at least near the time to get rid of this deposit guarantee scheme – and why not do it retroactively so they all don’t “fail” just before the scheme runs out.  Investors that get burned because they saw a high return and decided to face a high risks should have to deal with the consequences of it.

Update:  Bunch of details listed down on Rates Blog.

  • Cullen and Key should be jointly liable for losses here. Having dodgy finance companies included in deposit insurance, if I recall correctly, came from a stupid Cullen decision mid election campaign 2008, with Key just signing on for whatever Cullen came up with.

  • @Eric Crampton

    Yar, the decision to include finance companies was a shock – and everyone was saying it was a mistake.

    Hell to start with they were actually charging fees that were related to size – so finance companies had to pay proportionally less for complete insurance!!! They realised the mistake and based it on risk in the end – but credit ratings are currently rubbish AND it could be argued that the cost placed on risk was too low.

    Complete mess.

  • Am drafting post currently….

  • Miguel Sanchez

    To answer what I think are the non-rhetorical points:

    3. SCF did its dodgy lending before the guarantee was introduced. One of the troubles that finance companies have had is that most deposits have been going into terms that end just before the expiry of the guarantee (this October). With no visibility around their funding beyond that date, they haven’t been able to lend for any length of time either. Combine that with SCF’s ongoing cash shortage and I doubt they’ve done any lending in the last two years. There will be others in the same position, but not of any size – SCF is more like the underside of the iceberg than the tip.

    4. The problem was not just the price, but the fact that initially it was only charged on growth in the loan book since Oct 2008. So those that haven’t done any new lending (due to above) have had the guarantee for free.

    5. Because talk is cheap. How many of his defenders were willing to put new money into the business?

    7. Credit ratings will remain alive and well for as long as it’s the debt issuers footing the bill for them.

  • @Eric Crampton
    Hi, Why are worry about this topics.Government work on their way.They also use good economic experts too.So Don’t worry about this issue because this is not our matter.

  • Richard

    Is it wrong of me to get a slight warm fuzzy from seeing the SCF shareholders get wiped out? Sets a good example for the next investment crisis.

  • Government’s deposit guarantee was a stupid idea to begin with.

  • Kimble

    I think SCF was still BBB- before the guarantee.

    People invested a lot of money because of the guarantee. Yes, it was essentially “free” money given away by the government but the governments credibility was on the line. If they cancelled the scheme, they would be screwing over the people that invested relying on the guarantee. Pretty unfair I reckon.

    I would compare it to government creating a tax on the income you tell other people you make, and then back-dating it to when you first started dating shallow city chicks.

  • @Kimble: The answer would have been to switch quickly to actuarily-fair rates and let companies decide whether or not they wanted to stay in.

  • Kimble

    @ E.C: The thing should have been priced properly from the first. But once it was sold I think the solvency of the companies became very sensitive to the scheme. I think it is likely that the increase in price of the guarantee might have been enough to force liquidation of the company anyway.

  • Greg

    What I can’t understand is why the guarantee didn’t limit investors to receiving back only the money they put in? You could possibly adjust for inflation, but the timeframes are likely short enough that this is a minimal adjustment.

  • @Kimble: If they liquidated because they couldn’t pay the fair premium, then we wouldn’t be liable for the costs. Seems a good thing to me.

  • Kimble

    @E.C: I reckon the liquidation would have occurred before the guarantee was up. There had to be continuity of guarantee for those staying in the scheme. So the new scheme would have to be announced before the previous guarantee expired. This gives some companies time to reveal the truth about their sustainability and announce their collapse, leaving us on the hook anyway.

  • Kimble

    Questions: is this the death of the NZ finance company? Should it be?

    I would be interested to hear what people think.