What Has Changed Since the Crisis of '94?

The great crash of 1994 gouged deep scars in the collective memory, but it was only one side of the coin. The other was a bubble, in which hundreds of bitty little companies with no real reason to exist managed to raise easy money, transferring millions from naive investors to wily traders and controlling shareholders.

The conditions that enabled the bubble to develop included the dominance of the banks, the credit they lavished on customers to invest in securities, poor regulation of the financial markets, and perhaps also, that the public didn't know what it was doing. Some always add, though, that that's the nature of stock markets, to rise and fall.

Yet the spike of 1993 and crash of 1994 still cause shudders in Tel Aviv. In the last 10 years, many steps have been taken to correct the systemic ills to prevent a recurrence. One such step is the Consultancy Law, requiring investment advisers to be licensed; the Mutual Funds Law, forcing representatives of the funds to participate in general assemblies of shareholders; and caps on credit the banks may hand out for investment in securities.

Yet most concur these steps aren't enough to prevent another bubble from emerging. All they can do is prevent it from becoming too big. More work remains to make the market more liquid and sophisticated, and perhaps less volatile.

Haaretz on Sunday convened a panel of experts to discuss such steps. The panel:

l Moshe Terry, chairman of the Israel Securities Authority

l Eyal Ben-Chelouche, commissioner of capital markets, Finance Ministry

l Prof Amir Barnea, consultant

l Eli Yones, former chief executive of Bank Hapoalim

l Prof. Arie Ovadia, The Israel Phoenix Assurance Company chairman

l Hedva Ber, Capital Markets division, Bank of Israel

l Yitzhak Tal, former supervisor of banks, Bank of Israel

l Zvi Stepak, chairman of Meitav, a brokerage

l Shaul "Sam" Bronfeld, chief executive of the TASE.

Does today's capital market have similar problems to the ones 10 years ago?

Ben Chelouche: All in all, we've taken most of the steps that could be taken. The current market is much deeper, which is evident in the number of offerings, four times the volume ten years back. One of the most important steps yet to be taken is in the area of distribution of securities by the banks, mainly the two big ones, Bank Hapoalim and Bank Leumi.

It won't be easy and it isn't clear whether in practice, imposing restrictions on the big banks will expedite the process. At this stage I can't point at a consolidated plan, but at the Finance Ministry work is being done to look at the matter. The ministry is more prepared than ever before to lead moves.

Part of the recent gains, and surge in bond offerings, has been attributed to the pension funds entering the market. Does that arouse fears of a bubble like in 1994?

Ben Chelouche: The bond market today is much broader. I don't think the pension funds will have trouble finding assets to buy. Remember that real interest rates have dropped. When that happens, investors are far more willing to look for investments that offer something extra. All in all the pension funds' portfolios are conservative, so from their perspective it would be right to diversify them with other assets.

The market has changed in the last decade. In 1993 and 1994, the volume of trade in stocks was 41 percent to 44 percent of the total trade, compared with 12 percent to 14 percent today. Most of the trade today is in the big companies listed on the TA-100 index.

With 10 years hindsight, do any of you see any mistakes, could the crash have been prevented?

Bronfeld: I don't think anybody made a mistake. Stock markets rise and fall. It's a phenomenon of nature.

Boom and bust

Yones: Life is boom and bust. What characterizes the boom of the 1990s and the subsequent bust was various reforms. In the early 1990s, a lot of money was wandering about the market that the government did not pick up, since it didn't need it. These conditions lifted the entire economy, which helped create the bubble later on.

Aren't you treating what happened too lightly? The crash was one of the TASE's gravest traumas.

Tal: Some of the problems that created the bubble, such as credit to buy securities, have been solved and aren't a problem any more.

You forgot to prohibit credit for investment in structured deposits.

Tal: True, but you can't think of everything and have to remember that not all the problems have been solved yet.

We're talking about basics that were true 10 years ago and are true today too. The first thing that hasn't changed is that the public wants to get rich. The second thing is the inability of the banks to overcome temptations arising from conflicts of interest. That was very clear in 1983 and in 1993 and it's true today too. The checks in the system meant to handle that problem at the root don't always work. One example is the Consultancy Law, which has disappointed.

Stepak: Don't forget that some of the stock market gains in 1989 to 1993 were for perfectly good reason. A recession ended in 1989, there was a great wave of immigration [from the former Soviet Union], GDP grew.

The giddiness that inflated the bubble had multiple causes. Firstly, imbalance between very heavy demand and limited supply. Some of that demand was due to the low prevailing interest rates. In early 1993, the Bank of Israel got its inflation forecasts wrong and imposed an interest regime that resulted in negative real rates.

Another influence was the provident funds' inexperience in stocks. Although some started making their first moves in the stock market in 1986 and 1987, some of their people got drunk with power. They behaved like a kid with a new toy who doesn't know what to do with it. The level of professionalism at the provident funds was very low.

Another contribution to the bubble's development was that the supervisor of banks awoke too late. But the main problem was clearly, and remains to this day, the big banks' dominance over the financial establishment.

Barnea: The problem is that when you look at the stock market, you do see a tide, but that doesn't have to be the nature of things. Booms and busts are evident retrospectively, but not when looking ahead.

You can only decide to call a period a bubble in retrospect. Back in 1993, there were plenty of reasons to believe the stock market was faithfully representing the economy. Nobody knew where the Oslo accords would lead and if this would help the market.

With hindsight it's easy to say, what idiots, they borrowed in order to buy mutuals. But at the time, it wasn't that clear.

I don't think the domination [by the banks] is the primary problem. Nobody can say the U.S. market is controlled by a handful of punks. It's a sophisticated market with a lot of players, but it had bubbles too, just bigger ones.

Ber: One of the conclusions of studies we carry out at the Bank of Israel shows that combining a financial institution supplying credit and also providing underwriting services may not attest to conflict of interest, but studies do show conflict of interest when combining underwriting with portfolio management.

Even in an advanced market like the American one, there are elements of conflicting interest. It doesn't only happen in an over-centralized market. Are we on the verge of a new bubble? Can it be prevented?

Yones: The circumstances today aren't like the circumstances then. Israel has become exposed to the international marketplace and there are more investment alternatives, reducing the probability of crisis. In many cases the current share prices are relatively low today, even after factoring in the security premium.

Ovadia: Any stock market chart will show that long periods of gains are followed by a crisis at some point. That is inevitable and it doesn't matter if on the way, a few clowns manipulate some shares. I don't think regulation can help much.

Tal: What differentiates 1994 is the association with the banks. I don't claim the stocks rose because the banks pushed credit. The problem was that a lot of people were caused harm by the banks' behavior. In that respect, in many ways we're at the same place.

What things today are reminiscent of the times then?

Tal: I believe that most of the flaws that existed then still exist today, so a crisis that results in large numbers of financial casualties could happen again.

Two main problems in today's markets

Terry: Today's market has two main problems, overconcentration of power and liquidity. The power is of the banks, but also in the controlling structure of the companies. Less than 10 percent of the registered companies are purely publicly owned, and in the rest, controlling shareholders own 70 percent to 80 percent stakes.

The market could be improved in several ways, including through introducing market makers, involving bigger players, allowing short transactions and adopting additional methods found elsewhere to moderate the fluctuations.

At the ISA [which Terry chairs], we also hope to reinforce the public's faith in the market. Improving transparency and disclosure in financial statements would help. A lot has been done but much work remains.

Bronfeld: I want to tell my learned friends that we mustn't confuse building solid infrastructure for trade with preventing crashes. The U.S. market was there 150 years before ours and it still has bubbles and crashes. There is still no cure for the common cold but you want to cure human nature? Regarding infrastructure for trade, the situation today is far better than it was a decade ago.

Going nowhere

Tal: We have progressed a lot and gone nowhere. We don't even have a capital market.

A look at the last 10 years gives the nasty feeling that the stock market has become a tool to take from the many for the few. Will that change in the decade to come? Will the bourse create value for investors?

Terry: I think that if you look at returns over 20, 30 years you reach different conclusions, the returns are good. But it might be appropriate to educate the people, teach them how to invest in the capital market.

Stepak: I have to say that at the level of infrastructure, there has been great improvement. For instance, the Consultancy Law, requiring consultants to be licensed, or analysis, which has considerably developed in recent years.

Market norms have also improved. Ten years ago most companies didn't pay dividends. Now most do and share the profits with the public. Institutional investors participate in shareholders assemblies, helping curb the major shareholders' ambitions of making profit at the expense of minority shareholders. Maalot provides public ratings. Web sites provide information and access to data that people couldn't get 10 years ago.

But there are environmental problems that persist, the domination by the banks and the conflicts of interest in major players.

Yones [a former Bank Hapoalim chief]: I do not think the domination by the banks and their power are factors inflating the bubble. The absence of liquidity is the market's real problem. Liquidity can offset abnormal phenomena and reduce volatility.

Tal: The basic problem is that our capital market is small, and as long as it stays that way, our problems will not change. When a capital market is small and weak, it is easier for the companies to ask the banks for loans. I fear that problem, of the market's insufficient size, is here to stay over time, so we will have to continue relying on the banks. For that reason, it is highly important to improve the banks.

The banks here are highly dominant. Everybody talks about separating the mutual funds and provident funds from them. I don't support that view, though if the banks continue to fight for unreasonable interpretation of the consultancy law and fail to reform the management of mutual funds, there will be no choice.