Default on Govt stock

Press, 18 January 1986, Page 18

Default on Govt stock

The financial world works largely on confidence and, after a successful tenderer for nearly $lOO million of Government stock has defaulted on payment, some measures will need to be taken to restore confidence. A serious failure is made the more important because the Government stock tender system is the main instrument of monetary control being used by the Government. What happened was that Rakiura Holdings, a small company which has been known in financial circles in Wellington for about eight years, bought the stock but, when settlement was due on Thursday, informed the Reserve Bank that it was unable to pay. Mr Brian Alexander, the governing director of Rakiura Holdings, has not been available for public comment on the matter.

Mr Alexander’s bid was substantially lower than others. Until Mr Alexander can comment on what happened some aspects of the incident must remain obscure. There was a precedent for buying large quantities of Government stock; last year the Wellington sharebroker Jarden and Company bought $l5O million of the $3OO million the Government was offering. It was thus able to corner much of the market and those who wanted Government stock had to buy in from Jarden. To come out on the profitable side of such a transaction, the buyer has to be able to judge accurately which way interest rates will go. In the instance of the December 12 tender, had interest rates continued to fall, Rakiura Holdings would have been on the profitable side. As it turned out, interest rates climbed again and Rakiura Holdings would have been worse off by an estimated $lO million.

The result of the defaulting is that there is $lOO million more in the monetary system than had been expected. It could be argued that the Government has made a loss because, when it tries to sell the $lOO million in another tender, as it surely will, it will have to pay more interest. The difference between Rakiura Holdings’ bid and whatever the final bid for the $lOO million turns out to be could be held to be the Government’s loss. If the $lOO million of stock sells for an interest rate of 2 per cent higher than the December 12 bid, or higher than the bid that would have been successful if Rakiura Holdings had not entered the field, the Government could be the loser by $2 million in extra interest.

The Reserve Bank will have to take some significant action. It cannot let the precedent pass of someone bidding for Government stock and then defaulting. The Reserve Bank is considering what legal action can be taken. A larger dealer, such as a merchant bank, could be made to pay some compensation. Unauthorised dealers have to pay a deposit on their bids. Rakiura Holdings was authorised. Those dealing in large amounts of money often accept one another’s word as binding. The default will create some uncertainty for a while until a system is devised to avoid a recurrence. There is unlikely to be much effect on interest rates. The rise that has been seen is most likely to be because the Government’s deficit is expected to be higher than previous estimates. Even if there is a further rise, it is likely to be temporary. The important matter will be to restore confidence by some action to discourage others from defaulting.