Who Will Save Us?

How can we head off the plots to destroy the capital markets?

Toward the end of his stint as finance minister, Roni Bar-On began to grasp who really runs the economy. The truth started to glimmer last September, as banks in America fell like dominoes. One day that month, when Bar-On was at home, the unlisted family phone began to ring. On the line was the chairman of one of the big Israeli banks.

"Don't let the stock market open tomorrow," he told Bar-On. "You'll imperil the stability of the banks, of the whole financial system."

Bar-On saw red. He didn't understand where the banker had gotten his number, and he especially didn't like the banker's threatening tone, or his direction.

"Call me at the office," Bar-On barked and slammed down the phone.

Happily, the stock market opened as usual and trading went on normally.

In the six months following Lehman Brothers' collapse, the pressure on Bar-On from the biggest borrowers and bankers in Israel grew and grew. In an interview to Army Radio last Thursday, Bar-On talked about the pressure for the first time. Yet Finance Ministry sources say the pressure was far greater than Bar-On let on.

"The borrowers and bankers presented very detailed plans to take NIS 40 billion from taxpayers to rescue themselves," one says. "The threatening tone in their conversations with the finance minister was clear. It wasn't a suggestion, it was practically an order. When they realized he was firm, suddenly negative articles about Bar-On started to appear with amazing synchronicity in the business papers."

The big borrowers and bankers are fighting for their lives, for the control over their companies, said one of the treasury people last week.

"They're fighting to preserve their status and will stop at nothing - in fact, after the gambles they took and the collapse in the value of the properties they bought, their companies are bankrupt," the source said.

They don't own their companies any more, but they refuse to see it, he said. They still think public money can rescue their hides.

"We're all waiting for Netanyahu, to see whether he supports our battle against the big borrowers and bankers. There's a lot of fear at the Finance Ministry that Netanyahu won't withstand the pressure," he said.

If public money is used to maintain the status quo, without changing anything, there will be great moral hazard, explains a leading economist. However, if the tycoons give away shares in exchange for having their debt forgiven, thus diluting their rights, the moral hazard disappears.

Moral hazard may arise when a government (or anybody else, for that matter) rescues a company (or industry) in a manner that increases the chance the rescued company (etc.) will take risks, and otherwise continue their bad conduct. If they don't have to pay a price for their mistakes, why not repeat them?

The person who explained the disastrous consequences that will ensue from using public money to bail out the system, without changing the system - is one of the greatest economists in the world, a man with tremendous experience in financial crises and in reorganizing shattered economies, banks and companies.

The man who explained all that is...

Oh, actually, he didn't. He's the man who everybody expected would say all that, but he kept quiet. The silence of Bank of Israel governor Stanley Fischer is deafening.

To be more precise, he actually did say all that, but when serving as vice-chairman of the International Monetary Fund. He said it in Japan, in 1998. You can find the full text on the IMF Web site. He just hasn't said these things this time around.

Google "Stanley Fischer and moral hazard," and you'll get 8,240 results, the first 10 of which are him frothing at the mouth about bank or economic rescues that lead to moral hazard by neglecting to dilute or penalize the bad bankers or businessmen who took the risks that created the crisis.

Why is Fischer silent as Israel's biggest businessmen and bankers try to push through a rescue that would destroy Israel's capital market? Maybe he's afraid for the stability of the banks, which is his fiefdom. He has spoken time and again in recent months about the stability of Israel's banks as the global storm rages.

But he knows how much "toxic assets" are sitting on the balance sheets of these banks - loans that will go sour because they were used for unwise acquisition of properties and other assets outside Israel.

The way to stabilize Israel's banks doesn't lie through the taxpayer's pocket, or a rescue of the tycoons. Israel's banks have to reorganize, just as Fischer said at the IMF. They have to issue notes to improve their capital adequacy ratio and dilute their present shareholders, who would be punished for allowing their managers to take risks they shouldn't have while withdrawing huge salaries, assuming that if the crunch came, the taxpayer would save them.

The chairman of the IDB group doesn't give interviews. He has other ways to get his messages across. Two weeks ago, though, he deviated from habit and at the inauguration of a Super-Sol store in Sderot, he criticized the Ministry of Finance for fiddling while Tel Aviv burns.

His critique groups him with the other tycoons pressing the treasury to bail them out.

Dankner hardly needs our advice, but we have some for him anyway.

IDB is in much better condition than most of the other big business groups. Dankner had the good sense to take tremendous long-term loans from investors before the crisis broke out.

Of course, he made mistakes, like buying Koor Industries at the top and land in Las Vegas at the worst possible time. But his situation is still good compared with the rest. Yields on IDB group bonds are about 7%, reflecting faith that unlike his fellow business barons, he's expected to be able to refinance.

A blanket rescue of the biggest borrowers, through the taxpayer, would eradicate the capital market and the economic and ethical platform on which he sits.

If, when crisis arrives, the government retroactively abolishes the risk/reward equation and gives free lunches to the businessmen who made millions upon millions through market mechanisms in preceding years, the basis of the capital market is ruined.

Dankner has been one of the biggest beneficiaries of the free market in the last six years. He should be the first to oppose government intervention or any taxpayer-funded rescue of business or banks. He, who borrowed billions and billions, should call on the government not to touch the capital market. Let the bad companies fall or be bought, merge or vanish. Let the punishment of the market do its work.