Deals for the Dealers: How Financiers Were Saved After the Crash

Listener 1 November, 1997.

Keywords: Business & Finance;

The 1987 crash was devastating to the New Zealand financial sector. Debts of many corporations now exceeded the market value of assets, which had been bought at greatly inflated prices (or in the case of financial assets, were valueless when the issuer went bankrupt). Moreover, the financial sector makes it money from financial dealing. The margin charged on any deal is narrow, but when there are plenty during a boom, the pickings are rich. After a crash, deals dry up, and so does the revenue of the financial sector. Many institutions went to the wall, and their workers joined the unemployed from the productive sector. Except for those who specialised in corporate liquidations, the rest took pay cuts, and returns on their investment were low and zero. Some firms just squeaked through.

It could have been worse. Many financial institutions needed revenue to get their balance sheets back into the black. (One firm announced they had a deficit of $753m in their “investment fluctuation fund”. This represented a $1578m drop, from a surplus of $825m. Many accountants would have put that shortfall into the profit and loss account.)

The private sector would not be that forthcoming with new deals, so the government stepped in, with a major privatisation program from 1988. The government hired financial sector firms to help sell its assets, as did the bidding firms. (Fortunately the overseas crash had not been so devastating, so there were foreign firms hunting for bargains, and willing to pay generous fees for any assistance.) A positive side effect was that the privatisation thickened a sharemarket depleted by firms which had gone bankrupt, so there are more deals after privatisation. About a third of the major firms on today’s share market are there or larger as a result of the sell offs.

The financial advisers will tell you that the privatisation of public assets is beneficial. It is advantageous to them and their clients, which is no doubt why they are so anxious to promote sales. It is less evident that privatization is beneficial to the economy. The advisers’ argument was there would be efficiency gains, but they argued from a theory whose predictions are sensitive to plausible changes in assumptions. The empirical evidence is much more equivocal, and is consistent with the case that many sales, especially where there is a monopoly, give no benefit to the economy. (Improved profitability is not evidence: it might have happened under public ownership too, or the improvement may represent the private sector being more rapacious in its price setting.) We also know that some of the privatizations were badly managed, including that of NZ Steel (according to the courts) and the Government Printer (according to a select committee). It is not clear the advisers always earned their fees.

The difficulty with a privatization program is that each public asset can be sold but once. In order to keep the financial sector’s revenue up it is necessary to find further assets to sell. So the pressure moved on to sell local government assets. In the case of the sale of electricity supply authorities there has been further deals following amalgamation to strengthen the monopoly elements. (Not surprisingly, electricity prices appear to have be raised to pay for the dealers’ fees and other payments.) That bit of action is coming to an end, so there is now strong advocation for further privatisation: ACC, airports, local water supplies, producer boards, electricity generation, and TVNZ. After they have gone, it may be necessary to sell off hospitals, schools, and the heritage estate to ensure the financial sector has sufficient deals. After that, who knows?

The rest of the economy has not benefitted much (if at all) from the public assets sales. It is still not generating enough activity to keep the finance dealers happy, although there are now dealing opportunities via foreign investing activities, which the financial sector has been assiduous to cultivate. One chief economist of a major financial institution recently nominated his primary task as public relations. No one should be surprised, for economic analysis has been a very poor second for years. Recall a couple of years ago those public relations commentators wetting their pants after a few quarters of a strong economic growth. They failed to observe it was a rebound from an especially long and deep recession (partly caused by the 1987 financial crash), and promised ongoing high growth. Following the inevitable and, for the experienced, expected growth slowdown the dealers have the temerity to repeat their advice of the last decade that if we further strengthen the financial sector we will get improved economic performance. Their failures and failed promises for over a decade are ignored.

Why do we tolerate such nonsense, exhibiting a tenderness to the feelings of the financial sector not shown to others? One wonders what might have happened had the tradeable sector which drives the economy – farming, manufacturing, tourism and other exporters and import substitutors – been given as much government concern and assistance as was given to finance.