Bank stock crisis (Israel 1983)

The Bank stock crisis was a financial crisis that occurred in Israel in 1983, during which the stocks of the four largest banks in Israel collapsed, and were nationalized by the state.

Background

During the 1970s Bank Hapoalim, and its dominant manager, Yaakov Levinson, began trying to control the bank's stock price in the Tel Aviv Stock Exchange. To this end they recommended to their customers to invest in the bank's stocks. These investments allowed the bank to increase its available capital for investments, loans, etc. To get customers to continue investing in the bank's stock, the bank began buying back its own stock, thus creating the appearance of constant demand for the stock, and constantly increasing its value. The bank also gave out generous loans to allow the customers to continue their investments, also profiting from the interest.

These manipulations, or adjustments of the stock prices, by artificially creating demand, seemed to the other banks like a good way of procuring capital from the public, and they slowly adopted the practice as well. Eventually all major banks manipulated their stock price this way, among them Bank Leumi, Discount Bank, Bank Igud, Bank HaMizrachi, and Bank Clali. The only prominent bank not to join the adjustments frenzy was Bank HaBinleumi (a.k.a the First International Bank of Israel - FIBI).

The adjustments were performed through the use of other companies. For example, Bank Leumi used the "Holdings and Development of The Jewish Colonial Trust Company". The funding for these actions originated in loans from the bank's pension funds and similar sources. Sometimes the banks would practice mutual purchases - one bank would sell its stocks to a second bank, and buy the second bank's stocks for a similar sum.

Under the pressure of the Israeli Securities and Exchange Commission, the banks reported the adjustments in their reports, but these reports were partial, misleading, and sometimes even false. Toward their clients the bank's acted in manner later described by the "Beisky Commission" as based in their own interests, ignoring the clients' interests.

The adjustment were made possible, in large part, due the banks' unique owership structure. Bank Hapoalim was controlled by the Histadrut labor union's Workers Company (Hevrat HaOvdim) and Bank Leumi by "The Jewish Colonial Trust". The Hapoel HaMizrachi organisation had almost none of Bank HaMizrachi's stocks, but all of its control shares. The owners' representatives were usually members of the ruling political parties (especially Alignment, and the National Religious Party, or close to them). The banks' managers ran the banks for owners who understood little of banking, and did not involve themselves in these actions. The fourth major bank to join this practice, Discount Bank, was held by the Recanatti Family. Its head, Rafael Recanatti joined the adjustments practice reluctantly, unable to resist the temptation. They later continued the adjustments, unable to stop.

Also contributing to the possibility of the adjustment was the capital structure of the Israeli market. During the years following the establishment of the State of Israel, the governments used the banks as a channel for procuring capital, and instructed them on how to invest their funds. This level of control, coupled with the control of interest rates, allowed the government to effectively "print money", by getting the banks to buy government bonds. Additionally, the banks usually assumed that since their investments and loans in major players of the Israeli market, such as the Kibutzim, were according to the government's wishes, the government would guarantee these loans.

Due to these reasons, the banks believed they could act as they pleased, without fearing the consequences. The banks used the adjustments to get "easy money" by issuing more and more stocks, until, during the 1980s, the banks' stocks accounted for more than 90% of all issued stocks in the stock market. They used the capital thus gained to give out loans and invest, often without due inspection of the debtor's creditworthiness. Also, the banks grew exponentially, building hundreds of new branches and hiring thousands of new employees. The banks' managers paid themselves lavish salaries, and expended money based on the banks' nominal profits, completely unrelated to their real profits.

The large banks got addicted to the easy capital, but this method soon became a trap. Like the government, fearing recession, the banks avoided any move to limit their expenses. They feared for the pockets and jobs of the managers, but also the fact that the first bank to make such a move would appear inferior compared to the other banks.

All of the regulatory bodies were well aware of the adjustments regime, but aside from slight warnings, easily dismissed by the banks' managers, did nothing, failing even to warn the public. The Minister of the Treasury, Aridor, even remarked on television that had he had the funds to do so, he would invest in the stock market.

The adjustments were based in the promise of a constant rise in the banks' stock prices, irrelevant of the economic situation. The artificial prices thus achieved created an Economic bubble, where everyone involved continued investing growing sums of money for lesser returns. Every new issue of bank stocks further destabilized them, since more of the capital was invested in maintaining the adjustment regime, instead of profitable loans. Also, as the bank stock market share grew, the adjustment became weaker, as every cent (Agora, actually) invested by them became a smaller part of the total invested capital.

The real gain (i.e. over and above the Consumer price index) by investing in the banks' stocks diminished, from a 41% gain in 1980, to 34% in 1981, to 28% in 1982. Other investment options, especially purchasing US Dollars became more appealing, and the banks had to transfer more and more funds from their offshore tax havens to keep maintaining the illusion of safety of investing in their stocks.

Crisis

In the beginning of 1983 a crisis occurred in the free stock market (all the non-bank stocks), and large supplies in all market sectors forced the banks to invest very large sums of money maintaining their stocks' stability. During the months of January through March some regulators, among them the Minister of Treasury, Aridor, and the Governor of the Bank of Israel, Mendelbaum, approached the banks several times, trying to get them to gradually reduce their adjustments. Although some bank managers realized they could not continue this for long, they did not stop. Fearing a market collapse, Ministry of Treasury officials kept knowledge of this from the public.

Failing to stop the banks, Ministry of Treasury heads wished to execute a large devaluation of the Shekel, serving as an excuse to stop the adjustments. However, the August 8% devaluation was far too small for that end. Additionally, the supplies in the stock market grew steadily, and reached new heights in September. The public unremittingly sold bank stocks, and purchased US Dollars.

The crisis erupted fully on October 2. That day, the first day of trade after the Sukkot holiday, the public sold more bank stocks than in the entire month of September. On October 4 the Minister of Treasury appeated on television saying "We will not let the public dictate our moves", to say the large supplies would not bring about a devaluation or change of policy.

During those years the public trust in the Minister of Treasury's promises was non existent. Most of the public assumed the Minister would lie at any time, and gave no attention to his statements. Most of all, Aridor's denial made it clear that at this point the public was dictating the government's moves.

Later Aridor met with the banks' managers, who demanded the government limit the public's purchases of US Dollars, and allow it only for plane tickets. They assumed that without an option to save the money themselves, due to the high inflation, the public would be forced to invest in the banks' stocks. Even if their thesis was correct, one can assume such a move would only fuel the panic, and exacerbate the current crisis.

On October 5 the stock exchange again opened with large numbers of sell offers, and on October 6, 1983, nicknamed "Black Thursday", was an onslaught of sales. It was clear a collapse was a matter of days at most, since the banks declared that day they would be unable to absorb additional supplies without government assistance.

That night, in a meeting in Aridor's home, it was decided that the government would purchase the banks' stocks from the public, to prevent the loss of their investments. On Sunday, October 9, the stock exchange remained closed, and stayed closed till October 24. In the meantime a devaluation of 23% was executed. The stocks sold by the public were bought by the Bank of Israel at an average loss of 17%. 35% of the stocks' value was lost.

Results

The immediate consequences of the crisis were the loss of a third of the public's investments in them, the acquisition of the banks by the government, at a total cost of 6.9 billion US Dollars, and the nationalization of the major banks (Leumi, Hapoalim, HaMizrachi, Discount, and Clali).

Beisky Commission

Following the scandal, in 1984, the State Comptroller issued a report on the crisis, causing the State Review Committee of the Knesset, on January 7, 1985, to decide on establishing a national commission of inquiry. Heading the commission was Judge Moshe Biesky. The commission presented its findings on April 16, 1986.

The commission came to the conclusion that the October 1983 crisis was a direct result of the stock adjustment. The commission pointed to four criminal offenses allegedly performed during the adjustment: financing and giving loans for the purchase of bank stock by the banks themselves; fraud and deceit of the client to get them to purchase stocks; conditioning one service on another; and perjury before the commission.

Following the commission's conclusions, and after a long struggle, the banks' managers were dismissed, but no criminal charges were brought against them, as there was no "public interest" in that, according to the State's Attorney. In 1990 the Supreme Court decided to bring to trial the banks' managers, and the accountants who lied to the commission.

The commission's report states the regulatory bodies acted negligently and irresponsibly, but there were no recommendations for actions against them.

On the administrative side, the commission concluded that investment recommendation should be separated from ownership, that is, the banks should be separated from the Pension Funds and Trust Funds. These recommendations were not executed, due to the banks' pressure, and the government's conflict of interest, as the banks' owner.

The government later sold some of the banks to private investors, selling Bank Hapoalim in 1996, HaMizrachi in 1998. The government also sold a major part of its stock in Discount bank in 2006, and of Leumi in 2005.

In the first years of the 2000s decade some of the commission's recommendations were finally put into place.

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