Key Points:

In the beginning, there were the rotten eggs, finance companies which failed owing investors up to $2 billion dollars.

The public panicked.

There's a term in business for this panic. It's called the "contagion effect" and means that when a finance company collapses, small investors become jittery.

This nervousness grows with the collapse of every subsequent company and in New Zealand in the last three years a string of companies have collapsed or been forced to freeze investors' funds. Investors don't know who to trust, so instead of reinvesting with their particular finance company, they demand their money back.

Many finance companies, though, have lent the money out and can't give it back. Now, companies have frozen their funds.

Gone or frozen now is around $5 billion of investors' money _ money belonging to people who perhaps sunk their life savings or retirement nest eggs into finance firms, or who took out second mortgages on their homes in the hope of making a little bit more than they would at the bank.

People now face very uncertain futures.

While the global credit crunch played a part in feeding the jitters, and meant the lifeline of offshore funding was unavailable to troubled firms, financial experts told the Weekend Review that this situation is mainly home-grown.

When some firms failed, fear spread to sound companies which otherwise may have survived _ and still might _ had people not panicked and wanted their money out.

In the last few weeks the finance crisis buffeted some big, solid names: on August 4 AXA NZ suspended for three months redemptions by institutional investors from its Mortgage Backed Bonds fund even though it had not experienced abnormal levels of redemptions. The fund was concerned about investor confidence and acted pre-emptively after AMP and Guardian Trust suspended funds that invest in mortgages last month.

Herald columnist and financial author Mary Holm explains that at a very basic level, finance companies function in the same way as high risk banks. People deposit money with them and get interest. A finance company then lends that money to someone else, just as a bank lends money out often in the form of mortgages. The big difference, Holm says, is that finance companies lend the money to people who can't get a bank loan because their venture is too risky.

The finance company charges a higher interest than the bank and in turn can offer higher interest to lure depositors. In New Zealand, however, Holm says experts have been warning of two things for some years.

One is that finance companies have not been paying sufficiently high interest to take into account the high risk involved, and the other is that, ironically, experts have also warned people to be careful of interest offered at higher rates than the bank because higher interest equals higher risk.

She thinks perhaps instead of the people heeding the warnings, some of the finance companies took them on board instead and thought of a way around them.

"They thought `oh, well, we'll just offer not too much more than the banks, that will make us look lower risk and also reduce our interest expenses."'

So, says Holm, instead of offering 15 per cent to the bank's 8 per cent, they may have only offered only 11 per cent.

As a result, Joe Blow investor was lulled into thinking the investment was a little riskier than the bank, but didn't have a clue as to how risky it really was. And this is awful, she says.

"It made it even worse because these poor sods were not only taking high risks but were not even being rewarded for it."

She says the companies that got into trouble early on were the ones lending to people such as very high-risk property developers or buyers of used cars who, in the end, could not afford to pay the money back _ and this is where the trouble started.

When the downturn started in the property market the situation worsened, because some finance companies had lent money to a property developer with an agreement that the money would not have to be paid back for several years, perhaps until the development was finished or the units sold.

Sometimes such agreements are fine, says Holm, except that when the public became jittery after the first companies started crashing, instead of rolling deposits over they wanted their money out.

Those finance companies did not have the money to pay them out, hence the string of companies who have now frozen their funds.

A "mistiming" has taken place and in this, finance companies have made a pretty basic mistake, she says.

They have broken the golden rule of not lending money out long-term and borrowing short-term.

Investors faced with frozen funds have to be patient, she says. Even the most rock-solid bank could not survive a situation where confidence is so shaky every depositor wants their money out at once.

Chris Lee, managing director of sharebroking firm Projects Resources Ltd, says some good will come from the mess because at least the finance industry is being cleaned up.

Though this will be cold comfort to some.

One woman who contacted the Herald says she has contemplated suicide. She has lost or had frozen $20,000 with Bridgecorp, $30,000 with Five Star, $50,000 with Dominion, $15,000 with St Laurence and $20,000 with Strategic.

Lee says the real lesson in all this _ the one he wants to hammer home _ is that the problem in New Zealand was started by companies with no credit ratings and with no real capital.

"[They were] exploiting what I think was a very naive financial advisory industry _ you know, double brokerage and tickets to the World Cup and all sorts of incentives _ for them to get client money."

He estimates just six companies _ MFS, Lombard, Capital + Merchant, Bridgecorp, Nathans and Five Star Finance _ between them had a couple of billion dollars of the public's money.

"They were companies which, if they had been grocery shops, they'd have all gone broke because they all had far too little capital and they were all grossly overpaying themselves and doing things they had promised they wouldn't do."

A good example is Rod Petricevic, he says. The now-bankrupt Petricevic, Bridgecorp's founder and director, tried to transfer his Porsche into his family trust within a few days of the company going broke.

"That probably speaks volumes about the whole subject," says Lee.

Petricevic and co-director Robert Roest are on bail without plea on charges related to statements made in the company's prospectus and in a director's certificate.

The charges, laid by the National Enforcement Unit of the Companies Office, carry penalties of fines up to $300,000 and five years in prison. Bridgecorp went under owing $500 million.

Five directors of Five Star Finance also have been in court on charges relating to their company's demise. The Five Star group of companies lost about $80 million of investors money.

Lee doesn't blame the investors who have been stung. They were perhaps naive, but they were also exploited.

One thing is for sure, though, he says, and that is the sector will change. There already are far fewer companies in the industry and he predicts that within the year there will be more mergers and amalgamation, and more exits.

"[But] what we are going to end up with are companies that are all very, very good and who all have, I think, a genuine business model that will last."

The other upside is stronger laws. Already, financial advisers must disclose important information, from how much experience they have to their qualifications. And before Parliament is the Financial Advisers Bill. The finance and expenditure committee is pushing for the creation of tiers among financial advisers.

One would see those who give advice on complex financial products be directly authorised by the Securities Commission. Another tier would see those who give advice on simple products to be the responsibility of their employer who in turn would be registered by the commission.

The committee also wants a commissioner of financial advisers to be appointed to the Securities Commission.

Lee says that while these measures are overdue, public confidence may take time to recover.

"I think that, just like the 87 sharemarket crash, so many of the companies were completely nonsensical and just rubbish companies. It took years for people to get confident in the sharemarket again."

But at the end of the day, you want companies to be excellent and to be forced to set high standards, and this is happening.

And not all companies are in trouble. Lee says that some, like South Canterbury and Marac who lend money on the basis that they are repaid every month, rather than at the end of a property development, are doing well.

OUT OF POCKET AND ANGRY: WHAT INVESTORS LOST AND LEARNED

I have $56,000 frozen and at risk in this debacle. This is money accumulated for the sole purpose of easing the financial pressures of retirement. I believe it is criminal that the retired population will now spend their twilight years as paupers. There is also the disbelief and frustration at having been let down by expectations given by well-known identities such as Colin Meads (Provincial) and Richard Long (Hanover). It is time this type of problem stopped, with those responsible made to live in a manner that many of their investors will now have to live.
-ALLAN GRAHAM

Our son got his investment paid out from Hanover a few weeks before they froze all remaining funds. However, for several weeks before, they sent numerous letters asking him to reinvest his savings at 10.25per cent.
-GARRY SOOLE

Losing money isn't pleasant, but if a respected financial giant like Bear Stearns can get caught out in the euphoria of throwing caution to the wind and putting billions into (what turned out to be) extremely high-risk investment products then us little guys shouldn't feel like fools when we look back in hindsight and say, "What was I thinking?". A loss is only a loss when you don't learn from it.
-LEZANNE GIBBS

In 2006 I requested a prominent Christchurch financial management company to advise me of several low-risk and secure investments. I placed almost all of my retirement funds (circa $160,000) into those recommendations. Three of the strongest recommendations _ Bridgecorp, Strategic Finance and MFS Pacific (now OPI) _ are currently in receivership or under moratoriums. I was also told at the time of investment that these companies carried a high level of financial security, and had been recommended by MorningStar consultants. My opinion is that financial advisers are just one step away from used car salespeople and in fact, one used car dealer I know said that he repossessed more vehicles from financial advisers than any other single group of people.
-P FULLER

My elderly father has lost about $172,000, his lifetime savings in several company collapses including MFS Pacific, St Laurence, Strategic, and ING (NZ) Ltd. Both the finance companies and financial advisers should be held accountable. He is unlikely to realise these funds in his lifetime.
-WENDY HOLDER

We have been with Hanover even when they were still Elders. Our major savings account was due for payment on August 1 2008. We had received an acknowledgement with reassuring data from them about 10 days before the crash. We are in our 80s and face living below the poverty existence level for the rest of our natural lives. When are these financial wizards going to front up with their money to meet this crippling loss?
-DAVID GRAHAM

To this point in time I have lost or had frozen: $20,000 with Bridgecorp, $30,000 with Five Star, $50,000 with Dominion, $15,000 with St Laurence and $20,000 with Strategic. I have two more investments, and I use that term loosely, to mature by February 2009. I am at my wits' end and seriously contemplated suicide. I have virtually no income and back problems that preclude me from working in anything other than very light work. I am 10 years out from being eligible for a pension. What is a woman on her own supposed to do?
-L ALLEN

I have a considerable amount of money tied up in finance companies. Negative articles in the press have not assisted retaining confidence in the industry. Why not give some credit to the excellent job the receivers have done with Provincial or Instant Finance, allowing investors to convert from compounding interest to quarterly interest payments. The press is doing to the property market what it did to the finance industry.
-JOHN SHERA

Invested $10,500 with ING regular income fund on 17 July 2006. Worth $7,800.86 on 2 April 2008. Withdrawals frozen. Recommended as a safe fund for modest growth with guaranteed 30 day withdrawal. I've learnt that ING is 50 per cent owned by ANZ.

I've learnt that any guarantee or assurance by any suave suited self-assured finance house office-dweller must be regarded as if it were a statement of intent by the National Party.
-R MIDDLETON

I have about $140,000 tied up in various finance companies in various states of demise. I wish I had done more research myself, but then I paid the adviser a fee to do that when the portfolio was set up. If I'd known that "secured debenture" meant a loan on a second mortgage I wouldn't have gone near them. From now on I'm advising myself.
-JOHN MELLOR

My dad came from South Africa two years ago. He worked every day of his life from 16 to 73 and sold his lovely house to be with us. All his money went into now failed finance companies. At 80 he now has little to nothing. Moral: don't live an honest life and don't work your guts out.
-B SMITH

To date I may have lost a minimal amount of money _ $10,000 invested with Hanover. The operative word is "may" as, unlike many journalists who report negatively and inaccurately, some of the $10,000 will be recovered. The lesson I have learned is not to invest for too long a period. The $10,000 was invested for 3 years and shortly after making the investment, 2.5 years ago, Hanover became suspect as a secure finance house. I have no worries about money with St. Laurence or Strategic Finance as the interest on investments will be paid and eventually the capital will be returned.
-RONALD PALMER