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Opinion: Treasury's ambulance at the bottom of the Crown retail deposit guarantee scheme cliff wasn't good enough

Opinion: Treasury's ambulance at the bottom of the Crown retail deposit guarantee scheme cliff wasn't good enough

By Gareth Vaughan

Auditor General Lyn Provost's revelation that minimising the bill to the taxpayer wasn't as big a priority as it could have been to Treasury's boffins during their stewardship of the Crown retail deposit guarantee scheme is damning on a number of levels and smacks of idealogical, dogmatic thinking when pragmatism was required.

Provost's audit report on the implementation and management of the scheme outlines a Treasury busy parking an ambulance at the bottom of the cliff, waiting to pick up the pieces when companies failed, rather than getting their hands dirty at the top of the cliff in an attempt to minimise the taxpayers' bill.

This bill, remember, totals NZ$1.97 billion in payouts to investors' in failed firms. Of this NZ$900 million is expected to be recovered after receiverships and liquidations, although fees paid by companies in the scheme, totalling NZ$237 million up to June 30, 2010, will offset the losses a bit.

Provost notes that, before the global financial crisis, New Zealand was the only Organisation for Economic Co-operation and Development country without any form of statutory depositor insurance or depositor preference arrangement. Thus introducing a deposit guarantee scheme represented a major departure from this country’s long-standing approach to supervision and regulation, which favoured minimal intervention in the financial system and market based solutions.

With Treasury having championed minimal intervention and market-based solutions for the past 30 years, this particular government body and the Crown guarantee scheme were probably destined to be awkward bedfellows and so it proved.

Mascot's early warning signal

The first outward signs of problems came on March 2, 2009 with the receivership of Mascot Finance, whose application to join the scheme had been approved as recently as January 12, 2009. Mascot was a property lender in wind down mode that Westpac had withdrawn a NZ$650,000 standby loan from in June 2008.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.

Then there was Equitable Mortgages, which Treasury let into the scheme despite the Reserve Bank's view that the property lender, which ultimately failed whilst holding about NZ$178 million in Crown guaranteed deposits, wasn't eligible because it primarily provided financial services to a related party.

As Provost points out, Treasury didn't begin to intensively monitor individual companies until March 2009, when Mascot fell over. That's even though the nine finance companies that ultimately collapsed whilst in the scheme, or its successor scheme in Equitable Mortgages' case, started gaining approval from November 2008.

Provost rightly says Treasury should have established stronger governance and reporting frameworks.

We found no evidence of formal senior management oversight, such as a steering committee, to provide senior strategic direction and to ensure that all aspects of the Scheme’s implementation were addressed. More formal frameworks would have included clear roles and responsibilities for implementation and clear accountabilities for making decisions. We expected a gap in documentation in the hectic early weeks after the Scheme was introduced, but the documentation deficiencies continued for too long.

Some initial planning took place, but we saw little evidence of formal implementation planning discussions or documentation of important decisions and processes. No applicant was refused in the first few months of the Scheme based on the “other factors”, such as credit worthiness or business practices. Although we accept the need to process applications quickly, we consider that the Treasury should have made further inquiries about some financial institutions before accepting them into the Scheme. We did not see evidence that the Treasury sought additional information in the early days of the Scheme, even though there may have been some indications in the material considered that additional review was warranted.

We are not suggesting that these institutions should have been immediately declined, but further review would have placed the Treasury in a better position to understand the risks presented by these institutions. Although it was consistent with the supervisory model, we were surprised by the degree of reliance on the advice of trustees.

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.

South Canterbury Finance allowed to continue borrowing and grow lending

South Canterbury Finance (SCF) was the big kahuna of the scheme, from a taxpayer loss perspective, comprising NZ$1.58 billion of the NZ$1.97 billion in payouts.

In the four months after the guarantee was put in place, SCF's deposit base grew by a quarter and its loan book increased in the early part of 2009, with many loans made to property developers with capitalising interest and second mortgages, thus increasing SCF's risk profile in a sector where other property financiers such as Hanover, Bridgecorp and Strategic, had already hit the rocks.

So by the time SCF applied to join the extended Crown retail deposit guarantee scheme in January of last year, (it gained approval appropriately on April Fool's Day 2010), Treasury knew it was more than likely the company would fail and trigger the guarantee. But if the guarantee extension wasn't granted, Treasury's probably correct opinion was this would kill the company. So Treasury decided to rubber stamp its application thinking while SCF continued to operate there was the opportunity for a "private sector solution" to emerge to reduce taxpayer liability.

What about statutory management?

Instead of granting SCF the extended guarantee, Treasury could've pushed for statutory management. We know that government agencies were talking statutory management of SCF at least as early as October 2009 before ultimately deciding to put its owner Allan Hubbard into statutory management in June 2010, driving a nail into SCF's coffin as it was left to stagger on.

As for the hoped for private sector solution, this ultimately failed. To give Treasury credit where it's due, it did knock back the assortment of opportunists and bottom feeders, out to privatise the profit whilst leaving the risk with taxpayers, who emerged to pick over SCF's carcass. See more here in Alex Tarrant's story.

What about the Viaduct Capital option?

Another thing Treasury could've done with SCF, which it did with another firm accepted into the guarantee scheme in Viaduct Capital, is to have withdrawn the guarantee but still covered deposits made 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. Surely SCF was just as guilty on this front? SCF was able to offer 8% annual interest rates, well in excess of rivals, to punters who knew, thanks to the taxpayer guarantee, they'd get their money back plus the promised interest.

Then there were speculators who bought up SCF's NZX debt market listed bonds cheaply ahead of the receivership, and were handsomely rewarded by the taxpayer funded bailout.

Including finance companies in the scheme in the first place meant the New Zealand taxpayer guaranteed a broader range of financial institutions with a higher risk profile than in most schemes elsewhere in the world. This increased the potential cost to taxpayers and encouraged depositors to shift money to finance companies where interest rates were higher. The Government apparently decided, however, that leaving finance companies out of the scheme altogether could've caused the failure of a sector seen as important to the diversity of the financial system. As we now know few finance companies of substance survived anyway.

No objective of minimising the taxpayer's liability

Meanwhile, Provost points out that the objectives of the Scheme, which was effectively cobbled together on the evening of Sunday October 12, 2008 in a hasty reaction to news of Australia's scheme, didn't refer specifically to the 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 taxpayer's) finances, ought to have had more focus on limiting taxpayers' liability.

Provost says even when Treasury started closely monitoring companies seen as risky - after Mascot's demise - 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.

So Treasury was being reactive rather than proactive when if ever there was a time to proactively intervene in the affairs of private companies this was it. After all, it was taxpayers who were guaranteeing them and they who ultimately paid the bill when nine companies met their Waterloo.

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I think you mixed up the word - as a "boffin" refers to someone engaged in scientific or technical work - whereas our Treasury mandarins don't do any of that (as the article so rightly points out).... rather I think you meant to say "buffoons".

I like your comment, Kate!

Actually, the whole affair has been handled with disgraceful negligence & incompetence by Treasury.  I remember during that period various posters to this site bragging about how they were getting their high return thru SCF, with all risks carried by the taxpayer.  & good on them, they were just taking up the opportunity presented them on a plate by Treasury.   Absolutely scandalous.

It reflects just as damningly on the Govt, who control Treasury.  Again, total incompetence, when everyone else could see the risk.  Were they are ideologically blinkered as Treasury?  If so, heaven help us. 

It amazes me that the Opposition has been so quiet.  Is this because:

  • Labour actually set the original scheme, so they feel that any criticism might backfire on them?
  • They don't want to be seen to be saying anything that might be seen as criticism of The Saint of Timaru, considering that they will have political aspirations there?

Interested in thoughts.


Having made the very debateable decision to guarantee retail deposits I find it incredible they did not differentiate between existing and new deposits past start date.

Of course new money would flow to the new guarantees - and of course the companies would then embark on more wild schemes in a last throw of the dice.

Exactly what SCF undertook.

Always easy when it someone else's money ie Taxpayers !

EXACTLY. What we ended up with was the reverse of a run on the bank. It became a run to the bank. Sadly, yet another example of how compliant the average taxpayer here is, stuck on the state teet. This country is going nowhere fast.

@Kate - you may well be right.

But what has become evident in this excellent series of articles concerning the deposit guarantee scheme is Treasury's abject failure to devise a credible exit strategy. Or at best an inability to communicate such a strategy existed.

This a failing that can be ascribed to many of those purporting to be professional financial participants both here and abroad. 

It usually results from the appointment of those with the least direct market experiece and knowledge to positions of control.

In a previous proprietary dealing room life I came across this organisational deficit regularly.  

The promotion of accountants, lawyers and HR staff to positions beyond their ability to comprehend was the most disastrous.

Nevertheless, in a busy dealing room, these meddling neophytes were soon exposed for what they are and experience won out. Money had a way of talking. 

Unfortunately Treasury has too little opportunity to tune the hierachy on a daily basis in the face of what can only be described as financial war with participants acting as modern day gunslingers.

In times of relative calm those possessing the experience are passed over by the better connected and usually better behaved. Hence disaster follows disaster.  

Yes, while I was in central government, there was a clearly articulated paper from the SSC that said when hiring policy analysts (and the like), that experience/expertise in the operational area (i.e. fisheries, finance, mining engineering etc.) was less important than a candidates understanding of the policy development process itself.

Meaning: take on the "better behaved" (i.e. those compliant with the dominant ideology) as opposed to those more knowledgable in the practical aspects of the business to hand.

I recently went looking for this same document for some research I was doing - and it no longer existed on the SSC website.  Fascinating... but not that the "rule" has changed - it's just now unwritten policy for the "well connected" to implement from a top down approach.

My tax paid out the beneficiaries of these finance companies. I wonder what losses (joke) thta the family connections of Equitable Mortgages made!

And what political party do the  'speculators who bought up SCF's NZX debt market listed bonds cheaply ahead of the receivership' vote for. Methinks it wont be the party chosen by people who have their PAYE deudted from their minimum wage.

This is the reason why bureaucrats have a bad reputation.


The behaviour you allude to is non-partisan.

Actions conducted at others expense is not attributable to a political party. 

Those that cause such outrage as you express do it because they can regardless which poltical party rules the day.

The people are willing participants in as much as they foolishly believe complicity might bring them the same rewards. 

Politicians are captured not only by the moneyed but also by the majority of voters desirous of commiting the same indiscretions. 

Reading the Auditor Generals report is disturbing. About 12 months ago the question was posed here at as to why the government included Finance Companies in the scheme. No answers. During an interview with Alan Bollard, Bernard Hickey asked that very question. No answer. Now the Auditors report answers that question. Treasury outvoted RBNZ, because they thought there would be a run on the finance companies.

In guaranteeing both Deposit Taking banks (paying 5% interest) and Finance Companies (paying 10% interest) the Government effectively guaranteed the interest rate differential paid by the Finance companies. And lo and behold there was a stampede out of the banks into the Finance Companies. And why wouldn't they. Assuming economics is a pre-requisite to be employed by Treasury, even a 1st year economics student could have seen that one coming, if they had taken the time to ask the question, "what-if". What is more disturbing is the assumption by treasury there would be a run on the Finance Companies when basically they werent "Deposit Taking" operations. Most of the money invested with Finance companies would be in the form of debentures that are not on-call monies and can't be withdrawn instantly. That shows a complete lack of understanding of basic business know-how or acumen. Stupidity.

As alluded to by RobinT above:- who were the two biggest beneficiaries of the scheme. Looks like 2 rich-listers to me.

So at the end of the day, which was the predominant basis of this egregious failure?

1  Incompetence?

2  Ideology?

This is presuming that we can discount corruption.

Cheers, Philly

Allegiances, phone calls, the grapevine. The phones would have been running hot that night.

The lack of political fall-out is amazing. 

John Key is supposed to be the financial whiz-kid, yet he presided over this debacle.  As did Bill English.

At most, we are seeing muted criticism of Treasury.  & virtually none of the Govt.  Amazing.


"John Key is supposed to be a financial whiz-kid'. JK was a clever "trader" in currencies,not a proven financial whiz,in reality a clever gambler,and he shows all those attributes as a poli.

Alex:  The current evidence seems to suggest that you are spot-on in your analysis!  Not at all impressive performance from Key. 


@ Alex

John Key worked for Merrill Lynch - primarily an intermediary broking house - albeit a big one.

They were minnows in the forex interbank proprietary, market making arena, where the real action was seen. The likes of Citibank were the big boys in London.

Merrill issued research reports to clients recommending currency  trades - my understanding (and I could be wrong) is orders were aggragated and executed at one of the big market making houses and the execution price appropriately marked to the client to reflect a retail size trade.

And why wouldn't you if you could - no capital risk and excellent fee income  - that's what bookies do.

It's noticeable that Bank of America, Merrills new owner does not feature in the latest rankings.

Despite the report, no heads are chopped, no accountability for the gross incompetence. Maybe even criminal negligence. have a very big dog by the tail.....they would like this to go away......I sincerely hope that is not your intention........the word is out no breaks in the ranks....keep doing what your doing.....the muzzled Media will run with it if it blows but not, if you just fade away.

 Fantastic work on deserve a break , but keep making your own luck in the meantime ...yes..?

All the Best.

Thanks Iain ...lets hope the divots you leave provide some traction for those who follow this up.

from the Stiglitz interview-

''Another case would be they might say: ‘if we let the exchange rate fall it might make it very difficult for foreign creditors to get repaid.’ And I would say: ‘if you raise interest rates to try to keep the exchange rate from falling, it will cause enormous problems for domestic debt.’ They focused on the foreign creditors explicitly. And that led them in fact to pursue policies that were in many cases not actually good for the foreign creditors. Some people say: ‘well they didn’t save the foreign creditors’. That’s not the point. Their models were so bad that in trying to focus on the foreign creditors that they didn’t even serve what they were trying to do.

They believed raising interest rates would attract more capital into the country and that this would support the exchange rate. That was wrong because as they raised interest rates and cut back expenditures it led to deep recessions – and people leave countries in deep recession. So their simplistic models didn’t work even for the objective that they were trying to reach

Note though the comments of Eric Crampton at Offsetting Behaviour, as to where the blame actually lies:

  • Let's recall our potted history of the finance company bailouts. In short, in the midst of the 2008 election campaign, then Labour Finance Minister Michael Cullen wanted a deposit guarantee scheme to match the Australians. Our banks are Australian owned, so worries about differences in treatment across the ditch weren't crazy.


  • What was crazy was extending that protection to dodgy finance companies at no risk premium. Treasury worried that giving banks cover but not finance companies would have finance company depositors pull their funds and deposit them instead into banks (about which I'd have said "meh"), but Treasury also specifically warned* that they had to be charged a premium that reflected their higher risk. Instead, actuarially fair premiums weren't charged so we instead saw flight of funds into the dodgy finance companies.


  • Now everybody's mad that Treasury didn't do enough to stop it. Labour finance spokesman David Cunliffe was on Radio New Zealand this morning blaming Finance Minister Bill English and Treasury for the disaster. And National rightly takes some of the blame - they agreed with Cullen's rush-job deposit guarantee scheme and they subsequently didn't move quickly enough to force out the dodgy finance companies through higher insurance premiums.


  • I'm not really sure what Treasury could have done though once the Government had determined they weren't to charge premiums that differed by risk and while under government pressure to let everybody in. I'll have to read the Auditor General's report. It doesn't seem implausible that a Treasury juggling rather a few balls at the time could have fumbled one or two. But the root of the problem was the rush-job legislation with no provision for rationing access by differential premiums. And that goes to Cullen and Key, not to Treasury. 

A corrupt govt giving money to it's mates, and making the taxpayer pay.  Only the taxpayer is broke, so govt will borrow the money to pay for the mistakes of its mates and either the country will go broke or the masses will pay.

If there was any integrity in the govt, they would have stayed out of it alltogether, like they do with any other business or industry.  The crafar farms got no bailout, arguably they actually benefit the country through exports.  Yet these finance companies were used as proxies for the government to give taxed dollars to the rich.  Both parties are corrupt sides of the same coin, or else you would hear a lot more criticism.

On a slightly brighter note, the annual Crown accounts out today show Treasury collected another NZ$118 million in fees from companies in the guarantee scheme in the year to June.