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Playing with risk - A smart move?

Tuesday, October 14th 2008, 8:22AM 4 Comments

by Philip Macalister

The launch of the deposit guarantee scheme may be smart politics from the Labour-led government but you have to question the practicalities of it. It seems to have some pretty big flaws. What’s more, people like RBNZ governor Alan Bollard acknowledge that, but are happy to live with them. The two issues I have are that governments shouldn’t be underwriting the risks in the market. Perhaps the biggest irony in this is that Commerce Minister Lianne Dalziel has made innumerable comments over the past year or so about this issue. She has told people who have lost money in the finance company sector that it is not the government’s job to take risk out of the market. There was no way she was going to do this. What happens next? The government announces a deposit guarantee scheme which captures all the organisations the Reserve Bank regulates. Another irony is that until recently the non-bank sector was outside the central bank’s regulator ambit. Now it’s in and all these institutions are covered (if they opt in). Perhaps the biggest issue though is that the scheme captures banks, finance companies, building societies, credit unions and PIE funds. However, fund management firms and corporate debt are generally left out of the scheme. This seems a little unfair and makes one think the scheme should either be wider, or narrowed up. My preference would be to see it narrowed up. Such a scheme is likely to encourage a shift away from the investments outside the guarantee to ones inside. This could quite easily see the people shift from less risky investments like corporate debt to higher risk finance companies as the government is guaranteeing the returns. One good thing is that it will give people with money tied up in still functioning finance companies some confidence about their investments – even if the actual return comes from their taxes! I guess it will be a bit of a boon to advisers too – as they can safely recommend any investment which is guaranteed.
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Comments from our readers

On 14 October 2008 at 7:29 pm Suzanne Edmonds said:
Well of course all our members are following this current Government intervention closely. The organisation has received an unfortuate attitude from the Government this past year.

We are watching this very closely and finding that revisiting the Ministers attack on EUFA over the past 12 months to be very interesting!

Remember how many times EUFA have been told the Government cant do anything... mmmmmmm
On 14 October 2008 at 7:31 pm Suzanne Edmonds said:
It should be noted EUFA met with the Reserve Bank in April with very interesting discussion and no progress
On 15 October 2008 at 7:36 am Wayne Ross said:
Rather than a boon for advisers this represents yet another anomoly introduced by a Govt that clearly does not understand the concept of risk and reward.

It also highlights the fundamental problem with concentrating on product and who is offering it (aka the new Adviser regulations) rather than advice. It is difficult at the best of times to make an informed decision about the risk and return of an asset. Take Cash PIE's for example which in some cases appear to be nothing more than Finance Company debentures in drag, tarted up with an arbitrary tax break in the hope of hiding high margins and poor bang for your buck.

A blanket guarantee just muddies the water even further and will undoubtedly lead to more poorly diversified portfolios. It needs to be resolved quickly or once again the cost will ultimately be borne by investors.
On 21 October 2008 at 6:37 am Murray Weatherston said:
Very interesting development in Australia - the Australian reports "RBA warns on bank guarantees as Reserve and Treasury at loggerheads."
The unlimited nature of the guarantee is under attack - article suggests that teh Governemtn is belatedly considering a cap of $5 million - even this is miles above teh original cap suggested of $20k that opposition leader Turnbull suggested should be raised to $100K. Rudd et al seemingly had a rush of blood to the head and decided it should be unlimited.

Also in Australia, it appears there has been a huge flight of funds from instituions not covere4d to the banks who are - Australian investment banks wrote a pointed letter to Government pointing this out.

The NZ Government in its own rush to get something announced 10 days ago seems to have ignored a basic principle of insurance - if you are a greater risk, you should pay a higher premium. In NZ the safest organisations (registered banks) pay a 10 bp premium on all liabilites greater than $5 billion; other institutions with a credit rating of BB or above pay nothing; and other instutions either unrated or with credit ratings lower than BB pay 300 bp on the increase in tehir liabilities above what they were on 12 October.

It will be very interesting to see if and when the papers are released exactly what consultation the Government undertook with Treasury and the reserve Bank.

At the risk of getting my neck chopped of, I doubt that any rational business case could be made for the scheme that as at today we look like we are going to get stuck with.

And if it proceeds unchanged, what will be the impact when we are cold turkey weaned off it in two years time?
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