By Gareth Vaughan
Finance Minister Bill English has acknowledged Treasury didn't immediately establish the type of checks and balances you would expect for the management of such a big taxpayer liability when the Crown retail deposit guarantee scheme was set up in October 2008.
However, English has also suggested the only way Treasury staff could've been more interventionalist in their oversight of the scheme, which at its height guaranteed about NZ$133 billion, would've been by becoming directors of the companies participating in the scheme and taking over the running of them.
Answering questions in Parliament yesterday from Labour Party finance spokesman David Parker, English said it should be remembered the guarantee scheme was set up by the previous Labour led government with the "correct" focus of protecting depositors at the height of the global financial crisis.
"It was not intended as a means of running the companies," said English.
"While some people say that there should have been more intervention, no one has actually said what that intervention should have been short of becoming deemed directors of the company, and therefore essentially taking over the running of it," English said.
"And that, as I understand it, was never the intention even of the previous Labour government when it set up the guarantee."
Intensive monitoring started only after first failure
Parker was questioning English about revelations in Auditor General Lyn Provost's report on the implementation and management of the scheme. The report notes Treasury didn't begin to intensively monitor individual companies until March 2009 when Mascot Finance, the first of nine finance companies to fail with debts guaranteed by the taxpayer, was tipped into receivership.
Mascot's application to join the scheme had been approved as recently as January 12, 2009, just under two months before its March 2 receivership. Mascot was a property lender in wind down mode that Westpac had withdrawn a NZ$650,000 standby loan from in June 2008. It's demise saw NZ$70 million of taxpayers' money paid out to investors.
Parker said Treasury's main excuse for not monitoring finance companies or advising the Minister (English), as told to Parliament's Finance and Expenditure Select Committee by Deputy Controller and Auditor General Phillippa Smith this week, was that Treasury doesn't like to intervene in financial markets. He asked English whether he agreed with the Auditor General that this didn't withstand scrutiny given the Crown had already intervened through the establishment of the guarantee scheme and should've been guarding against that risk growing unwisely.
"The Auditor General's report says it took five months for Treasury to begin monitoring. South Canterbury Finance's deposit base rose 25% in the first four months, and it increased its loans including many new loans capitalising interest, in other words Ponzi schemes, and second mortgages, all of which increased the risk profile under the guarantee," Parker said.
English acknowledged that in the early stages of the scheme Treasury "did not have immediately in place the kind of arrangements you would expect for the management of such a large liability." Furthermore he said he received no written reports from Treasury about the increased Crown liability in the first few months of the scheme as companies increased both their borrowing and lending. However, English said he discussed the management of risks associated with the scheme "regularly and intensively" with the Treasury.
NZ$133 billion was guaranteed by taxpayers
At the height of the scheme taxpayers' were guaranteeing deposits worth about NZ$133 billion with 72 financial institutions including the big banks, building societies and deposit taking finance companies. The National government replaced the original scheme when it ended in October 2010 with the extended Crown retail deposit guarantee scheme, which ended on December 31, 2011.
Nine finance companies were tipped into receivership while participating in the schemes, led by South Canterbury Finance, from whose demise the government expects to recoup about NZ$680 million leaving a loss of about NZ$900 million.
The others to fail were Mascot Finance, Strata Finance, Vision Securities, Rockforte Finance, Viaduct Capital, Mutual Finance, Allied Nationwide Finance, and Equitable Finance (which failed whilst in the extended scheme after Treasury allowed it in against the advice of the Reserve Bank). All up, taxpayers have paid out NZ$1.897 billion to investors in failed firms. Last October English said the total amount recovered and repaid to the Crown from the nine receiverships so far was NZ$523 million, with about NZ$395 million of this from South Canterbury Finance.
South Canterbury Finance was the big kahuna of the scheme, from a payout perspective, comprising NZ$1.58 billion of the NZ$1.97 billion in taxpayer funded payouts to investors.
Up to the Crown's June 30, 2011 financial year end, fees collected from participants in the retail deposit guarantee schemes totaled NZ$355 million, effectively helping to offset some of the losses. Still, based on the recoveries disclosed by English and the fees collected, the taxpayer's still just over NZ$1 billion out of pocket with the thick end of that likely to be the ultimate loss given further recoveries from the nine receiverships probably won't amount to significant sums.
Of South Canterbury Finance, English said in early 2009 it was regarded as a "large, strong, sound" finance company.
"But in hindsight it now appears their bad lending practices meant that regardless of the guarantee they were going to fail because of the impact of the global financial crisis," English told Parliament.
"It actually took most of 2009 for anyone to get enough information about their activities to understand that it was likely to struggle to survive and matters went on for another six to eight months with every effort being made to protect the taxpayer by supporting South Canterbury to trade through. As it happened, they couldn't."
English is wrong to suggest the only way Treasury staff could've been more interventionalist in running the scheme would've been by becoming directors of the companies participating in the scheme and running them. In fact his comments smack of the same ideological, dogmatic thinking in a situation where pragmatism was required that I accused Treasury of in this opinion piece last October.
In her report Provost had some alternative suggestions:
The Treasury was responsible not only for implementing the Scheme but also for giving ongoing policy advice to Ministers on possible ways of enhancing the Scheme. Although there were ongoing discussions with Ministers about policy settings, we did not see evidence of strategic analysis of the range of options alongside the unfolding risks. In particular, we consider the evidence of increasing deposits and liability should have prompted more policy work.
For example, early in the Scheme, the Treasury could have considered whether it might need additional powers to ensure the effectiveness of the Scheme. These might have included powers to issue directions, restrain activities, require extra capital, or improve risk management practices.
We understand that imposing constraints on weak institutions to stop them making their financial exposures worse was a common feature of deposit guarantee schemes in other countries.
There was also the Viaduct Capital option, which Treasury could've used on other companies too. What Treasury did here was withdraw the guarantee but still cover deposits made with Viaduct Capital up to a certain date. This was done to Viaduct because its business was being conducted in a manner believed to be inconsistent with the intentions of the Crown.
Wasn't South Canterbury Finance just as guilty on this front? It was able to offer 8% annual interest rates to investors, well in excess of rivals, to punters who knew that whatever happened, thanks to the taxpayer guarantee, they'd get their money back plus the promised interest.
And instead of rubber stamping South Canterbury Finance's entry to the extended guarantee - appropriately on April Fools Day 2010 - when Treasury knew it was more likely than not the company would fail, surely it was time to call in statutory managers? We know that government agencies were talking potential statutory management - of South Canterbury Finance not its then owner Allan Hubbard - as early as October 2009.
As Provost's report points out the scheme was effectively cobbled together on the evening of Sunday October 12, 2008 in a hasty reaction to news of Australia's scheme. In the haste no specific reference was made of a need to minimise taxpayers' liability. The scheme's primary purpose was to maintain the confidence of depositors and the public in the financial system. No banks failed and there was no run on bank deposits. But Treasury, as manager and guardian of the Crown (read taxpayers') finances, ought to have had more focus on limiting taxpayers' liability.
Provost adds that even when Treasury started closely monitoring companies viewed as risky it was largely only doing so to prepare for potential payouts.
It did not see itself as able to interact with a finance company to attempt to moderate that behaviour, even when it could see the Crown’s potential liability increasing markedly. The view appeared to be that it was better to recover what funds it could after an institution failed, than try to influence events before a failure.
Treasury boffins were being reactive rather than proactive when if ever there was a time to proactively intervene in the affairs of private companies - given the risk carried by taxpayers who Treasury staff as public servants represent - this was it.
This article was first published in our email for paid subscribers this morning. See here for more details and to subscribe.