Taking Stock / In Rakefet's Closed Room

How many years have passed since the credit crunch at the banks? Since the Bank of Israel declared that a major Israeli bank could be in danger of collapse? How many years have passed since Israel's banks traded at half their shareholders' equity? Or since the banks made combined provisions of no less than NIS 5 billion for loans they thought might go sour?

Many years, evidently. Maybe as many as fifteen, or ten, or seven - at least that's what one might think after listening to Bank Leumi's latest acquisition, Rakefet Russak-Aminoach, who manages its corporate banking department. It was a very interesting speech she delivered at the Maalot - The Israel Securities Rating Company conference.

But the calendar shows that only three years have passed since that horrible quarter, and we still clearly remember the conversations we held with Rakefet's boss, Leumi CEO Galia Maor, and the chairman of Bank Hapoalim, Shlomo Nehama, and with the credit officer at Hapoalim, Shy Talmon.

Never again!

It is fresh in our minds how Shlomo Nehama explained that Hapoalim didn't want to extend long-term credit - institutionals should be doing that. But he had no choice, he said, because Israel's capital market was a crippled beast that couldn't finance Hapoalim's clients.

We remember Galia Maor telling us that future banking will be confined to short-term financing ("we have to become more like the banks abroad"). We recall Shy Talmon telling us that the days of mindless competition between the banks, over whose credit portfolio was growing faster, were over ("I don't mean to repeat the mistakes of the past, even when the good times roll again").

All that is history. In an impressive, smooth presentation, Russak-Aminoach savaged the concept of borrowing money outside the banks. She explained to potential customers why they shouldn't borrow via the capital market, but only from the banks. Hers, specifically.

Over at the bank, problems are solved inside closed rooms, she explained. With us you won't be exposed in the glare of sunlight ("beyond a few lines in financial statements that nobody notices anyway"). We are considerate of our customers. With us, you will be safe from hostile takeover in the event of difficulty in repaying a loan, or if your business fails.

No question that her words are a balm to the ears of many a company staggering under the weight of its leftover debt from the gay days of the late 1990s. They are grateful to her and to her counterpart Talmon for their forbearance and confidentiality, their willingness to reschedule and roll over debt, giving their businesses a chance to recover.

But that is merely the view of the customers in trouble. Perhaps the view that the bankers, the issuers and the economic leaders should adopt is something rather the reverse.

Over in Tokyo

The list of services that Russak-Aminoach offers - a "closed room," minimal disclosure of the true situation, rescheduling, rolling over, postponements - has a name: Japanese banking. The opposite system in the capital market also has a name: flexible economics, market efficiency, or our personal favorite - mark-to-market economy. Namely, an economy in which prices in the markets adapt themselves quickly to changes in circumstances, and the conduct of the players adapts in turn.

In the "closed room," the banker, the economy and the managers try to continue acting as though the reality had not upped and changed on them. Slog on as though it was business as usual, even though that usually meant simply putting off the problem for later. In capital market argot, companies like that are called zombies. Dead men walking.

Her method hampers economic activity, prevents companies and managers from moving from the past to new and better things. It is a system in which companies and sometimes whole sectors trudge along slowly, weighed down by past mistakes, instead of advancing.

With the capital market "flexible" method, everything is right out there in the open. There is no point or way to drag things along, roll along a problem and dodge the bullet. Market prices adapt quickly. Masks are nonexistent. Companies can enter debt arrangements and shed excess baggage.

In the open, capital market method, bad managers get ejected, making room for new blood not shackled to bad decisions from the past. Flopping companies get taken over by good ones, or better management.

It is surprising to see that the very representative of the new, young blood at Bank Leumi argues for such outmoded banking methods in her very first public speech.

The bankers know perfectly well that their balance sheets are still stained with the staggering sum of NIS 60 billion in problem debt. They know the sum had been high enough to jeopardize the entire banking establishment when the economy weakened. They are also familiar with the graph showing the spike in credit they had granted during the boom of the late 1990s.

The bankers should welcome the rapid development of the capital market alternative to their resources. They should be pointing out the problems that remain to be resolved in the marketplace, for instance that a large part of the corporate bonds being issued are nonmarketable, and therefore the market fails to properly price the risks of the borrowers, or to monitor them adequately. The ex-banking market has far to go before it presents a decent alternative to the banks.

The question is what sort of economy we want: one of closed rooms where bankers make decisions - some good, some bad, but in any case nobody really knows; or an economy in which information reaches the markets immediately, a market in which prices and risk premiums are adjusted on the spot, where corporate conduct also adapts immediately, and where ownership and management structures change as necessary.

Our answer is clear. We hope that the answers the bankers and economic leaders give is also clear, and that the "closed room" speech by Rakefet Russak-Aminoach will be relegated to the status of swan song, a hymn to the old system of banking and capital market structure that we do not want any more.