By ZIV HELLMANExtract from an article in Issue 14, October 27, 2008 of The Jerusalem Report. To subscribe to The Jerusalem Reportclick here.
Israel will not escape the effects of a global slowdown, but the experts are confident that the economy can handle it
Is Israel prepared for an economic storm?
There are some worrisome signs. The Tel Aviv stock exchange marches in lockstep along with all the other world bourses following Wall Street's lead, and in the past year that march has been decidedly down-beat. Israeli investment funds, including those holding the majority of pensions, have lost an estimated 40 billion shekels ($12 billion) this year. Israeli financial institutions are estimated to have had an aggregate exposure to the failed Lehman Brothers Holding company of $250 million to $300 million, and a further $90 million in assets held in the collapsed Washington Mutual Bank.
Inflation is up, running at close to 5 percent over the past 12 months, well above the government's target of no more than 3 percent inflation per annum. After four consecutive years of greater than 5 percent growth, the GDP growth is expected to slow to 4.2 percent this year and 3.5 percent next year. Government ministers, foreseeing a possible worldwide recession, speak of preparing for an "economic tsunami."
But although Israel is not immune to the economic ill winds blowing in coldly from the United States, the country's financial foundations seem solid at the moment, according to leading analysts.
Local banks have, relative to their asset portfolios, tolerably small exposure to the internationally-traded "toxic" mortgage-backed investments that have wiped out much larger banks in the United States and Europe. A growth rate of 4.2 percent may be less than the economy has been accustomed to in recent years, but it is far from anemic. The shekel remains a very strong currency, not only against the U.S. dollar, but against virtually every major world currency, due to a general feeling that Israel is a safe haven in which to park money while the financial crisis sorts itself. The overall macroeconomic picture is sound, which many observers attribute to the steady and professional leadership in recent years of the Bank of Israel and the Finance Ministry, which maintained proper regulation and consistently met macroeconomic targets without excessive political meddling.
"The roots of the macroeconomic problems in the United States run deep," says Dan Galai, professor at Hebrew University's Business School and the author of a book on risk
management. "The United States went through 15 years of a housing bubble, a situation that has no historical precedent. And when the bubble looked like it might be winding down earlier this decade, it was given a push by [U.S. Chairman of the Federal Reserve] Alan Greenspan by a slashing of interest rates. Property prices there have now fallen 20 to 30 percent, with all the attendant problems. Israel has nothing comparable. The economy here went through a recession in the years 2000 to 2003, during which time the real estate market went through a correction, and it is now in good shape."
Nor does Israel have a homegrown sub-prime mortgage crisis - because there are no sub-prime mortgages. In contrast to the United States, where it was not unheard of at the height of the housing bubble for people of limited incomes to be granted no-money-down mortgages of 120 percent of the value of the properties they were purchasing, Israeli mortgages do not exceed 70 percent of the value of the purchased property. When exceptions to this rule are permitted, some form of collateral security other than the mortgaged property are required.
"Not only do Israeli banks not give excessive mortgages, they have recourse to mortgage repayments beyond the mortgaged property itself," points out Asher Blass, a former senior researcher at the Bank of Israel who is now a professor in the Economics Department of the Ashkelon Academic College. "They can demand repayment from the borrowers and sometimes from personal guarantors to the mortgage." In many states in the United States, in contrast, in case of foreclosure banks may often be stuck with property that has lost its value, taking a heavy net loss on the mortgage, while mortgage holders walk away.
Galai praises Israeli banking regulations enforcing a 70 percent cap on mortgage debt-to-equity rations. "The banking regulations are important because they set a safety level, he says. "Yes, there are incentives to skirt them because they may be restrictive, but one could say the same thing about laws against jaywalking - sometimes it may be more efficient to cross the street in the middle of traffic, but the risks can also be high. Before the bubble burst, there were suggestions to rein in the sub-prime market, but they were unpopular in Congress. As long as times were good, nobody wanted to put a stop to it."
There is also a simple reason that Israel has avoided a financial meltdown in the secondary mortgage market, along the lines of the collapse of Fannie Mae and Freddie Mac in the United States - there is no secondary mortgage market in Israel. "There have been attempts to create a secondary mortgage market," says Galai, "but they have all failed because regulatory and taxation issues made them unprofitable," even though the Ministry of Finance supported the idea and even drafted legislation to encourage mortgage-backed securities in Israel.
"There is less competition in the banking industry in Israel, more conservatism and much less sophistication," adds Blass. Although in hindsight it appears that the non-sophistication of the Israeli financial system - including its lack of a market in derivatives based on mortgage-backed securities - was a blessing compared to the chaos that is purging major players on Wall Street, Blass warns that this does not justify a blanket endorsement of non-sophistication. "There is a price paid for lack of sophistication," he says. "It makes the overall economy less dynamic."
As stable as the Israeli banking system
appears today, it went through a major crisis in 1983 that resulted in the virtual nationalization of the four largest banks. The crisis was precipitated by the banks themselves, which deliberately manipulated their own share prices in order to expand their capital base. They achieved this by recommending their stocks to their customers as investments, lending money to clients specifically for purchasing bank stock - thus also profiting from the interest on the loans - and buying their own stock in order to create the appearance of greater demand. Investment funds deposited in banks were used to buy bank stocks, as bank managers used every tool available to them to pump up share values.
A frenzy typical of runaway bubbles ensued, with increasing numbers of Israelis buying bank stocks, lured by an astounding 41 percent real return on bank stocks in 1980. Many became convinced that it was a foolproof way to make money in the stock market. With capital pouring in, and against the background of rising hyperinflation, the banks gave out easy loans, especially to kibbutzim, who often used the credit on offer to bump up their living standards.
Extract from an article in Issue 14, October 27, 2008 of The Jerusalem Report. To subscribe to The Jerusalem Reportclick here.