Article By Adv. Itay Geffen, Gornitzky & Co. (Israel)
The irresistible ease of raising money from institutional investors in Israel (similar to QUIBS in the US), by issuing unsecured bonds with a very low interest rate, has generated a massive level of debt and a long list of Israeli firms that cannot make repayments.
The worldwide crisis has caused an historic, hysteric, domino-like downfall in the once assured bonds market, and forced many institutional investors to disclose their severe losses to savers.
Excessive leverage has been the key characteristic of today's turmoil. There were clear gaps in regulatory and accounting standards regarding the treatment of 'off-balance sheet' financial vehicles in Israel, as well as lending practices.
The Israeli rating agencies played a key role in the securitisation process. They did not have sufficient information or experience to assess the risk-return profiles of the now well known investment vehicles, when assigning prime and triple-A ratings. This paved the way for the boom in a range of structured products, such as collateralised debt obligations and asset-backed commercial paper.
The prevailing attitude 'the market always knows best' proved to be wrong both in Israel and abroad. The failure of the Israeli authorities to regulate and to stop the irresponsible lending practices fuelled the bond market and led to the current crisis.
Israel has taken steps to minimise future turmoil. The first act of defence is to cut interest rates to help bank margins and earnings. The governor of the Bank of Israel caught the market by surprise by cutting half a percent from the rate, only two weeks after shaving off 0.75 percent. The Bank of Israel will follow the trends of central banks around the world and maintain an interest rate policy that supports growth and employment, along with financial stability, without hurting the downward trend in inflation.
The Israeli Ministry of Finance is set to cushion the Israeli economy from the shocks of the international credit crunch by implementing an economic stimulus plan that would increase investment in projects related to infrastructure, energy, transportation, water and tourism, boost employment, and help increase liquidity in the market. As a last resort, we may see governments supporting the firm's balance sheets by using taxpayers' money to limit damage to the real economy.
In the near future, we shall see further involvement of the Israeli authorities planting seeds of regulation in order to better supervise institutional investors and rating agencies.
Eventually, financial markets in Israel will recover. In the meantime, with anxiety swirling, many investors have abandoned any assets they consider risky. As a result, investments in every corner of the Israeli capital markets offer the potential for substantial returns. This 'risk premium' has soared along with fear. History shows that investments made in these moments of distress, when potential is much higher than normal, are usually the most rewarding. But to reap those rewards one must stay invested for the long term – even though this approach is usually accompanied by anxiety.
Adv. Itay Geffen is head of the Capital Market & Project Finance departments at Gornitzky & Co. Israel, Law Offices (http://www.gornitzky.co.il). The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.