I learned in the weeks after meeting Maier in April 2010 that the investment public really had been kept in the dark. They had every reason to lose confidence and trust in those who controlled the financial system. Most worryingly, the people elected or appointed to make sure the public was not deceived were the ones doing the deceiving.
The problem caused by the poor construction of the deposit guarantee scheme could be attributed to Helen Clark’s government and Michael Cullen’s lack of private sector networks. From then on, the problems developed under John Key’s government, which allowed the ugly but retrievable Hubbard empire to strip Hubbard, investors and taxpayers of at least a billion dollars.
Within a few more weeks, Key’s government and its predecessor Clark’s government would be seen to have made at least thirteen mistakes, which led to the destruction of that money.
Those mistakes in my opinion were:
The Key National government by 2010 knew a great deal of information had been kept secret. The Cabinet and Treasury had specific information, uncovered by private sector experts paid by Treasury to do forensic inspection of South Canterbury Finance. By December 2009, months before my meeting with Maier, the government, Treasury, SCF’s advisers (Forsyth Barr), the new auditors, (Ernst and Young), SCF’s new board of directors, and its contracted CEO Maier all should have known that SCF was insolvent, its loan portfolio demonstrably incapable of repaying anything like its gross value. The government and Treasury had allowed Hubbard to address the Crown’s liability under the deposit guarantee scheme either by a long-shot recapitalisation plan or by a sale to a third party.1
To buy time for these two possible solutions to be tested, the Key government and Treasury, as well as the SCF directors, appeared not to respect the market’s expectation that all relevant matters would be disclosed to the NZX. The SCF directors would have broken the law if they had realized SCF was insolvent yet was still paying dividends. It seems extraordinary that SCF should have been seeking huge financial incentives, hundreds of millions, for potential buyers while still paying dividends, as though the company’s assets were really worth more than its liabilities. If assets are not worth more than liabilities, any company is insolvent. SCF paid dividends to its preference shareholders each quarter, including the quarter ending in June 2010, thereby signalling to the market that SCF was solvent and was acting correctly in paying dividends. The continuous disclosure regulations were ignored.
Treasury also wouldn’t be drawn on whether SCF had breached its legal obligations by paying dividends when ostensibly insolvent after being admitted into the government’s deposit guarantee scheme. In a 6 November 2018 response to an OIA request on this and various other SCF issues it commented:
Decisions on dividends paid by SCF or Southbury, including ensuring SCF or Southbury were solvent when either of them paid a dividend, and SCF’s compliance with its continuous disclosure obligations were at all times the responsibility of SCF’s and Southbury’s boards and management, not the Crown. The Crown did not at any time appoint any directors to SCF or Southbury’s boards or any of SCF or Southbury’s management.2
The 2010 directors chose not to discuss in public the potentially fatal illness of SCF, just as the 2009 directors had, before their resignations and dismissals. Treasury appeared to believe that it had no responsibility to ensure the company acted legally.3 Clearly in all but technical law, Treasury was the effective owner of SCF, the guarantor of its deposits and liabilities, the overseer of its behaviour, the agent of government that controlled all relevant decisions. The various attempts to buy SCF, for example, were of course referred to Treasury and Key’s government. Treasury chose to sidestep accountability for the laws that the public believed were protecting them from chicanery. Key’s Cabinet did not intervene.
Treasury and the Reserve Bank openly discussed putting SCF into receivership or statutory management. Whatever it might now say, the Crown had inherited the rights of the owners of SCF, in my opinion.
Misled investors continued to buy the SCF listed perpetual preference shares right up until 27 August 2010, when Maier sought and received an NZX suspension of trading in all of SCF’s listed securities.4 The two parties who knew, or should have known, that this silence represented a false signal, arguably tantamount to fraud on the market, were the Cabinet and Treasury.5
Treasury had no excuse. Any seasoned navigator of New Zealand’s commercial history would recall the inexcusable error made by Treasury when it sold NZ Steel to Equiticorp in the 1980s. They would know of the damage done to the government’s reputation by the Crown’s handling of Development Finance Corporation (DFC) in the same period. Many would also recall the failure of the National government in the 1990s to ensure that the Crown received fair value during the sale process of NZ Rail.
Treasury should have a manual written in bold italics outlining the cause of those shocking and highly expensive failures. With the DFC it allowed a regional development bank to morph into a commercial bank, competing with other moneylenders, raising bonds from sovereign countries and wealth funds at artificially low rates because of its Crown ownership. That ownership implied a Crown guarantee as well as implying that the DFC would behave legally and morally.
The great deception came when the then Labour government allowed DFC, at a time when it was arguably worthless, to be ‘sold’ for around $132 million to the National Provident Fund, which was not owned by the Crown. The NPF had no implied Crown guarantee. Various Japanese institutions had bought tens of millions of DFC bonds in the 1980s. The Japanese, like all creditors, discovered that the demise of the DFC under its new owner stripped them of their expected guarantor, the New Zealand government. The government saved themselves some tens of millions. That proved to be a false bargain.
The cost of the chicanery was a reputation in Japan better suited to a banana republic. One experienced New Zealand corporate banker recalls the period without pleasure. Every Japanese company he met in the 1990s brought up the DFC deal. He recalls that for many years no Japanese institution trusted any New Zealand company. Japanese investment in New Zealand for many years thereafter was next to nothing.6
Treasury’s files had all this information in 2008. Treasury should also have still been feeling the wounds caused when in the 1980s it illegally constructed a deal with Allan Hawkins’s Equiticorp, enabling the Crown to sell NZ Steel for around $300 million. The illegal component of this deal was the payment by Equiticorp to the Crown. Instead of paying cash, Equiticorp issued Treasury with Equiticorp shares, and Treasury negotiated a put option with Equiticorp, to sell the shares back to Equiticorp if the shares lost value.
In effect, Treasury had the right to demand that Equiticorp buy back its own shares at an agreed price, a device designed to ensure that Treasury one way or another would eventually receive the agreed value for NZ Steel in cash. The legal problem was that at that time no listed public company was allowed to use its shareholders’ money to buy back its own shares. Today, the law is different.
Treasury knew the deal was illegal. It was forced to demand that Equiticorp buy back its shares at the nominated price when Equiticorp began to collapse and the share price tumbled. Equiticorp destroyed its liquidity by paying out Treasury. Ultimately, Equiticorp collapsed, leaving its debenture investors with just 22 cents in the dollar. Equiticorp crashed because it had used its investors’ cash for a transaction it could not afford to undertake other than by issuing shares and accepting a put option.
The investors were later saved, thanks to the very mechanism that Treasury should have installed when it designed the 2008 Crown Deposit Guarantee Scheme. In the 1980s the government and all capital markets knew that Treasury was ill-equipped to enter the battlefields of commerce. Analysts, policy wonks and theorists do not live in the same world as property developers, asset arbitrageurs and entrepreneurs.
So, in the 1980s the Labour government had sensibly appointed a private sector advisory committee to oversee Equiticorp’s ultimate statutory management and eventual liquidation. That committee included excellent people outside the government and the public service, including QCs, the eminent accounting professor Don Trow, and commercial people. With the help of this advisory committee, the statutory managers John Tuck and Fred Watson found the knowledge and the strength to sue the Crown over Equiticorp’s illegal put option arranged with Treasury.7
After many years, in July 1996 Justice Robert Smellie delivered a judgment in the Auckland High Court ordering the Crown to repay a sum well exceeding the $300 million sale price of NZ Steel, providing the funds to repay virtually all of the money lost by Equiticorp investors. In effect, the Crown had realised a nett negative sum for its sale of NZ Steel. Treasury was disgraced, as was the government of the day.8
If Michael Cullen had appointed a private sector advisory committee to supervise the Crown Deposit Guarantee Scheme, the illegal behaviour which has now permanently stained Treasury and Key’s government would never have occurred. No such committee would have allowed:
If the DFC and Equiticorp examples were not mandatory reading in Treasury’s manual, perhaps it might have thought about NZ Rail. When NZ Rail was restructured, the government allowed private interests to buy Railways assets. The sales process reflected rather less than best practice. One party finished up in jail, after selling steel to Japanese buyers but failing to account properly for the sales proceeds.9
Railway houses were sold at prices that turned buyers and on-sellers into instant millionaires at the expense of taxpayers. One collection of houses, in Ohakune in the central North Island, had been erroneously registered on just one title. This required someone in the Crown’s bureaucracy to persuade the local council to issue titles so the occupiers of each home could buy their home. If they chose to move out, the Crown could have sold each house individually.10 This proved too hard for the Crown. It sold the whole collection of houses for little more than an ice cream and a bag of sherbet; the sole buyer made a killing. He went to the local council, politely negotiated titles for each house, and sold them for a fair price. His gain was, as you would expect, extreme.
It was clear that SCF’s failure would cost the Crown close to a billion dollars, yet Treasury and Key’s government seemed to prefer a hands-off approach, almost as though there was no requirement for any party to be accountable for the minimising of the Crown’s losses. The party most motivated to minimise losses was naturally Allan Hubbard. By May 2010 he had not lost hope but he clearly needed outside help. It arrived, not from Treasury, but almost from heaven. But before that happened, Hubbard in June 2010 was to re-enter a period of torment that he did not deserve.