Taking Stock / Are We Really That Great?

On Israeli regulation, twisted Krugmanism and bankers' judiciousness.

We continue our discussion of how the amount of rubbish in the public debate on the financial crisis is even larger than the pile of junk in the public's bond portfolio.

Hm. What is true is that the crisis presents the regulators with a stellar opportunity to sell their success story to the press, which is serving a public desperate for information about what the government and Bank of Israel are up to.

Sad to say, regulation can't take the credit for Israel looking better than the rest of the advanced world (as it does, at this point). No, the credit belongs to far more prosaic things. To wit:

? From 2001 to 2003, Israel was washed over by a wave of ceaseless terrorism, unprecedented in scope, which savaged the economy as well. While the rest of the world was recovering from the high-tech bubble (also to be known as "Alan Greenspan's financial bubble"), Israel was sinking into intense recession.

That recession had positive sides, though: It forced Israeli companies to become more efficient. It prevented Israeli companies in particular and Israelis in general from gorging on loans. And when the recession finally ended in 2004, it left behind a collective scarred by the memory, and consequently, careful.

? That deadly wave of terrorism, along with the end of the high-tech bubble, wreaked havoc on the balance sheets of Israel's banks. That in turn enabled the Bank of Israel to clamp down on the banks' lending practices. In 2002 and 2003, Israel's banks had to make gargantuan provisions for doubtful debt, because of the loans they'd lavished on overextended businessmen. You can trust Israel's banks that if it weren't for the second intifada and the painful memories, they'd have leaped joyously into the global credit extravaganza.

? The recession, the government's heavy debt and its dependence on the bond market forced the treasury to behave with fiscal responsibility, while over in Washington, U.S. President George Bush and Alan Greenspan were running amok, pouring money into the markets by every means at hand.

We just weathered the first financial tsunami, and come our sages and suggest that we forgo one of our only assets: budgetary responsibility.

Tax revenues are slumping and the budget is developing holes. And they're suggesting that we loosen our belts and kill any chance of future economic recovery after our exports collapse in 2009.

Our politicians may be overlooking the fact that unlike the U.S., Israel doesn't have a mint that can print dollars. Nor can it issue bonds that the rich nations of the world eagerly soak up. Here, a big government budget deficit suffocates the capital market, causes interest rates to rise and frightens the consumer, who realizes that Jerusalem is burning up money as though there's no tomorrow. The consumer knows that tomorrow will come.

And why should they dabble in derivatives? While investment banks in America, which operate in competitive markets, lost much of their profit drivers at the start of the decade, over here, nothing changed with Israel's banks. They still have complete control over households and all businesses but the giants. The bankers could merrily continue to pay themselves sky-high salaries.

Unlike their peers on Wall Street, they didn't need to leverage the bank into the stratosphere and dabble in weird securities in order to claim bonuses. And don't forget that when the boys from the Street offered weird securities to Bank Hapoalim, it bit, only to wind up writing off a billion dollars.

Not Greenspan, mind you, the free market. At least that's what he tried to sell to Congress at his hearing last week.

The free market system had plenty of holes, but Greenspan was responsible for not a few of them. The main reason Wall Street and the world developed the financial bubble was his monetary policy: He kept real interest rates below zero for five years, to inflate the economy by force.

Another central reason for the financial bubble was Washington's intense involvement in the U.S. mortgages market. The very Congress now howling about the crisis is the same one that preached a year ago that every American should be able to buy a home, never mind the price and leverage. Why? Because a house is part of the American dream.

The last reason is paramount. Greenspan, like his boss Bush, sold the theory that the markets, the business sector and the players should regulate themselves. That's part of the reason why he opposed regulation for the derivatives market.

Plenty of Israelis buy into that theory. The Israel Securities Authority has been lauding the wonders of "voluntary regulation," and some of Israel's tycoons habitually attack any regulation that threatens to look at their empires.

But the developments on Wall Street have proved that without violent, diligent regulation, the free market will reduce investors to dust. Israel's regulators should bless their lucky stars, and implement the lessons the Americans have been forced to teach.