Which Israeli firms would be too big to fail?
Clarifying the Republican-Democrat debate on when the government, on behalf of the public, should rescue a business on the brink of collapse.
When should the government, on behalf of the public, rescue a business on the brink of collapse? This question has made its way back into the public discourse in, of all places, the United States, the bastion of capitalism, as part of the ideological and economic debate between Republicans and Democrats.
It was President Barack Obama who raised the issue, and the reason is clear: One of his first decisions after being sworn in was to rescue General Motors and Chrysler. Their debts were frozen, ownership was transferred to the government, the companies recovered, and the government sold its shares in a public offering. GM was saved.
Former President Bill Clinton, speaking at the Democratic National Convention in what is considered his best speech ever, also focused on GM. "Now there are 250,000 more people working in the auto industry than the day the companies were restructured. Governor Romney opposed the plan to save GM and Chrysler," said Clinton, concluding with a charismatic flourish: "So here's another jobs score: Obama, 250,000 - Romney, zero."
Are these figures accurate? That's far from certain. This was an election speech and each candidate cooks the statistics according to his objectives, but the effect was convincing. Nobody has any doubt anymore that in every economy there are companies and organizations that are too big to fail. These can be divided into several types:
1. Organizations that are part of a complex and extensive network of business relationships, and by failing could take an entire industry or even the entire economy down with them. Banks are the best example. Four years ago Lehman Brothers collapsed, nearly dragging down the global financial system.
Today nobody would let such a bank fail except via a structured, orderly and slow process. In a bailout of this type, price has almost no significance because it's clearly much less costly than the alternative: doing nothing and letting the whole economic system collapse.
In Israel too the entire financial system bears the stamp "too big to fail." During the financial crisis, Bank of Israel Governor Stanley Fischer and the banks supervisor made it clear the state wouldn't allow any bank, large or small, to fail.
This commitment is stronger now than ever. Israel's banks carry a full government guarantee against the possibility of collapse, and the fact they conduct themselves as private enterprises is something of a glitch. The high salaries of management and tenured ("generation A" ) employees at banks, like the self-interest pursuits of some of their directorships, are out of place at what are in fact public institutions. If only the state had the political will, it has both legal and moral authority to supervise the banks and their conduct much more tightly.
2. The state would probably step in to assist companies whose fall would have dire political implications, like when the failure of a business could lead to a wave of unemployed or the destruction of a brand that embodies national pride. Politicians would fear criticism if they didn't rise to meet the challenge.
In GM's case, for example, the United States didn't really need to resuscitate the company. The U.S. economy wouldn't have suffered any irreparable damage from its collapse. Other manufacturers would have built factories there and easily fulfilled demand. But in the United States the key political test of any leader is preserving jobs, and Obama didn't have any difficulty gaining a majority to save a national symbol such as GM.
But this type of bailout also requires something else: a clear business model. The public too understands there's no point in a rescue without an economic analysis showing a strong chance for the new entity to stand on its own feet, and perhaps even return the government's investment.
3. Another type would be a combination of the first two types above. The most immediate example is the European Union. Many commentators have speculated over the past two years that the EU won't survive because it is fundamentally flawed: Europe's leaders created a monetary union with a single currency, a single interest rate and a single central bank but without any fiscal (budgetary ) union. The outcome was the collapse of countries like Greece.
But the commentators missed the point. The EU was created due to a political and deep emotional motivation: to prevent wars like the two world wars.
Although the generation of leaders with firsthand experience of war is being replaced, that motivation still exists. The Germans, who are being called on to pay most of the price for bailing out southern Europe, weren't ready for claims that, after having destroyed Europe twice militarily, they would be the ones to destroy it a third time - this time economically.
So after long opposing the purchase of bonds issued by the failing countries, the German government agreed to the central bank’s plan and approved the purchases. In other words, at the brink, the Germans finally understood that the political and economic damage from the EU falling apart would be several degrees greater than the price to save it. The only way left was to bite the bullet, pay and advance several more steps toward a more cohesive European Union.
Here in Israel too we have several companies and organizations in desperate straits and perhaps on the verge of collapse. The following are some familiar examples. Should the public bail them out?
Founded 60 years ago, Phoenicia is Israel’s sole manufacturer of flat glass. The company has 400 employees and provides a livelihood for suppliers employing hundreds more. Israel’s economy won’t particularly suffer if the company shuts down, few Israelis would mourn the passing of the Phoenicia logo, and nobody will change his vote because of it in the next elections.
But if there’s a business plan showing that the company can become profitable and self-sufficient thanks to temporary government assistance, that’s what should happen. The process should go through the courts with the company sold as a going concern, but if that doesn’t happen there’s no reason for the government not to help with bridge financing; in supplying the plant with gas, for example. This wouldn’t be any different than what the Americans did with GM.
Channel 10 TV has suffered steady losses since the day it was established. Its owners injected over NIS 1 billion to cover its operating expenses and its demise is seemingly a foregone conclusion. But unlike the daily newspaper market, television advertising budgets haven’t shrunk and could be much greater if a large slice of the advertising pie, sometimes reaching 50%, wasn’t left to just a handful of ad agencies. Neither are viewers required to subscribe.
The channel’s financial fate stems from its ratings compared with production costs. If Channel 10’s management could produce a series of hits or adopt a model of generating lower ratings at much lower costs, the channel could balance its books. Since there is room in the market for another commercial channel besides Channel 2, and since the existence of an independent TV news company provides added value to the public, the government should find a way to help keep Channel 10 on the air.
IDB Holding Corp.
IDB Holding is in trouble and it isn’t clear how it will meet its payments in the coming years on its bonds. This is a company several times the size of Channel 10, Phoenicia or Maariv. But IDB is a holding company controlling firms like Super-Sol, Cellcom and Clal Insurance that, although not as profitable as in the past, aren’t in any danger of closing down.
Despite what several mayors in the country’s outskirts have been calling for, there is no logic in providing government assistance for the IDB pyramid’s continued existence in its current form. In the event of IDB Holding’s liquidation or debt restructuring, the most that could happen is that control of the operational companies − those that provide employment and sell products − would be transferred to new owners, or perhaps even to the public.
Such diffuse public control is the norm in many foreign countries and occurs in Israel as well. Bank Leumi and Teva Pharmaceutical Industries are two examples of publicly-controlled enterprises, and Clal Insurance and Cellcom could also be controlled the same way.
What about the debts to bondholders? Most of the damage has already been done. Investors have taken a trimming as the bond prices have fallen, and the losses are already accounted for in the public’s pension funds.
If the government wants to help people accumulate larger pension savings, it has more direct and efficient ways to do so than bailing out a holding company and keeping a handful of people in control who have conducted disastrous interested-party transactions and led the group to its current situation, without generating jobs.