Taking Stock / The Bonds That Saved the Financial System

They say there are two kinds of investors: those with short memories, and those with no memory at all.

But the truth is that stock market investors are no different from any other set of capital market players. How long has it been since the banks launched their blitz, helped by their friends in the media, against the corporate bonds market? Five years? Two? One?

No. In stock market circles, things move fast. Gains accrued over ten years can vanish inside three months, returns of five years vanish in weeks and slogans that had been on the tip of every tongue suddenly disappear from the public debate.

So, to recap for the short of memory, at the height of the financial crisis we were told from every soapbox that the age of stock is over and that having anybody but banks lend money had been a terrible idea. Some went so far as to suggest that the entire capital market be nationalized again, or at least subsidized.

But the main thrust of the attack was on the corporate bonds market. Bankers, who had been accustomed to controlling all lending in the land, proclaimed far and wide that the global financial crisis proved what a bad idea it is for anybody but banks to lend money. All financing for business must pass through them and them alone, the bankers explained. Also, the public's savings shouldn't be recklessly deposited in the hands of the stock market sharks.

The heavy losses that provident funds suffered last year beautifully augmented the bankers' campaign against the corporate bonds market. Commentators, politicians, Knesset members and all sorts of passing "economic experts" rushed to jump onto the bankers' bandwagon. Trying to explain to these tempestuous, maddened hordes that the financial crisis was actually caused by bankers taking irresponsible risks didn't work. When stocks are falling like stones, it's impossible to convey simple economic messages. And thus some bankers and their sidekicks in the popular media exploited the panic to fan the flames, frighten savers and drive home the message that bankers aren't the problem, they're the solution.

The end of the first half of 2009 is a good time to revisit those theories and examine them. Maybe now that the panic level has abated, we'll stand a better chance of bringing the players' attention to a few simple facts.

First of all, some numbers. Most of the provident funds, insurance programs, training funds and pension funds, through which the general public invests in the capital market (whether the general public knows it or not), have returned most or all of their losses in 2008. Happily, only a fraction of people fled their long-term savings at the height of the crisis. Those who did locked in their losses. But the financial damage done by the banks' terror tactics against the capital market wasn't that bad.

More important than the losses, profits or fluctuations in the market are the conclusions about the capital market's structure. The financial crisis impacted Israel too, but only as a corollary of the global troubles. The sudden demise of the worldwide credit bubble temporarily clogged up the arteries that stream blood into business - these arteries being the banks, the money market, the stock market and the bond market.

Governments everywhere infused trillions of dollars into the banks and capital market, to unclog the arteries and stabilize the system. As of now, their prompt action seems to have worked. The side effects of their infusions may be painful and protracted, but the global economic system is out of intensive care.

And which financial system was first to recover, first to start streaming blood into the starving organs of the global economy? Was it the commercial banks? Mortgage banks? Investment banks? No, no and no. The first system to recover was the corporate bonds market. Precisely that market outside the banks that lends to companies.

Not only did the bond market rally fast. Within months it had shot up to levels allowing companies to raise money again, while the banks were still balking at lending. From the start of 2009, companies around the world have issued $3 trillion worth of fresh debt. That's more than they'd raised from the capital market throughout 2008.

That doesn't mean the financial crisis is over, or that the economic troubles have passed. It just proves that the bond market is back in business, no less, no more: It's pricing risk again, separating the good companies from the bad and streaming blood into the economic system.

Here, too, the first arena to recover was corporate bonds. While the bankers licked their wounds and wrangled over what to write off, what to set aside, what to recycle and what to rescue, Israel's corporate bonds market was moving fast. Yes - at first corporate bond prices collapsed. The second stage was discussions of debt arrangements. The third phase brought selectivity, separating the corporate wheat from the chaff. And finally, the door opened again, enabling companies to raise money anew.

Until just a couple of months ago, certain elements were still arguing that the state had to step in, to intervene in the bond market in this way or that. Some suggested using taxpayer money, others to reschedule debt repayments, still others to subsidize provident fund investments, and so on. If these suggestions had been adopted, Israel's capital market would have died. The players would have realized that when trouble raised its hairy head, the government would step in and save them. In the absence of punishment, they'd have been freed to take whatever risks took their fancy.

Intervention in the market isn't the solution. It's the source of crisis.

Happily, a handful of technocrats at the Finance Ministry stood firm against these ideas. As soon as they were off the agenda, the bond market started pricing risk again. From the start of the year, Israeli companies have raised NIS 16 billion on the corporate bonds market. If they'd had to rely on the banks, they probably wouldn't have been able to raise that much.

Israel's corporate bonds market is very young. Granted, it's been around for decades, but it only became a serious player in the last five years. It therefore has a lot of children's maladies.

The institutional investors managing our money need to learn to work with bonds, to price risk and manage debt. The regulator's job is to give them the tools to do so, and force the institutionals to operate responsibly and professionally.

But it isn't too soon to say that the only market that weathered the global economic crisis is the bond market. Here, too, it proved that the method of non-bank lending, in which thousands of investors reevaluate the risks of each company every morning, is better than the previous situation we had, in which three banks ruled all financing for corporate Israel.