An Island of Stability in a Sea of Pain

Political leaders insist that barring an unforeseen deterioration of the situation, Israel's financial system is safe.

As the economic storm storm batters the planet, Israel has proven to be an island of stability. Political leaders insist that barring an unforeseen deterioration of the situation, Israel's financial system is safe. The Bank of Israel is predicting that a recovery will start next year.

By nature, politicians rarely tell the unvarnished truth, whether out of self-interest or for fear of consequences. Their behavior indicates worry: The Bank of Israel twice sprang surprise interest-rate cuts and the Finance Ministry is forging an economic emergency package.

The analysts at Tel Aviv-based Israel Brokerage & Investments have no agenda. Ayelet Nir, Eyal Klein and Yuval Zehira, three of the most respected names in local economic circles, say that Israel indeed is safe - thanks to its relative backwardness and far-seeing economic policies handed down from Jerusalem. But danger lurks from without: islands exist in the wider world, and when the tide rises, their shores get wet. And from within: Populist moves could wind up loading our children with unbearable debt.

I.B.I. is one of Tel Aviv's oldest investments firms. One of the largest private investment houses in Israel, it's located in the Shalom Tower, formerly the tallest building in the Middle East.

The good news is that the analysts believe the world is turning a corner in the global crisis. "The situation is starting to stabilize," avers Eyal Klein, I.B.I.'s international markets chief strategist at 32.

The bad news is that an actual recovery hasn't begun yet and prophecies of doom, spurred by "too much information" can become self- fulfilling, warns chief economist Ayelet Nir.

Economies behave cyclically. The trouble will pass. The question is when and how. The regimes of the West have proven pragmatic in abandoning tenets of free-market theory for serious practical steps. But while the Bank of Israel predicts a recovery starting next year, at I.B.I. they think 2010 or 2011 is more realistic.

Growth has already ground to a halt or worse in the United States and Europe. But Klein isn't one of the bears predicting a protracted recession. "We see governments making serious efforts to resolve the credit crisis. It is highly unlikely that these efforts will be in vain," Klein says.

Through sheer doggedness, the governments will prevail, he predicts. Ultimately they will restore shattered confidence, after a painful interim of shrinking global trade. He doesn't see any more major bank collapses either.

Klein spent more than six years at the Finance Ministry. After serving as executive director of Foreign Currency Transactions and External Debt, from where there wasn't much room to grow, he moved to the private sector. Married with a baby daughter, the tall, articulate manager volunteers on Saturdays at the Israeli Center for Sea Turtle Rescues.

The job facing governments is: (1) Stop the slide. (2) Restore confidence. (3) Walk away. Here in Israel, there's no need for government intervention in the capital market to stop the slide, Finance Minister Roni Bar-On has said firmly. It isn't needed. What is, says the minister, is investment in infrastructure and support for small-to-mid-sized businesses.

"Government support is a good idea not because we're on the brink but because we could be in a better position than we're heading for today," argues soft-spoken chief analyst Yuval Zehira. "It isn't necessary here. It's smart."

Psychology is key to economics. A bad headline in a major paper could still trigger an avalanche, points out Nir, 39, a mother of three, the most recent being baby Shy ("It means 'gift' in Hebrew but in English too it's a nice word for a girl," she says.) Today I.B.I.'s chief economist, Nir joined the firm eight years ago. She finds relaxation in cooking.

People need relaxation these days. In the worst-case scenario confidence isn't restored, banks continue to fall, and governments run out of money. At I.B.I. they think that unlikely. "But if people read that the end of the world is coming, that's exactly what could cause it," she cautions.

The development of the crisis therefore depends in part on the public's reaction, on how many people run to withdraw money from banks. "Even the mighty Bank of America or Citi will fall if a rumor causes a run on the bank. No safety net could help even Citi if a real run develops," Klein says.

While I.B.I. sees recovery starting in 2010-2011, stocks and bonds are another story. States have to finance rescues somehow, and that somehow is by selling bonds.

Israel can also sell bonds. What it must not do is increase overall debt, points out Nir. Tax revenues in Israel are declining. If Jerusalem steps up spending, as some politicians demand, its deficit will mushroom. Israel already spends a vast one-third of its national budget on debt repayment and service. More spending today means a greater burden on our children, warns Nir.

Foreseeing that the global economy will start to rebound in 2010 or 2011, Klein believes that the bond market will remain depressed in 2009 - which would be a good time to get into it.

As for stocks, no sector and no country have escaped the wrath. The pullback has been indiscriminate: All companies have dropped. Opportunity has been created for investors with a long horizon, at least five years, but people must be careful to diversify, Klein urges. Also: "Don't overweight with stocks, but don't shun the market. When the market rebounds, it will happen very fast. You can't tell where the bottom is and if you aren't inside, you'll miss the rebound."

Though Israeli equities are down and unemployment is rising, Israel's situation is infinitely better than the rest of the world, the I.B.I. analysts insist. "Our peer group had included the countries of East Europe. During the boom everybody was swimming along beautifully and then the tide ran out, and we saw who was swimming naked," Klein says. "Israel, it turns out, was wearing a bathing suit."

Hungary, Bulgaria, Romania, Estonia and Ukraine are in serious trouble. "Some have remnants of slightly dark regimes that are now collapsing. Ukraine for instance kept its exchange rate steady, selling and buying foreign currency to keep its exchange rate from moving, and is out of money. Hungary had to ask the European Central Bank and IMF for help," Klein says.

They had financed deficits through bonds. And when the markets shut down they ran out of money all at once.

The recession there will be dramatic, he says. "We're a completely different story."

The reasons are really nothing to boast about. Israel's banking system had been considered retarded. "Our banks didn't give mortgages of 100%. Probably in five years we'd have gone the same way but now we're an island of stability," Klein laughs.

Israel's troubles are entirely imported. Property prices here never reached bubble proportions, says Nir. But exports are hurting, which means fewer jobs. Some companies fire because they have to and some to prepare for lean times. Israelis frightened for their jobs are buying less. Private consumption, which had risen in the last few years, is falling. "Even if your sister hasn't been fired, there are enough people afraid they'll be next," Nir says. And imports of raw materials, investment products and consumer products are falling as manufacturers brace for a recession.

But Israel entered the global storm strengthened by reforms and responsible fiscal policy. Israel's debt remains high but it has surplus assets over liabilities, a surplus in the balance of payments and a strong base of manufacturing and exports.

"Also, the Bank of Israel has been building up its foreign-currency reserves while the dollar was cheap. Credit rating agencies upgraded Israel. It all made us more stable to crises. I hope looking ahead that our leaders won't go backwards," says Nir.

For 2009 she predicts Israeli GDP growth of 2.1%, though the Bank of Israel is still predicting 2.7%, and the Finance Ministry's forecast is 3.5%. Both will be amended downward, predicts Nir.

Meanwhile, keep this in mind. Nobody knows where the bottom is, all three analysts point out. And nobody knows when the recovery will begin. When stocks rebound, it could be fast and violent. And if you aren't in the market, you'll miss it.