Taking Stock / How to wipe out the Israeli capital market once and for all
Are the decision makers taking advantage of the crisis to create a fairer, more competitive market structure? Or, is the crisis simply presenting another opportunity to roll losses of the few onto the many?
How it happened is anyone's guess.
Is the sheer complexity of finance to blame? Maybe it's the word "bond" that deterred.
Or maybe it's just that powerful tycoons directly and indirectly pull the strings at the business press.
What's sure is that a handful of people who control a vast amount of money belonging to other people have completely muddied up the debate about plans to "rescue the economy", be it the "Goshen plan" or the "Fishman plan" or any other plan, behind which stand not economic theorists but lobbyists.
These days the public debate is all about whether the plans to rescue the tycoons will work and could help restore economic growth and jobs creation, or whether they'll do nothing more than help five or 10 or 20 of the richest families in the land to hold onto their wealth. The real question hasn't even arisen for discussion, even though it's simpler. You don't have to be an economist to understand what it is: Are the decision makers taking advantage of the crisis to create a fairer, more competitive market structure? Or, is the crisis simply presenting another opportunity to roll losses of the few onto the many?
This story probably began 22 years ago, when in the wake of the financial crisis of the 1980s, Israel decided to emulate the West, extracting the government from the capital market and opening up the markets.
The concept underlying the free market is that entrepreneurs raise money from savers on the capital market. The market, as opposed to government officials, decides which deals to fund and at what prices. The market, not the government, allocates most of the resources.
Until half a year ago, one could say that the system worked pretty well. The global economy went through two decades of unprecedented growth and rising standards of living.
Then came the global financial crisis. Trillions of dollars were wiped out, as stock exchanges, equities, companies and whole sectors went into free fall. Investors the world over, and in Israel too, suffered tremendous losses, while many managers and entrepreneurs remained millionaires, multi-millionaires, billionaires.
Which brings us to 2009, when one fine morning Zohar Goshen, the chairman of the Israel Securities Authority, presented his "plan": to take money from taxpayers, invisible money, unquantifiable, under the guise of "guarantees," and allocate it to institutional investors as a "government subsidy" with which to buy bonds on the stock market.
We think it apt to revisit a lesson from Prices Theory 101, in which fledging economists learn that the planned target for such subsidies isn't the one who actually gets them. The flexibility of demand and supply curves is what determines who takes home the government funds.
In the case of the capital market and Goshen's plan, the government subsidy would be pocketed by the biggest borrowers, mainly the tycoons and real estate entrepreneurs.
Yet that lesson from Prices Theory is secondary to the lesson on Moral Hazard. What happens when a government hands out insurance policies for free, and effective retroactively, to players in the capital market? What happens when they are shielded from loss, whether caused by having taken too much risk, bad management or wasteful habits?
Answer: As soon as they realize they'll be rescued in the event of crisis, they decline to change their ways. They will continue to gamble and, sometimes, to steal. They don't pay the price.
Government rescues that grant retroactive insurance, as Goshen proposes, are not the answer to the problems in the capital market. They are the root of the problem.
If the companies and managers and investment funds realize they'll be rescued by taxpayer money, then in the future, in five or ten or 15 years, again, trillions of dollars will evaporate, the players will walk off with their riches and the public's pension savings will be diminished.
Does that mean the government shouldn't intervene? That it should leave market forces to work it out? Not at all. It should intervene, but only after assuring that the big borrowers and managers and gamblers pay the full price.
For a company to be eligible for help, direct or covert (through guarantees), it should have to meet at least these three criteria:
1. The owner has given all his shares to creditors in lieu of debt the company can't repay. In other words, the owner has agreed to full dilution, which reduces the company's leverage, but allows it to regain its strength, and to invest and grow.
2. The owner returns all management fees, pay checks and dividends that he withdrew during the boom, assuming that if trouble came, the taxpayer would handle it. Returning money to the company will enable it to reduce debt and make more investments.
3. The owner transfers his private assets to the company, to strengthen its equity structure and keep it running, investing and employing.
Wait a minute. Are we trying to deny the underlying legal principle that separates a company limited by shares, from its shareholders and managers? No. That principle is fundamental to a developing, flourishing economy. Without it, it wouldn't be possible to do business.
We think these measures are necessary only when a company is asking for taxpayer handouts.
Any businessman who holds the principle of separation dear always has the option of liquidating the company and restructuring its debt in court, where he'd probably have to give up most of his shares anyway, or of continuing to lead the company and refinance its debts based on free-market rates.
Benjamin Netanyahu is a man of the free markets, a declared capitalist who advocates a market that rewards excellence and punishes poor performance. He firmly believes in tax cuts. He should also be the first to understand that the proposal to harness taxpayer money to rescue capital market borrowers means, in effect, to wipe out the Israeli capital market.
Netanyahu should thank Goshen for his initiative, saying he understands the plan reflects the ISA chair's desire to strengthen the Israeli capital market, and that it was proposed in good faith. Then he should ask Goshen to strengthen the Israeli capital market, not by using taxpayer money as a bailout, but by restoring people's faith. This is how it can be done:
1. Eradicate the conflicts of interest between investment management companies and insurance companies, and their owners.
2. Step up investigations. Arrest the people who misused savers' money to maximize their own personal profit.
3. Force the insurance companies, and the provident and mutual funds, to fully disclose their investment decision-making processes. Wide swathes of the investment world are a black hole, in which sophisticated players do as they please.
4. Force all the capital market players to fully and accurately disclose their fees, known and hidden. Require institutional investors to divulge how much of their profits, or losses, over three, five, seven and 10 years result from service fees taken from clients.
5. Expand the reform led by the Israel Securities Authority to make companies divulge how executive salaries are set, and disclose information on insider transactions.
There are other ideas, too, for restoring the public's faith in the market. But using public money to bail out tycoons who flew too close to the sun is the way to burn that faith to ash once and for all.