Give the capital market back to the people
With narrow interests which stifle competition, Israel's market today affects salary levels, competition, business norms, corporate culture, ethics, values - and democracy.
The capital market? Equities? I'm not interested.
For decades the Tel Aviv Stock Exchange and local capital market were considered a casino, a playing ground for speculators, a club for the fat cats. Only three types took an interest in this sort of thing: speculators, rich people floating their companies on the stock exchange, and the financial mediators - brokers, bankers, advisers.
But it's high time that every Israeli, every taxpayer, every citizen, every saver and every worker start to show an interest in the capital market. Not because finance is the future or the stock market poses opportunity for profit: quite the opposite. Israelis should take a close interest in the capital market because we've reached a point in which the capital market has become the most important thing in the economy.
The public portfolio of financial assets tells the whole story. In 15 years it's grown fivefold, from half a trillion shekels to NIS 2.5 trillion. A trillion is 1,000 billion. To put that into proportion, the country's national budget is NIS 350 billion.
But the public portfolio's increase by NIS 2 trillion is just part of the story. The second part is much more dramatic. In 1995 the public portfolio of financial assets consisted of government bonds - "designated" ones issued to pension funds and provident funds, and liquid bonds. In 2011, most of the public portfolio was invested in the open market: in stocks, corporate bonds and bank deposits.
The capital market affects the entire economy. It allocates most of the sources, it dictates what most people's pensions will be (barring those, of course, who have no pension savings, and government workers who don't have to save and are given pensions by the state ). The capital market affects salary levels, competition, business norms, behavior by companies and executives, corporate culture, ethics, values, inequality - and democracy.
The capital market of 2011 is the vascular system of the body called the Israeli economy. If this system is healthy and robust, over time the economy's prospects will be good. If it is sick, it will hurt performance throughout the economy. It will hurt our pensions, but far beyond that: An unfair and uncompetitive capital market riddled with concentration and inefficiency will infect all parts of the economy. It will depress productivity, exacerbate inequality, weaken democracy and damage meritocracy.
Meritocracy is the rule of talent: A capital market suffering from concentration will not allocate capital to the best, but rather to the strong, the cronies, the violent, the corrupt, the ones who know how to defang the watchdogs of the free market and of democracy.
What is the state of our vascular system? Is our capital market healthy or sick? A survey of the big businessmen and bankers, and brokers, will apparently find it hale and hearty, and if they see a problem in the market, it's over-regulation.
A new caste has arisen here during the last decade: some 1,000 company owners and their executives, who control the great companies, monopolies, cartels and financial institutions, who built up wealth and power unknown before in Israel's history. They like things the way they are and would like them to stay that way. They will hire experts, academics, economists, politicians and reporters to explain from every dais that our capital market is terrific.
Of course it is. Hundreds of top people in the capital market and at the big companies have made fortunes in the last decade - tens or hundreds of millions of shekels. Each.
It is true that the capital market has made a dramatic leap forward since 1985. But in recent years it's been going backward fast. In fact, the country's capital market of 2011 - based on interviews with regulators, business people, academics and market people - is highly concentrated and dangerous. The number of people who shape it is very small. Even worse: Most are deeply conflicted in terms of interest. And these people are linked by a network of connections that stop them from doing their real jobs.
The Israeli capital market of 2011 is, therefore, a web of interests that suffocate competition, encourage mediocrity, inflate pay for a thin layer of people at the top, preserve the power of cartels, monopolies and concentration groups - and push the workers, smaller entrepreneurs and everybody who's not a member of the club to the sidelines.
There are parallels to the United States: The financial crisis of 2008, and the stagnation of the American working man's situation over a period of 20 years, proved that Wall Street is the most powerful lobby in the land and that the government - whether Republican or Democratic - mainly serve the interests of the Wall Street chieftains.
The intense concentration of the capital market exacerbates the risk of financial crisis and creates conflicts of interest that damage corporate governance - supervision, controls, and integrity of decisions and transactions - sometimes mortally.
Concentration and conflicts of interest prevent institutional investors, which manage the public's money, from supervising the companies properly and protecting the public interest. The upshot is not only long-term harm to the public interest, but even worse: corruption of the local corporate and organizational culture. In the absence of supervision, the Israeli capital market functions improperly and weakens the economy.
The concentration of economic power in the hands of the few threatens not only business sector productivity and competitiveness and the public's pensions, but democracy and government. The more the financial power is concentrated in fewer hands, and the more tightly inter-linked those few are - with ties of partnership, lending, membership on each other's boards and in their social circles as well - the less the government can supervise the capital market, the economy and the business sector. And the less it can institute reforms.
Wall Street's conquest of government led to the greatest financial crisis in history three years ago. It almost brought down the entire global economy. Unemployment doubled. The cost to the American taxpayer will ultimately come to trillions.
'Market knows best'
In the U.S., absence of supervision and blind faith in the "market knows best" concept led to tremendous risks, the cost of whose materialization was rolled onto the American taxpayer. The ills of the Israeli capital market are different. Here the main disease is concentration, cross-ownership and conflicts of interest.
A few months ago, I asked one of the country's top managers, who had once held high position at the Finance Ministry, what he thought about the allocation of resources in the capital market as compared with the allocation of resources in the national budget. His answer astonished me. Despite the tremendous waste and the corruption that characterize state systems, he felt that in recent years, the allocation of resources in Israel's financial arena was worse.
That is tantamount to saying that the free-market revolution - the change experienced by the local capital market during the last 30 years - has failed. It is saying that the market mechanism and competition have not proven themselves. We do not share that opinion. The free market and competition are still the best way - or the least bad one - to advance the economy and the general good.
The rub? Israel's market has gradually cased to be a free one. Its concentration, its conflicts of interest, its pervasive structural weakness that has weakened corporate governance to the point of stifling it entirely - all this has made it unfree. It is a market riddled with cronyism, with nepotism, a market that is dragged backward, not propelled forward, by too many branches.
The people of Israel rose up in recent weeks, protesting on Facebook and in supermarkets alike against the increase in the price of cottage cheese. They deserve all due respect for deciding finally to use their power, and for grasping that as a people divided, they stand no chance against the cartels, the monopolies and the concentrated economic groups.
But the public has yet to fully understand that the root of general economic concentration, the absence of competition, the low productivity and the weak purchasing power of the individual, lies in the concentrated capital market. The public has not grasped that the cancer lurking in the capital market will damage the whole body. It will direct large amounts of blood to some limbs while drying others up. The limbs will not function properly and the upshot will be that the body as a whole will fail to realize its great potential.
The public measures the capital market through the prism of returns from provident funds, training funds, mutual funds and life-insurance policies. That is a serious mistake, for three reasons.
The first is that the market is volatile by nature. It moves from one extreme to another. The public may be delighted with its performance, but when the crash comes, the public, the regulators and the policy makers react rashly, to the point of hysteria, making decisions that may treat the symptoms but ignore the root of the problems. Just look at the last financial crisis, which led a host of regulators to push the treasury into using taxpayer money to rescue the tycoons, instead of using the money in exactly the opposite way: to strengthen the interests of the general public.
The second reason is that in the Israeli economy, rife as it is with monopolies and cartels, handsome profits made by certain players at any given point in time isn't indicative of a healthy capital market. In the last five years, most of the returns in the market were thanks to surplus returns by cartels, monopolies and uncompetitive companies traded on the stock exchange. These gains were the mirror image of the high prices that consumers pay, and reflect an absence of the competitive pressures that lead to productivity, efficiency, innovation and growth.
The third reason is that the capital market plays another important role in the economy, beyond generating profits: It is supposed to encourage productivity, innovation and growth. But our market has failed to do that in recent years, even though its performance in terms of savers has been reasonable. Moreover, the decline in interest rates during the last decade has distracted attention from much of the damage that economic concentration and conflicts of interest have caused investors. As interest rates start to rise, the sickness of the capital market will start to hurt savers a lot more.
You don't want to wait for that to happen.
A yoke and a lever
While the issue of returns has been intensely reviewed by academia and the press because it's easy to measure, the other role of the capital market - its effect on the broader economy, on democracy, on productivity, on meritocracy and on economic inequality - has not. Government, academic experts and the public have hardly touched on it. That is a shame, since the capital market may be a yoke, but it also could be a terrific lever.
The prime minister's committee on economic concentration and competition, led by Finance Minister Yuval Steinitz and treasury director-general Haim Shani, could start a revolution in the capital market. The problem is that a handful of officials and regulators sitting on a committee that's supposed to protect savers, investors and the stability of the financial system can't get much done without the stench of crisis in wafting in: It cannot fully grasp the dangers created by the distorted structure of the market. Its members are busy protecting the status quo on behalf of the strongest players in the economy.
A hundred years ago, U.S. Supreme Court Justice Louis Brandeis warned about a handful of individuals ruling the people by using the people's own money. The premier's economic concentration panel could find a way to give the people control over its own money again, and turn that NIS 2.5 trillion into a lever that would push the economy forward, increase their share of the pie, divide it up more fairly and lay the foundations for a stronger, more competitive economy.
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