Taking Stock / A Populist Attack

In the last month, the public debate in Israel on the financial crisis has sunk to a new low. The various interested parties understand the basic economics perfectly well, but will stop at nothing to push the regulator, or harness the taxpayer, for their own gain. And just as in our bond market, where everything has turned into junk, thus new trash talk has arisen in the capital market, characterized by the following type of questions.

Is the Bachar reform to blame for the crisis?

Some say the whole problem in Israel is the fault of Joseph Bachar, for forcing the banks to sell their provident and mutual funds.

We would like to point out that 50 stock markets around the world lost more than 50% of their value in the last year. This crisis is wholly imported. It is Made in Somewhere Else. Also, most of the foreign pension funds have lost 20% to 30% of their assets in the last year, but out there, they understand the rules, and know that in the market, one day you gain, one day you lose. Nobody has been asking governments to bail out the pensions sector, except here.

If the banks had controlled the funds, it wouldn't have happened

Three points:

1 The companies whose bonds are trading at yields of 20% or 50% to maturity usually owe even more to the banks than they do to bondholders. The chances that the hidden bank loans will be repaid in full are not always greater than the chances that the debt to bondholders will be repaid in full.

2 The market caps of most of Israel's banks are now at about half their equity, in most cases, precisely because of all those outstanding illiquid loans. A bank share trading at half or a third of the bank's equity per share is also a kind of junk security.

3 Please note the performance of the few provident funds that remained in bank hands until the last few months. Wonder of wonders - they had the same proportion of high-risk assets as the funds taken over by non-bank companies.

Who will manage our long-term savings?

Some argue that it doesn't matter whether a provident fund or pension fund is managed by a bank or somebody else, the main thing is that they shouldn't invest in the capital market. They should continue to buy designated treasury bonds assuring interest of 5.25% a year, as was the practice 20 years ago.

Terrific idea. Let the government handle all long-term savings. Companies and managers wanting to raise money will kindly make an appointment with the accountant-general in Jerusalem, or at the Ministry of Industry and Trade, stand in line, and receive their funding, maybe. This will work fine.

The capital market needs a safety net

Now we're told that the government has to lay out a safety net for the provident funds. Or that it should buy the wilting corporate bonds.

But who's suggesting that? Pensioners? Of course not - their voice isn't being heard.

That's the proposal of the big boys on the capital market, the ones who made money hand over fist the year before and the year before, because it's a free market, isn't it.

I want to expand on that proposal, with your permission. Subsidizing or rescuing long-term savings vehicles of any type means, that at this time, neutralizing all or part of the risk factor from those vehicles.

Neutralizing the risk factor, ladies and gentlemen, is the silent enemy, the enemy one can't see, but it will wipe out the capital market in Israel and sow the seeds of the next crisis.

Neutralizing risk means rewarding all the people who don't deserve reward.

It is a reward to the controlling shareholders and to the managers who gambled and leveraged the companies, using money raised from the public. It is a reward for people who paid themselves sky-high salaries based on fictitious profits that disappeared this year, or will disappear next year.

It is a reward to the institutional investors who bought the risky corporate bonds without demanding a margin (spread) reflecting the true dimensions of the risk. It is a reward to the institutional investors whose performance doesn't justify the high management fees they take.

Neutralizing risk at this time would be a reward for the pension managers who didn't warn their aging clients about the risks to which they were exposed. A reward for the regulators who didn't warn the public, and left hundreds of thousands of people in shock and pain.

The greatest danger in a "safety net," or direct intervention in the provident funds market, isn't just the tens of billions of shekels it could cost the taxpayer. It is that it would eradicate the market's mechanism of punishment. If the ones who took the risks and behaved irresponsibly aren't punished, we can rest assured of another crisis in a few years' time. We can be sure that these people who lost all that money will lose the lesson, too.

So should the state sit tight and do nothing?

No. What should it do? First of all, it should focus on the primary reason for the retreat of the capital market, beyond the forbidding international environment, which is - the real economy outside the banks. Crisis creates an opportunity to carry out the reforms and structural changes that cynical politicians block when the times are good.

As for the financial sector, the opportunity is tremendous. When hundreds of thousands of people are licking their wounds, that is the time to make changes.

It is an opportunity for Yadin Antebi, the commissioner of capital markets, savings and insurance, and for the government, to finish the capital market reform begun by the Bachar Commission and to eradicate the conflicts of interest that remain in the capital market - in insurance, in underwriting, in the credit rating agencies, and in the boards.

It is an opportunity for institutional investors to go to war against companies and controlling shareholders that sought to deny their commitments using clever debt rearrangements. It is an opportunity for the public to remind the institutional investors that they're supposed to fight the sky-high salaries through which all too many CEOs and controlling shareholders milk their companies dry.

It is an opportunity to complete the reform of the insurance sector, to allow people to withdraw their money when they want a different risk profile and lower management fees. It is an opportunity to set up IRA-type private-sector provident funds for savers who want to minimize management fees. It is an opportunity to remember that over time, these management fees can eat up your returns.

It is an excellent opportunity to remember that despite all the fuss, the regulator hasn't done much about management fees and conflicts of interest, while savers wind up paying the bill.

Note that five years ago, the treasury had to reduce pension rights by 10% to 30% for savers in the "old pension funds," in one single reform, because of the funds' bad management. In fact it shows that if management is bad, it doesn't matter if the fund's assets are invested in the capital market or in treasury bonds.

Also note that there are hundreds of people blissfully unaffected by all this. They are the government servants and soldiers living off high noncontributory pensions paid entirely by taxpayers. Boom, bust - they're out of the game and sitting pretty. Now that the government is thinking of sticking its hand into all our pockets to pay for a "safety net," we should all be asking aloud whether some pockets are worth more than others.