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The finance ministry announced its NIS 11 billion emergency intervention plan for the capital market yesterday. The plan is comprised of two main components. The state is to pour money into funds devoted to investment in the corporate bond market together with institutional investors. In addition, state guarantees are to be provided to banks, enabling them to inexpensively raise capital, which they will then use to issue credit.

The plan calls for NIS 5 billion in state funding to be allocated to funds for investment in corporate bonds - NIS 3 billion immediately, and another NIS 2 billion in about another five months. The government will invest, together with institutional investors - pension funds, provident funds and the like - in 5-7 year funds that will invest in the corporate bond market, both through buying of bonds and providing financing to companies facing repayment of matured bonds (recycling of non-bank debt). The rate of government to institutional investor participation in the funds has yet to be decided, as has the division of earnings, but Accountant General Shuki Oren said yesterday that he will be pleased with an investment ratio of NIS 1 of state funding for every NIS 3 of funding from institutional investors.

However, the government will take on most of the risks involved in the funds: participating institutional investors will be entitled to full repayment plus minimum interest before the state sees more than 10% of its investment.

No limitations will be placed on the choice of corporate bond the funds will invest in, other than that most of the company's activities are to be conducted in Israel. In other words, the funds will not invest in real estate companies that issued corporate bonds in Israel to raise financing for investments in Eastern Europe, for instance.

The funds are to be established and managed by independent entities, likely brokers or some other type of financial specialists. To avoid any conflict of interest, no institutional investor will be allowed to own more than a 15% share in a single fund. The funds investment committees will be operated by a body of members independent of institutional investors.

Yesterday, the plan for the funds was submitted for approval to the Knesset Finance Committee to assure the issuing of the first tenders for establishing the funds by the end of the year, ensuring that the necessary financing will be included in the 2008 budget. This will allow the government to continue uninterrupted investment in the plan during the first quarter of 2009 before next year's budget is approved.

The government will also offer guarantees to banks totaling NIS 6 billion. But while the state will be investing NIS 5 billion in the funds, the guarantees will cost nothing, at least initially.

The government undertakes only to assure repayment of debt raised by the banks through the capital market; bonds that serve as the basis for increasing bank equity. As a result of this move, banks are expected to pay substantially lower interest rates on the bonds. For investors in the capital market, it means that the inherent risk in these bonds is about the same as that of standard government bonds, and banks will have an easier time raising necessary capital.

The government's aim is to make it easier for banks to raise capital, which in turn will be used by the banks for issuing of credit to businesses. To this end, the plan includes an incentive mechanism for issuing credit: banks will be charged a fee for the guarantee, but entitled to a substantial discount of up to 60% with the increase of their credit portfolio.

There is one fundamental problem with the bank guarantees that the government is offering: the banks may not want them. Experts note that banks in Israel are in excellent shape compared to the rest of the world. They are not short on capital, and the sole reason that they are now limiting the issuing of credit is that they do not want to do so in a period of economic crisis. And not only is it unclear whether the banks need government guarantees in order to raise capital, there is also a concern that doing so would signal weakness on their part.

Oren confirms that some of the banks have indeed told the treasury that they are not interested in government guarantees to raise capital, and others have said that 'it's not a bad idea.' "Clearly, as a government, I have no way to force banks into issuing credit. I can only make it easier, to create incentives, to try to persuade, and stand ready with tools - when the banks want to raise capital they will be able to, and reduce their costs of doing so. Naturally, if the banks manage to raise capital through the capital market without government assistance, it will be wonderful," Oren added.

Two additional steps included in the plan are the establishment of a mechanism for assisting bondholders to reach debt recycling agreements with bond issuers. A representative body on behalf of bondholders will appoint credit officers specializing in creating solutions and reaching debt arrangements with corporate bond issuers. The credit officers, who will oversee the process on behalf of all bondholders, will coordinate with the corporate issuers, bond holders and other creditors to quickly reach arrangements that are beneficial to bondholders (and subject to their approval).

An additional step is a proposal for tax legislation that aims to encourage the flow of foreign capital into Israel and investment in the capital market. The legislation will reduce the tax on dividends earned by foreign companies held by Israeli firms from the current rate of 25% to just 5%. The legislation will also provide foreign residents tax exemptions on interest earnings on corporate bonds traded on the Tel Aviv Stock Exchange and a sweeping tax exemption on the sale of shares in Israel by foreign investors.

The plan was consolidated by the treasury, the Bank of Israel and the Israel Securities Authority. The treasury estimates that the plan will supply tens of billions of shekels in credit leverage. The global credit crunch and its effect on the capital market, together with concerns of market failure, make the new plan essential, the treasury said yesterday. But some of the banks have already rejected the offer of state guarantees in order to raise capital.

Upon his return from Washington tomorrow, Prime Minister Ehud Olmert intends to announce his own alternative emergency plan to deal with the economic crisis, aimed at protecting the pension savings of persons over 60-years-old and nearing retirement age.

The plan by the Prime Minister's Office was prepared by the National Economic Council, headed by Prof. Manuel Trajtenberg, and will be more extensive the treasury's.

This is expected to lead to a clash between Olmert and his finance minister, Roni Bar-On.

Sources in the PMO were dissatisfied with the treasury plan, and said the discussions in the treasury over long-term implications were not serious or deep enough.