The panic to bail out SCF reveals cracks in the economy, writes Gareth Morgan, director of Gareth Morgan Investments.
Let's hope the unfortunate demise of South Canterbury Finance is the closing act of the era of financial sector profligacy.
That indulgence has been responsible for a lost decade of raising living standards. It's a scary indictment that the economy remains so fragile the Government has moved to take control of that firm's receivership - appointing bailiffs under direct orders from the minister, who will decide with what haste assets will be sold and proceeds recouped because to leave the normal commercial receiver processes to play out will threaten economic stability.
Alan Hubbard would have us believe there's nothing amiss, that if creditors just sit tight their investments will reappear - and in Timaru and Hobbiton many still believe that. The Government's view is not just less sanguine than Mr Hubbard's but reflects terror of the domino effect on property and farm prices, should an unseemly "race to the bottom" be precipitated by lending houses fire-selling assets before their value drops further.
In other words, SCF is too big to fail. If we accept that SCF would have been New Zealand's Lehman Brothers if the Government hadn't stepped in, then the obvious question is to understand how one of the country's largest and most respected non-bank lending institutions managed to unhinge itself from reality like this.
Only then do we have a chance of financial sector reforms that actually have content.
We know, and the Government has acknowledged, that part of the disintegration of prudential standards at SCF was triggered by the Government guarantee scheme.
The moral hazard that intervention presented lay in SCF being the recipient of a funds inflow tsunami, that weight of money spurring management to biff the surplus at anything that looked remotely possible of earning a return. But it would be an exaggeration to think of this as anything more than the icing on a cake of half-baked lending and governance.
The firm's penchant for capitalising interest - a stunt that signals loud and clear a lender assuming a quasi equity position under the guise of so-called lending; its pursuit of deeper subordination to other creditors in its lending practices; the extension of its lending to activities that historically it wouldn't have a bar of and its loose governance of the rights of depositors - all belied its "mom and pop" persona of country values. In this instance, the Waltons were way off beam.
But SCF is no isolated instance of lender derangement, of course - indeed, it's one of the last in the sector (we all hope) to implode.
That raises questions, yet again, about the regulatory environment that facilitates such delinquency en masse. For some years now, the indications of a forthcoming Jonestown among our lending fraternity has loomed.
Farm prices have long been driven up to unrealistic levels where the income yield no longer matters because it's all about farming for capital gains. That asset class continues to defy gravity - courtesy of petrified lenders too scared to set off a domino value demolition - and remains overvalued on any fundamental basis. The Reserve Bank has moved to direct the banks to be more prudent here but until income yields on those assets are at the 6 to 8 per cent mark, the sector's value will remain on the endangered list.
But the most gross distortion of asset values remains property in general. A couple of decades of extremely ill-conceived Reserve Bank guidelines to lending directives to banks have made this happen. Its belief that lending on property is somehow "better" or less risky than any other form of lending has produced a gross distortion in our capital markets.
The net result is a landscape littered with half-baked hotel, apartment and vineyard developments, a rising count of empty buildings as tenants signal they cannot afford yesterday's rent rates and a mass of residential property owner-occupiers in denial about the real value of their houses.
If they were to try to trade their houses to the extent they would have just two years ago, they'd find out they are worth 20 per cent less. When you're geared to the gunnels, that reality doesn't bear facing.
Reserve Bank prudential policy, wherein it has directed lending institutions to favour lending on property over all other forms of lending - in a jurisdiction where there is no tax on capital gains - has been the poison pill that has contaminated New Zealand's economic prospects. Accordingly we now sit, still sinking down the OECD league tables with South Korea now passing us by.
A myriad financial sector reforms are trying to lift competence levels in the private sector, minimise conflicts of interest and related party swizzles and align the sector's behaviour with consumer preferences. But despite a plethora of taskforces, we still haven't paid any attention to the standard of competence that has undermined the Reserve Bank's prudential supervision of the banking system, which time and time again can be shown to have been the largest single piece of policy negligence of the past 20 years.
The officials responsible for it should at least be subject to an inquiry - not as part of a witch hunt but to make them justify (or not) the directives they've made to the banks - the bill for which we as taxpayers now have to fund.
If New Zealand is going to go forward in any sort of sustainable way after this meltdown of asset prices that still threatens, then the rules governing our financial sector must align with the goal of sustainable economic growth.
A public self-examination is overdue for Reserve Bank governance of the banks - and we all agree, don't we, that taxpayer-guaranteed banks these days are little more than arms of government lending policies. Bring it on.