While Chris Lee’s “The Billion Dollar Bonfire: How Allan Hubbard and the Government Destroyed South Canterbury Finance” traces the rise and fall of the finance company, it also provides valuable insights into how the financial system works – or doesnt.

At the core of a successful economy is ‘trust’. Buy a can of beans and your decision depends on trusting a whole chain of suppliers. Admittedly, you also trust that the law is working in your favour too; it usually does.

You trust greatly when you invest. Even something as simple as depositing your savings involves your trusting that the financial institution will repay the debt (and any agreed interest). You may be betrayed – fraud is not unknown in finance – or you may find that the entity is unable to pay, despite good intentions.

Trust is one of the reasons why Allan Hubbard did so well at acquiring funds from depositors. He had started out as a part-time accountant in Timaru, bought a small-time lender to local businesses and households and turned it into the giant South Canterbury Finance. Chris Lee portrays him as an essentially honourable man, despite his rough childhood. He discovered God (and boy scouts) in his teenage years, and thereafter pursued an ethical lifestyle. His home and car were not ostentatious and he is thought to have donated $200m to charities.

Admittedly, he was casual about the law – apparently he did not always have a driving licence and he could be equally sloppy over financial law and practice. However, in the case of a serious bad debt his practice was to take personal responsibility (that is, take it out of the financial institution’s portfolio by assuming the liability). In this way he guaranteed the deposits of South Canterbury Finance. He could do that because he may have been worth, at one stage, $800m.

Coupled with this strong ethical commitment, he was a risk-taker (hence some of SCF’s investments going dramatically wrong); Lee at one point describes him as investing for the ‘thrill of the chase’.

Hubbard learned his trade prior to the great financial liberalisation which began in the 1980s. Before then, risk taking, perhaps associated with operating in the grey areas of controls, could be very rewarding if you were a good judge and lucky. But as his business expanded, it hardly modernised. Some of Hubbard’s accounting practices in the 2000s would have seemed Dickensian forty years earlier.

As the deposits flowed in, the investments became more widespread and complicated. Hubbard seems to have been a very shrewd investor in areas like farming but, Lee argues, neither he, nor those who surrounded him, understood the complexities of ‘mezzanine finance’ which is the basis of finance companies. (They are in the middle between ‘safe’ trading-bank lending and risky equity investment, offering finance which is less secure than what banks offer and so getting higher but riskier returns.) Lee criticises his asking a banker to run a finance company, arguing running a bank and a finance company involve different expertise and experience.

SCF grew rapidly from the mid 2000s. Its reputation and trust meant the deposits flowed in. However the inflow had to be invested and it is far harder to find quality investments. The usual assumption is that a rapidly growing financial entity takes on riskier projects. Investing would have been a challenge even for a team that had all the skills to do the job.

Perhaps things seem to have been going reasonably well (remember, Hubbard was willing to back the SCF with his own wealth). But in 2007 the 80 year-old had a cancer operation, and Lee leaves open the possibility that his judgement was reduced by this and subsequent illnesses.

A consequence of the 2008 Global Financial Crisis was that the government guaranteed depositors in approved financial institutions including SCF. The justification was that without such a guarantee there would be a run on the company, with investors’ funds going to Australia where there was already a depositor guarantee. As a finance company cannot unwind investments as fast as it can lose deposits, it would be in severe difficulties.

The deposit guarantee meant the investment risks were shifted from the depositors to the Crown. More shortly. But one unintended effect was that the apparently generous payments to staff were now a charge on the taxpayer – a parallel to the grumble that overseas banks continued to pay extremely generous staff bonuses while they were ‘owned’ by their governments.

In June 2010, Hubbard was stood down as Chairman of SCF, probably because of the events to be recounted in the next two paragraphs. Less than three months later the company was placed in receivership after failed negotiations over recapitalisation.

It seems a reasonable bet that Hubbard planned to use his personal wealth to bail out SCF – although whether he had enough, given the post-2008 expansion, is not known. fHis rescue efforts were blocked. It was claimed that Hubbard had committed fraud with Aorangi Securities Ltd, another part of his empire; subsequent investigations proved he had not. It seems that the problem financial transaction would have benefited all other investors while adding to Hubbard’s exposure. Such transactions were so unfamiliar that the team hired by the Securities Commission took some clumsy time to sort it out.

In the interim Hubbard and various associated parties (including his wife Jean who was integral to Allan’s success) were put into statutory management, which meant that Hubbard could not access his funds to support SCF.

In September 2011 Hubbard died in a car accident (Jean survived). I’ll leave you to read about it, but it explains the otherwise strange choice of the scene on the cover of the book.

The death is reported about three-quarters of the way through the book. The remainder is about the breakup of SCF, which by now was, in effect, owned by the Crown. Broadly there were two choices. One, Lee’s and Hubbard’s preference, was to keep it limping along until the economy recovered and the investments became profitable again. The other was to break the company up, which was the government’s preference.

This involved a fire-sale of SCF’s various assets, flogging them off at prices below their long-term value. Hence the title of the book, for in Lee’s judgement the bonfire cost the taxpayer a billion dollars.

Lee is unable to explain the government decision, in part because he could not get hold of the Treasury papers. He excoriates John Key and Bill English and he is uncertain whether the Treasury was imposing its neoliberal rigour or whether it was incompetent, lacking the staff with the understanding of how the financial sector works. Let me offer three more explanations.

First, the Treasury fears uncertainty and setting precedents. Who knows what saving SCF might have involved in the long run? Whatever, if Lee is right, a government agency which regularly fights with other agents over sums less than $10m must have been very angry seeing a hundred times that going down the drain.

Second, SCF was a strange beast as the Hubbard implicit guarantee indicates. I wonder whether the beast had outlived its time. It would not be the only example. Brierley Investments Ltd was past its peak shortly after the 1987 sharemarket crash (and the financial liberalisation which preceded it); it too limped on for many years after, a living fossil looking for a new ecological niche.

The third explanation, is where I disagree with Lee. Certainly it was a bonfire of taxpayers’ money. But neither the assets that were sold nor their value went up in flames. Rather, the fire-sale transferred a billion dollars, say, from the public sector to the private sector. This may not have been the explicit intention of the policy but we should recall the privatisation program after 1987 which boosted the struggling private finance sector with an implicit subsidy from the taxpayer.

The book ends with 13 recommendations for further regulating the financial sector, which come out of Lee’s account of Hubbard and also from his wide experience in the sector.

When Hubbard began, everyone in Timaru knew him personally; later his reputation spread beyond the town. That day is long past and increasingly we replace personal trust with a trust that the law will always adequately protect us. Currently, as Lee shows, it does not.

Financiers will always innovate ahead of any regulations. But that is no excuse for not trying to have as comprehensive a set as possible, even if the trade-off reduces innovation and flexibility. So once investors move out from vanilla investing, like depositing in a bank, they need to appreciate just how complicated finance is – as the book shows. Trust is fine, but informed trust is irreplaceable.