Taking Stock / Handouts, Hangovers and Heftsiba

You're wrong, Prof. Haim Ben-Shahar said to his old friend, Stanley Fischer. Inflation is back, it's just hiding behind the weak dollar. You're inflating a financial bubble.

You're wrong, Prof. Haim Ben-Shahar said to his old friend, Stanley Fischer. Inflation is back, it's just hiding behind the weak dollar. You're inflating a financial bubble.

A few days before Ben-Shahar made that comment, the central bank had published the minutes to its policy meeting, which had taken place on May 28. Fischer had decided to cut local interest rates by 0.25 percent, to 3.5 percent, though two senior managers counseled against it. The economy was booming and inflationary pressure would build up, they argued.

A month later, Fischer had to reverse gears and raise interest by 0.25 percent. In two weeks he'll have to do it again - raise the central bank rate back to 4 percent. The central bank is supposed to be our rock, but it's looking mighty confused.

Its vagaries came to mind when reading a Bank of Israel paper on a topic it generally ignores: managerial wages. It stated that the CEO of a publicly traded company generally earns five times what the director of a government company does.

First reaction: They call that a study? Did we need the bank to tell us that? The government discloses what it pays the CEOs of its companies, and publicly traded companies disclose pay at the top, too. The annoying thing isn't the report's lack of value, it's that the study seems to serve the petty interests of the Bank of Israel's senior people.

The central bank has been battling over salaries after its own corrupt practices during over 20 years were exposed. The battle peaked two months ago, when Fischer persuaded Prime Minister Ehud Olmert to approve a monthly gross of NIS 32,000 a month for 68 members of the management. That's well above public sector norms. Now the "study" comes to prove that it's hard to hire talented executives because the private sector pays five times more.

Wage gaps are a worthy subject of study. But if the Bank of Israel is going to clamber down from the ivory tower of econometric research studies and dwell in economic reality, we can think of more urgent subjects to investigate, such as:

b What is the real actuarial cost of Bank of Israel pension packages for workers retiring at 50, which is 17 years below the usual such age in the private sector?

b How many years does a private-sector businessman have to work, at NIS 50,000 a month, to accrue the pension sums equivalent to the roughly $2-million packages which employees of the Bank of Israel, and security and legal establishments receive?

b What is the difference between the overall wage cost of workers at government companies and monopolies, and that of workers in private-sector companies?

b How much could marginal tax (and the price of services provided by government monopolies) be lowered if these bodies paid the same wages as the private sector does?

b By how much could old-age stipends for hundreds of thousands of pensioners living in penury be raised, if the defense budget was cut by 5 percent a year each year over the next decade?

That brokerage firm took a body blow to its image this month when the Heftsiba real estate company collapsed, leaving Analyst customers with combined losses of NIS 33 million.

Of course, that loss is nothing compared with the scope of Analyst's assets. It will barely impact the performance of its investment funds, but that's an embarrassment because Analyst was one of Heftsiba's underwriters (marketers) and was therefore embroiled in a structural conflict of interest.

Since Analyst was established more than 20 years ago, it's been one of Tel Aviv's better, more reliable capital market companies. The Heftsiba affair is a stain that won't easily be wiped off by the company and its founders, Shmuel Lev and Ehud Shiloni. But, actually, it could be. Analyst could close down its underwriting arm because the culture of managing other people's money doesn't suit the culture of marketing corporate offerings. If it does that, Analyst would join other major asset management companies - Prisma, Yelin-Lapidot and Psagot, for instance - which made strategic decisions to desist from involvement in the underwriting business, lucrative though it may be.

News flash for investors: If you've been following the Heftsiba affair, if you're astonished at how Boaz Yona and his crew managed to siphon off NIS 120 million under the nose of the bankers, the board and Israel Securities Authority, and if you sigh with relief that you never bought a flat from Heftsiba or invested in its paper - we have news for you, good and bad.

The bad news is, you are invested in Heftsiba, directly via the stock market or indirectly through your pension or provident fund. We've written on these pages about builders and developers raising billions upon billions in variable interest on the Tel Aviv Stock Exchange with low interest rates that fail to adequately compensate for the risk factor.

"The TASE has been through not a few ups and downs in the last 20 years, featuring young, daring Jaegermeisters," we wrote a month ago, starting with Yuval Ran in the 1990s and going to Tal Jaegerman in this millennium. "But this time the story is a lot bigger because Israel's capital market is a lot bigger, deeper and more liquid, and the amounts of money they manage to raise will be much more than their predecessors could score."

And when the fall comes, we wrote (TheMarker, July 20, 2007), they and the institutional investors that bought the bonds will blame the bad market, some crisis in Europe or India or Russia, or the Okefenokee Swamp. "But the truth is that the seeds of the crisis are closer to home - right on the TASE, where there are investors with short memories or no memories at all."

There will be more Heftsibas. Some will collapse overnight, leaving investors with nothing. Others will gradually sink into debt arrangements and bond repurchases at bankruptcy prices. Investors will lose their money in that case, too, but the noise factor will be less of an issue.

The good news: Implosions like Heftsiba, whether because of chicanery or incompetence, or both, are part of business. What should worry investors isn't a company's collapse, but whether the institutional investors managing other people's money are demanding interest rates and terms that truly reflect the risks they're taking. It's called risk premium - and the risk is yours.

Investors have been more and more lenient on risk premiums in the last couple of years. Borrowers, ranging from hedge funds to any Joe Shmoe who wants to buy a house or car, had it easier and easier. This summer, that situation has ended in pain. Overnight, oceans of liquidity became credit crunch. Risk premiums doubled and tripled. Now bankers and brokers are running amok and nobody knows how long the pain will last. The only thing we know is that the bonuses they received won't be returned. The hangover from the liquidity binge is ending in sobriety, where risk is being given the respect it's due.