The Price of War

Ben Bernanke and Henry Paulson threw out the textbook and rewrote doctrine. They were right to do so - but all of us will pay.

When the cannons roar, not only the Muses fall silent. So do the treasurers. Nobody calculates how much a preventive war will cost - not when the battlefield is flesh and blood, and not when it is Wall Street.

The battle to stop the U.S. and global economies from sliding into 1930s-type recession was crucial. Now that the markets are starting to show signs of stabilizing, we can even hope that the steps being taken will actually work.

Thus now is the time to address the price of the war: $1 trillion tacked onto America's debt and cash injections amounting to hundreds of billions of dollars by central banks in the United States, Russia and Asia. It is completely impossible at this stage to accurately quantify the ramifications of these developments. But they will include higher inflation, tax hikes and, apparently, gargantuan bond issues by the U.S. treasury - steps that were anathema just a month ago. Yet they are the new reality.

When the panic passes and the U.S. treasury starts flooding the market with bonds to finance its deficits, these investors will discover that even under the government's wing, they can lose money, and a lot of it.

Just six months ago, Bernanke and Paulson sent JP Morgan Chase to buy the remains of Bear Stearns, in a transaction fueled by taxpayer money. The Fed did not want to take over Bear Stearns itself: It was an investment bank, not a commercial one, and formally lay outside the Fed's supervisory purview.

Last week, as the noose tightened around the neck of insurance giant American International Group, nobody stopped to read the fine print. AIG was seized and nationalized even though it is not a bank at all and is not formally under the Fed's supervisory purview, because its collapse would clearly have destabilized the entire global financial system.

Bernanke and Paulson threw out the textbook and rewrote doctrine on the fly. Over the last couple of weeks, they adopted the rule of thumb that anything that would calm the panic should be done - never mind how extreme, unprecedented or even beyond the scope of their legal authority it might be. Bernanke and Paulson did not stop to cover their behinds or hang about waiting for the imprimatur of Congress. They did what had to be done, and it is a good thing they did.

Before you bewail the death of the free market - it is still there. But it has become crystal clear to regulators that the capital market is just as important as the banks, and that some of the market's instruments need protection from collapse just as the banks do.

Yet even the most tightly regulated banks in the world - including the likes of Switzerland's UBS, which had adopted the world's tightest risk management system (Basel II) - found themselves up to their necks in muck, with losses amounting to tens of billions of dollars. Thus banks worldwide need to draw conclusions. Basel II was supposed to be the future of risk management in banking, yet it failed before even reaching the starting post.

Supervision of the investment banks has to be fundamentally rethought. The process can begin by sharply boosting equity requirements for investment firms. Israel's brokers manage money for their clients in trust, and are theoretically not responsible for any losses incurred from investments in the markets. But do you really think Jerusalem would allow a pension or provident fund to be wiped off the map, leaving thousands of people bereft of pensions?

Just as the state guarantees bank deposits de facto (this is not a law, but Israel's government has rescued savers every time a bank has collapsed), it will not leave pension savings at the mercy of the storm. And if there is to be public security for long-term savings, then it is only right and proper for pension fund shareholders, insurance companies and provident fund managers to help finance the guarantee. They must do this by providing equity cushions to cover extraordinary losses.

Managers of mutual funds and ETFs must be required to increase their minimum equity, even if that means excluding a whole slew of bit players from the game.

Did Israeli savers know that half their money was being put into loans to private companies, some of which were decidedly dubious borrowers? Were any of Israel's savers consulted about it? They were not: In Israel, pension funds invest at the sole discretion of the investment manager.

Last January, when Prisma's provident fund Hermon lost 8% of its value in a month, we wrote that greater transparency was crucial. We said it was high time for provident funds to work with binding prospectuses, allowing investors to know exactly what the fund's policy is.

The need was clear after Hermon's debacle. It is now screaming.

Savers in Israel's provident funds, pension funds and insurance policies cannot be left to the tender mercies, talents and whims of investment managers. It is time for savers to be informed of exactly where their money is going and what risks they are exposed to, so that they can choose the pension portfolio that suits them. It is the duty of the Finance Ministry's commissioner of capital markets, savings and insurance to make sure this happens.