Taking Stock

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Taking Stock 5 December, 2019


Chris Lee writes:

IT is a modern trend to scoff at the pre-1985 public sector that decades ago built the country's infrastructure and created our reputation as having one of the least corrupt public sectors in the world.

Those who reformed the public sector in the 1980s were led by some outstanding people like Roger Kerr and Graham Scott, and earlier advocates of reform including Noel Lough.

They advocated that pricing mechanisms led to efficient allocation of resources, enabling economic growth to occur efficiently.

Outstanding public servants like Murray Sherwin had watched the 1970s economic management of the likes of Robert Muldoon, whose autocratic ways paid little heed to expert advice.

Buying into the liberalisation of the NZ economy, Roger Douglas, Richard Prebble and David Caygill oversaw a transformation that might be described as a transition from excessive, arbitrary and often illogical over-regulation to an era of deregulation, almost non-regulation, leading to all those absurd practices that resulted in the 1987 financial market collapse.

To put that into perspective, by 1987 the NZ Stock Exchange had approximately 450 listed companies. Just a few years later, that figure had halved. It is today around 150. Deregulation had led to chaos.

Many who built personal fortunes in that era did so because there were often no rules in such key areas as insider trading or front running.

As a simple example, if Brierley Investments was going to offer $5 a share next week to buy out a company whose shares were at $4, there was nothing to stop Brierley's directors telling their mates, and nothing to stop Brierley’s directors instructing their personal superannuation manager to buy as many as possible at $4. The insiders could fill their pockets. The law said so.

In the 1980s, the public sector had either abandoned the concept of sensible regulations or failed to convince the politicians in charge to install such controls during the process of liberalisation.

At the same time, the public sector was changing dramatically, with government departments being rebranded as state-owned enterprises given financial rather than social objectives and seeking out ''chief executives'' with private sector-like remuneration for short-term contracts.

New Zealand in full sprint converted from a perhaps stodgy public service to a fleet-footed new model, attracting people with financial objectives.

Experience and knowledge were often discarded, as highly-paid chief executives with short-term objectives were given the reins, reporting to politically appointed boards, with little or no heed paid to governance experience, relevance and talent. Given the generally poor performance of politicians in governance, what chance did the SOEs have with ''directors'' chosen by politicians?

In the minds of the agents for change, NZ had to get rid of the likes of tariffs, reserve asset ratios, subsidies and over-engineered infrastructural projects.

In the terminology of the day, all the cardigans and short pants had to be replaced by three-piece suits (worn by either gender).

My uncle had much earlier headed the Government Stores Board, a government department which bought all supplies, from cars and trucks to typewriters and blotting paper.

He would delight in his successes in negotiating discounts and accessing functional but cheaper supplies. He was never highly paid.

His reaction to the changes was of horror, as would have been that of my grandfather, who was the ''secretary manager'' (chief executive) of the Wairarapa Hospital in Masterton.

They had represented an era when long service, knowledge and experience were prioritised.

The new initiatives mocked the old standards, promising improved services, based on the concept that the market would vote with its wallet, ensuring Crown services were focused on optimal outcomes.

Doubtless NZ needed to leave behind Muldoon's cantankerous and often ignorant ''I know best'' approach.

But has it worked out as planned?

Has the new culture of short-termism produced an unintended consequence of the reforms?

Recent figures released by Treasury suggest there have been disastrous consequences.

Staff turnover, especially at executive level, has been extraordinary, exceeding 25% per annum in Treasury. Twenty-five per cent! Continuity? Experience?

New and inexperienced ministers like Robertson have been tasked with learning a job without anywhere near the input from Treasury that, say, Douglas had in the 1980s.

The story may be apocryphal but it is alleged that Treasury's criteria to select executives has now resulted in an alarming shortage of economists with analytical skills.

The criteria to be used have been set to avoid any unintended bias on the basis of gender, race and maybe universities, Waikato, for example, seen as a much lesser university that Auckland. To prevent bias these sort of details are deleted from applications.

Old timers look at the government departments of today and opine that highly-paid, short-term contracts might help people to put a sheen on the curriculum vitae but do nothing to safeguard the quality of advice being offered.

When Bill English was Minister of Finance, he spoke the language of his mandarins but one could hardly expect the likes of Robertson, after a career in foreign affairs, to integrate political agendas with public sector-speak and advice.

Indeed, Robertson briefly talked of changing the culture of Treasury. His talk has remained unsubstantiated by action to date. Perhaps the change is to arrive next year.

The reforms of the 1980s have undoubtedly removed some inefficiencies but the unintended cost seems to have been a focus on the short-term, a loss of skilled experienced advisers, high staff turnover and a great number of poor decisions.

The Reserve Bank, independent of political interference, seems to have been an exception. We will all watch the Reserve Bank's new approach to its supervision of banks, insurance companies and finance companies, with an expectation that the errors of the past two decades will not be repeated. A great deal rests on Adrian Orr's agenda, which will again be in the spotlight today, as he reasserts the changes he wants in our major banks.

One old-timer told me that the awful Ministry of Business, Innovation and Employment (MBIE) was nowhere near the worst of the public service departments, certainly less corroded than Treasury. If other departments are worse, we need serious surgery. Investors need to ponder what this means.

Perhaps none of this would matter as much if our Higher Salaries Commission, chaired by a former politician (of course), had not converted the concept of attracting politicians with ''a mission'' into attracting those to whom a life-changing salary is a goal of its own.

When Maggie Barry announced she would retire after nine years of ''fun'' in Parliament, some of those years as a Cabinet Minister, she retired having been paid in those nine years around $1.5 million and looking forward to a lifetime pension of around $60,000 per annum after tax, if my calculation is right. Nine years in Parliament is the minimum stint to pension entitlement.

Many politicians retire after nine years, Nathan Guy being another example.

A lifetime pension of $60,000 after tax probably has a capital value of around $1.5 million, at Barry's age.

Barry, previously a gardening journalist, had been remunerated at a level one might expect if one were a highly successful business executive with a great deal of expertise.

I pick on her example solely as her nine-year stint and salary have been widely observed.

What is now visible is the change in the type of people attracted to politics, given that the remuneration is so generous.

Our Prime Minister is paid more than the PM of Britain and is the seventh highest paid Prime Minister in the world, according to Purdue University research.

Go back 45 years and you had Muldoon as Prime Minister, earning a little less than $14,000 per year, when third-year schoolteachers earned $3,500 per year, a quarter of Muldoon's salary. What would that ratio be today?

If we are to have people aspiring to be on the ''list'' to enter Parliament on salaries that might be described as their ''main chance'', and to be advised by executives with short-term contracts, how are we going to get wise long-term decisions?

Is it not obvious that we will get tourism ministers who prioritise more tourists next year rather than seek to build infrastructure to ensure we have repeat tourists forever?

Wire barriers down our highways bring in no short-term revenue but they save the lives of those who might not be accustomed to driving on the left.

Would a slick short-term tourism minister have budgeted for highway barriers or promotional advertisements?

Would a government departmental head on a huge short-term contract, with bonuses based on revenue, advise the minister to choose the barrier or the promotion?

I use that as a fictitious example of the difference in wisdom between short-termism and those with long-term objectives.

If our public service sector really is filling its boots with the rewards of short-termism, and if the substance of our politicians is changing, we are watching a category 10 storm heading our way.

Investors need to link this with the highly sensitive issue of business confidence and should be reading carefully any changes in how our country is viewed in matters like corruption.

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ONE simple explanation for the lack of effective scrutiny of politicians in the last decade is the smokescreen our political parties can now raise by accessing the media to manipulate public opinion.

Major political parties now habitually engage social media manipulators to fill social media with faux information, phony opinions and saturation of kind comments, whenever a politician is under pressure.

Stuff articles allow anonymous comment that is no longer treated like a letter to the editor, which would be verified before publishing. Anonymous drivel sets the tone, often initiated by political parties.

Using pseudonyms, a political party might bombard the comments section with lies, without any accountability, distorting the apparent public response, exploiting those who are not familiar with the strategy.

The thought of the government owning our major media channels is itself frightening, especially for investors, who rely on the facts being presented transparently and expect accountability to control behaviour.

As we saw when the truth emerged after the South Canterbury Finance debacle, the government and the public sector is easily able to avoid accountability, and can manipulate the public through social media, allowing weak ministers to avoid scrutiny.

This is tiresome in itself but Crown control of the major players in television and radio would allow even more deception.

Do we need an expanded Ombudsman's office to reinstate accountability?

Do we need a media Ombudsman to prevent all the faux commentators?

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Jonny Lee writes:

Shareholders of New Zealand's listed electricity companies will be patiently waiting for the conclusion of Rio Tinto's review into the Tiwai Point aluminium smelter, expected in February or March of next year.

A further twist in the story occurred this week, with both Contact Energy and Meridian Energy announcing they were each contributing $5 million towards fast-tracking an upgrade to some of Transpower's transmission lines in the South Island, allowing them to better handle any excess supply caused by a closure of the smelter.

This seems prudent and, more importantly, will shift some of the bargaining power away from Rio Tinto.  Part of its bargaining power was its position as the sole buyer of such a volume of electricity, and that the smelter's closure would result in an unusable excess of electricity.

Rio Tinto still maintains a strong position for bargaining. A closure would impact hundreds of jobs and multiple industries, as well as disincentivising any new projects to increase New Zealand's electricity production.  It would impact share prices, devaluing Kiwisaver accounts across the country, as well as reducing Government revenue as the majority shareholder of several major power companies.

It would be premature to suggest that Contact and Meridian's actions foretell a closure of the plant. In its announcement to the stock exchange, Contact Energy made it very clear that a closure was not in its best interests, and would be a very poor outcome for the country.

The announcement should give shareholders confidence that their respective boards are considering all options, and ensuring the market is well placed to handle whichever outcome is decided.

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IN what is shaping up as the worst year in recent history for the banking sector, Westpac now faces its worst month yet, as shareholders and regulators line up to engage in action against it.

Westpac was found to have breached its anti-money laundering obligations across more than 23,000,000 transactions, barely a year after the conclusion of the Hayne Royal Commission.

The timing could not have been worse, with the regulator announcing its conclusions in the middle of Westpac raising $2.5 billion in additional capital.  The retail investors taking part in this capital raising, amounting to $500 million, were given the option to withdraw their offer.  Given the recent share price performance, I imagine many chose to accept this option.

The size of the fine is, at this stage, unknown.  News media are reporting it may eclipse Commonwealth Bank of Australia's fine of $700 million.  A fine of a billion would represent 40% of its recent capital raising and less than half of a single dividend payment. It is not inconsequential, but it will not bankrupt the bank.  Ultimately, the shareholders will pay the cost of Westpac's gaps in process.

Long term, the reputational damage caused is likely to be more relevant.

Westpac also faces the potential of further legal action, as questions are asked over its adherence to continual disclosure obligations.

This would be a complex issue to resolve.  It is undoubtedly true that Westpac, internally, was aware of the magnitude of the problem it faced well before the announcement to market.  It is also true that the public announcement caused a large fall in share price value.  Were the buyers in the lead-up to the announcement fully informed?  Should the stock have been trading when Westpac was aware of an imminent announcement, likely to send the share price tumbling?

2019 has not been a kind year to many of New Zealand's financial institutions, with the insurance sector facing reform, and the banking sector under increasing regulatory scrutiny.  Many will be looking forward to a Christmas break, and a renewed focus for 2020.

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THE Reserve Bank has delivered its final decision on the updated bank capital requirements today.  At first glance, the Reserve Bank seems to have largely stuck to its guns, conceding mostly in the timeframe for implementation, from five years to seven years.

The initial share price reaction was muted, with Heartland responding quickly to comment that the revised Framework will not cause Heartland ''to change its approach to dividends or to raise equity from shareholders''.

Kevin will expand further on this topic in Monday's Market News.

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Edward will be in Wellington on 12 December.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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