Friday, September 3, 2010

What Price The Guarantee?

Amongst all the blog, talk back, letters to the editor and other hysteria surrounding the invoking of the Retail Deposit Guarantee for the benefit of SCF depositors (note, NOT for the benefit of SCF shareholders or directors) there is a huge vacuum where there should be informed and reliable commentary on the benefits New Zealanders have enjoyed as a result of the guarantee's existence.

I sincerely hope Fran O'Sullivan reads this and produces an authoritative and professional dissertation. Meanwhile Adolf will attempt a few amateur guesses at what might have been, had Cullen, Key and English not acted responsibly and astutely in times of crisis.

Michael Cullen introduced the scheme to stop a massive withdrawal of capital from New Zealand by foreign investors on whom we rely for the nation's working capital. We rely on them because too many brainless New Zelanders have all their investment eggs in residential property which in turn earns the nation not one penny of real (export) earnings.

Adolf is a rural valuer by profession so let's try and attach some values to the consequences of such a capital flight in late 2008.

  • The banks would have immediately stopped All lending and would have called in many loans prematurely as they struggled to maintain their prudential capital ratios as required by the Reserve Bank. As a result businesses would have immediately ceased all investment and employment with many shedding staff. The cost to the taxpayer in loss of taxation revenue and increase in social welfare? Maybe $2 billion in 2009.
  • Our international credit rating would immediately have been downgraded to junk status, resulting in a two, three or more percentage point increase in the cost of servicing our existing overseas gummint debt. The cost to the tax payer? Maybe $1.8 billion in 2009.
  • A massive number of skilled people would have fled to Australia. Let's imagine an extra 20,000 more than usual with 15,000 of them wage and salary earners paying on average $15 k tax. The cost to the tax payer? Maybe $0.25 billion in 2009.
  • As business and household spending contracted sharply amidst general panic and uncertainty, the nations GDP would have plummeted with resultant huge reductions in company tax and GST revenue as we moved into severe recession. The cost to the tax payer? Maybe $4.0 billion in 2009?
  • The gummint is forced to borrow heavily at high rates just to pay the extra unemployment benefits created by this sudden recession. The cost to the tax payer for the interest and principal? Maybe $2.0 billion in 2009?

So there's ten billion in 2009. It goes on and on and on and that's just the first year.

Just as the decision to bomb Hiroshima in 1945 caused the deaths of half a million people in return for the lives of three million, the decision to put in place the retail deposit guarantee scheme was the choice of the lesser of two evils. Some potential for minor fiscal pain instead of the inevitable cataclysmic upheaval which was the alternative.

People should not forget that if corporate doctor Maier had succeed in putting together a recapitalisation of SCF, the guarantee would not have been invoked and nobody would have said boo. That is why the gummint and the officials allowed SCF to remain in the guarantee system for so long, even though all was not well. It would have been irresponsible to have pulled the plug while there was a reasonable chance that the guarantee would not be needed. As soon as that last chance evaporated, the receivers were called in.

Talk of an electoral backlash is nothing but arrant nonsense from people who should know better. Instead, we have seen an example of superb economic management in the best interests of all New Zealanders, most of whom are intelligent enough to see the reality, notwithstanding many in the the media's best efforts to talk up a nonexistent disaster.


Eric Crampton said...

Is there any outcome under National that would not have been the best of all possible things under this the best of all possible governments?

Anonymous said...

corporate doctor, no wonder nz companies are screwed. how much of the really bad lending occurred with him at the helm?

Adolf Fiinkensein said...

Eric Crampton, instead of smart arse sarcasm, what about some factual response? Do I take it you would rather we did not have the guarantee scheme or are you just another useless academic socialist troll?

And since when has Michael Cullen been part of National?

Adolf Fiinkensein said...

Anon 9.25. If you take the time to look I think you'll find most if not all of it was under Maier's predeessors.

Eric Crampton said...

You have no clue how much it pleases me to be called a useless academic socialist troll.

There should have been a deposit guarantee scheme. But if it were extended to finance companies, it should have been done following Treasury advice to charge premiums that reflected credit risk. Cullen, with Key's agreement as best I understand things as the policy was implemented during the election campaign, put in a system that didn't adjust rates for risk. Once the scariest part of the crisis was over, Key should have moved to get premiums in place reflecting risk: any new deposits would only have been guaranteed at actuarily fair rates, while old deposits would have to have been grandfathered in.

David said...

Hear what you say Eric but you must remember that the guarantee was framed as something to provide comfort to those with surplus cash in the economy, not the mathematically inclined, actuarially savvy individuals who generally between them haven't a brass razoo and scratch out their livings by arbitraging fine opportunities that most of us wouldn't recognise if they hit us in the face.

As such it really had to be "all or nothing" to work

Eric Crampton said...

@David: Why does all or nothing require giving finance companies such a discount on their insurance premiums that we saw a big rush of cash out of the banks and into the finance companies when the scheme was put in place?

Adolf Fiinkensein said...

"Cullen, with Key's agreement as best I understand things as the policy was implemented during the election campaign, put in a system that didn't adjust rates for risk. "

Are you sure about that?

I thought I recall from somewhere or other that finance companies paid a significantly higher rate than trading banks.

Eric Crampton said...

When the scheme was first adopted, premiums varied only by the total amount insured, not by risk. Seriously.

Eric Crampton said...

The scheme was changed to reflect risk somewhat. But the direction of cash flows suggested that it was still a considerable discount.

James said...

Nice one eric...spanked adolf like a beeetch!


Adolf Fiinkensein said...

Oh dear James. Some spanking eh?

Now run along why don't you, before it gets dark.

Eric Crampton said...

See here for the rush of funds to finance companies.

Here's the schedule of premia that apply. Here's the changes made mid-stream to try and avoid some of the worst problems.

Unrated firms were charged a 300 bp premium on the growth of their book post 12 October 2008. Recall that a basis point is a hundredth of a percent. So a crap finance firm taking in $100 m in additional assets would pay $3m in insurance; that insurance, best I understand things, covered everything in the book.

I'm no expert on the scheme though so a useless academic socialist troll like me could easily have things wrong.

Anonymous said...

Gracious Adolf. A hissy fit. That's the problem really, smart and stupid comes in all colours and the message is what matters yet so many decide smart or dumb simply because of its red or blue origin. This is why politics is a cancer.

barry said...

Adolf - why is it that commentators blame property investors for buying property and not investing in other categories.


1. I did an exercise and found the historical share price of the top 15 NZ companies. 15 years ago (yes there are a few a bit younger so I had to start when they came onto the market) if you bought 1 share in each of them, they would have cost you $39. If you sold them recently you would have got back $35. This simply reflects the low quality of NZ managers and directors, and perhaps at the top of the list are the fund managers who seem to do bugger all to hold these halfwits to account (and for example the directors of AirNZ who voted to buy Ansett - they should have gone to prison)
And theres the 1980's collapse that many remember......

2. So the next possible investment would be finance companies. Hmmm - no need to say any more.

3. So whats left? Gold - well thats being heavily promoted just as its price reaches max and the current owners need to find a sucker to buy it off them.

4. Maybe consortium is a possibility. eg: 100 people put money in to buy a dairy farm. Bloody hard to organise and if you go to financial advisors they wont be promoting it - theres no money in it for them.

5. So whats left? lets face it the only remainder is property. Almost all property today is worth more than it was 15 years ago (ie: compared to the share prices in 1 above) and the owner has had anywhere between 5 and 8% rent return, and the value is very unlikely to be slashed by the stupid actions of a public company manager or completely disappear in a finance company.
And as soon as immigration starts on the up (and it will) the property prices will go up again.

Adolf Fiinkensein said...

Eric, you'd better check your maths.

Last time I looked, 300 basis points or 0.3% of $100 mil was $300k, not $3 mil. If that's all the likes of SCF were required to pay, then you are right in suggesting it was a ridiculously inadequate premium for risk.

Eric Crampton said...

Basis point: "A basis point (often denoted as bp or ‱; rarely, permyriad) is a unit related to the change in an interest rate, and it is equal to 1/100th of a percentage point.[1] [2] Put another way: 1 bp = 0.01%"

It was still ridiculously low. If SCF was BB at the time, they were only paying 100 basis points: 1% of the value of new deposits.

Paul Walker said...

"Do I take it you would rather we did not have the guarantee scheme or are you just another useless academic socialist troll?"

Eric a "academic socialist troll", now that's funny! I'll bet he has never been called that before.

But to the point about whether or not we should have had the guarantee scheme, we shouldn't have had it. The moral hazard problems alone are enough to be opposed to such a scheme. But if you must have such a thing then at least run it like a true insurance scheme and charge premiums based on the real risk. And there is still the question as to why you would want finance companies in along with the banks.

Anonymous said...

Although it sickens me I have to agree with you adolf.

People walk around saying SCF should be left to sink out of principle but given the multiplier effect of lending and the reliance of coys on bank funding the collateral damage would have been huge.

Anonymous said...

we may yet see the first casualty of the SCF collapse, in that the irrigation scheme for Canterbury looks to be literally up a creek with no paddle, as there is now one less potential source of finance for the project, despite finally receiving RMA consent (subject to appeal). Which is a further blow to the productive sector, in that increased yields from better irrigation will not eventuate, thus there are a few million dollars less for the likes of Bill Double Dipton to get their claws into

JC said...


A potential wipeout of rural property values due to no guarantees would be a huge long term boon, but it wouldn't happen because Labour would be back at the next election to istitute vast social programmes to deal with the shorter term fallout. There would be much higher taxes and migration would rocket etc.

If we could import Frank Bananarama as benign dictator for a decade we'd do very well from a huge property devaluation and a 25% reduction in core Crown expendture.

Not too good for the oldies, but.


kevin said...

Mascot was first in back over a year ago... another SI outfit

Adolf Fiinkensein said...

Eric C. I take your point (pun intendded.) I was wrong.

I see from John Armstrong's piece in today's herald that SCF was not paid out under the recently amended scheme but under the terms of the original Cullen scheme which expires in October 2010. That provides an answer to the question, why were they kept in so late. So I was right. It was a calculated and correct gamble to delay the collapse for just a few months until Maier could have a decent go at a rescue.

The damage would have been no little different if the plug had been pulled earlier.

Anonymous said...

Cactus Kate wrong again on the guarantee being breached, Red Alert are screaming about her great conspiracy on it. And Maier has a law degree from Havard, so she is wrong about him being 'lawyerless' too.

kehua said...

I see old Hubbo has enlisted the forces of nature to make his debacle disappear off the front pages. I personally think that we can no longer afford the South Island and therefore the cable should be cut and the mainland can float away taking its` problems with it.

Anonymous said...


A lawyer who represents him or herself has a fool as a client. Maier had no lawyer. Unless you are from SCF and involved in the company before and after the guarantee was signed I do not think you are qualified to state what you have with any certainty. We all await Hubbard's account of proceedings. Maier's account on National TV suggested the guarantee was breached as they wrote riskier loans after the guarantee was in place.