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. In previous episodes of share price weakness, the banks bought back their own stocks, creating the appearance of constant demand for the stock, and artificially supporting their values. By October 1983, the banks no longer had the capital to buy back shares and to support the prices causing share prices to collapse. The Tel Aviv Stock Exchange closed for eighteen days beginning October 6, 1983,[1] whilst a recovery plan was implemented and the banks were nationalized.
During the 1970s, Bank Hapoalim, and its manager, Yaakov Levinson, began attempting to control the bank's stock price on the Tel Aviv Stock Exchange by recommending to their customers that they invest in the bank's stocks by fraudulently providing guarantees that the prices of shares in the banks would rise indefinitely.[1] These investments allowed the bank to increase its available capital for investments, loans, etc. The bank also gave out generous loans to allow the customers to continue their investments, also profiting from the interest.
In practical sense banks loaned out the capital for clients to buy bank's own stocks, increasing bank capital to loan out. While being a loop rather than the "pyramid", this scheme is similarly precarious, as nominal volumes of capital and loans grow very large in proportion to the actual capital in the system. This very high leverage - called over-leverage - at the bare minimum requires a very strict risk control based on transparency. However, because the capital changed hands multiple times between banks and their clients-investors, the actual degree of leverage was masked from involved parties as well as from government regulatory bodies.
The adjustments were performed through the use of other companies. For example, Bank Leumi used the "Jewish Colonial Trust Holdings and Development 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 pressure from 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 banks acted in a manner later described by the Bejski Commission as based on their own interests, ignoring the clients' interests.
The adjustments were made possible, in large part, by the banks' ownership 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 organization had almost none of Bank HaMizrachi's ordinary stocks, but all of its controlling shares. The owners' representatives were usually members of the ruling political parties (especially the 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 different, insofar as management and control had not been ceded to outside managers.[2]
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 kibbutzim, were according to the government's wishes, the government would guarantee these loans.
Due to these reasons, the banks used the adjustments to issue more and more stocks, until, during the 1980s, bank stocks accounted for more than 90% of all issued shares on the stock market. They used the capital thus gained to give out loans and make investments. The banks also grew exponentially, building hundreds of new branches and hiring thousands of new employees.[citation needed]
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.[citation needed]
All of the regulatory bodies were well aware of the adjustments regime, but aside from slight warnings, easily dismissed by the banks' managers, they did nothing, failing even to warn the public. The Minister of the Finance, Yoram 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 on the promise of a constant rise in the banks' stock prices, irrespective of the economic situation. The artificial prices thus achieved created an economic bubble, where everyone involved continued to invest increasing 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 market share of bank stocks grew, the adjustments became weaker, as every cent (agora, actually) invested by the banks became a smaller part of the total invested capital.
The real return (i.e. over and above the Consumer Price Index) on investment in the banks' stocks diminished, from a 41% return in 1980, to 34% in 1981, to 28% in 1982. Other investment options, especially purchasing U.S. 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 early 1983, share prices across all non-financial stocks on the Tel Aviv Stock Exchange suffered from weakness. The banks invested heavily in all issues, hoping to maintain liquidity in the market. From January through March, some regulators, among them Finance Minister Aridor and Bank of Israel Governor Moshe 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, Finance Ministry officials kept knowledge of this from the public.
However, the 8% devaluation in August was far too small to accomplish the purpose. Additionally, the supplies in the stock market grew steadily, and reached new heights in September. The public unrelentingly sold bank stocks, and purchased U.S. dollars. Failing to stop the banks, Finance Ministry officials wished to execute a large devaluation of the Shekel as an excuse to stop the adjustments.
Bank stocks remained under pressure. On October 2, the first trading day after the Sukkot holiday, the public sold more bank stocks than in the entire month of September. On October 4, the Minister of Finance appeared 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's trust in the Finance Minister's promises was non-existent.[citation needed] Most of the public assumed the minister would lie at any time, and paid no attention to his statements.[citation needed] Most of all, Aridor's denial made it clear that at this point the public was dictating the government's moves.
Aridor later met with the banks' managers, who demanded the government limit the public's purchases of U.S. 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 crisis.
On October 5, the stock exchange again opened with large numbers of sell offers, and on October 6, 1983, nicknamed "Black Thursday", there was an onslaught of sales. It was clear a collapse was a matter of days away at most, since the banks declared that day they would be unable to absorb additional supplies without government assistance.
That night, in a meeting at 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 the shekel was devalued by 23%. The stocks sold by the public were bought by the Bank of Israel (the nation's central bank) at an average loss of 17%. Eventually, 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 the banks, the acquisition of the banks by the government at a total cost of $6.9 billion (for reference, Israel's entire GDP in 1983 was about $27 billion), and the nationalization of the major banks (Leumi, Hapoalim, HaMizrachi, Discount, and Clali).
Executives of each of the banks were convicted of criminal charges. Raphael Recanati of Discount Bank and Mordechai Einhorn of Bank Leumi were both sentenced to 8-month prison terms.[3] Recanati's sentence was suspended on appeal when one of five charges was quashed.[4] As part of the settlement, the controlling interest in Discount Bank, as well as the other banks, was ceded to the government.[4]
Following the scandal, in 1984, the State Comptroller issued a report on the crisis, causing the Knesset State Review Committee to decide on January 7, 1985, to establish a national commission of inquiry. The commission was headed by Judge Moshe Bejski. The commission presented its findings on April 16, 1986.[5]
The Bejski 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 committed 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.
The commission's report states the regulatory bodies acted negligently and irresponsibly, but there were no recommendations for actions against them. Following the commission's conclusions, and after a long struggle, the banks' managers were dismissed, but no criminal charges were brought against them initially, due to "lack of public interest", according to the State Attorney. In 1990 the Supreme Court decided to order a trial of the banks' managers, and the accountants who lied to the commission.
On the administrative side, the commission concluded that investment recommendations should be separated from ownership, that is, the provident funds and mutual funds should be separated from the banks. These recommendations were not implemented, due to pressure from the banks and the government's conflict of interests as the banks' owner at the time.
The government later sold some of the banks to private investors, selling Bank Hapoalim in 1996, and HaMizrachi in 1998. The government also sold a major part of its stock in Bank Leumi in 2005, and of Discount in 2006.[6]
In the early years of the 21st century, some of the commission's recommendations were finally put into place. After all four banks were sold by the mid-2000s, the recommendations of the subsequent Bachar Committee, which reached the same conclusions regarding separating the banks' depository and investment banking/fund management operations as the Bejski commission, were finally carried out as well. It may be argued that the timing of the crisis may have also had some additional positive effect, as the implementation of the subsequent tough banking regulations and reforms, albeit somewhat belatedly, were put in place just in time to help Israeli banks avert many of the problems experienced by banks in many other western countries during the Global Financial Crisis of the late 2000s – by limiting Israeli banks' exposure to risky activities. This helped ensure a stable domestic banking sector, which contributed significantly to the relative resilience of the Israeli economy in face of the late-2000s recession.
In economics and finance, arbitrage is the practice of taking advantage of a difference in prices in two or more markets – striking a combination of matching deals to capitalize on the difference, the profit being the difference between the market prices at which the unit is traded. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, it is the possibility of a risk-free profit after transaction costs. For example, an arbitrage opportunity is present when there is the possibility to instantaneously buy something for a low price and sell it for a higher price.
Finance refers to monetary resources and to the study and discipline of money, currency and capital assets. As a subject of study, it is related to but distinct from economics, which is the study of the production, distribution, and consumption of goods and services. Based on the scope of financial activities in financial systems, the discipline can be divided into personal, corporate, and public finance.
A stock exchange, securities exchange, or bourse is an exchange where stockbrokers and traders can buy and sell securities, such as shares of stock, bonds and other financial instruments. Stock exchanges may also provide facilities for the issue and redemption of such securities and instruments and capital events including the payment of income and dividends. Securities traded on a stock exchange include stock issued by listed companies, unit trusts, derivatives, pooled investment products and bonds. Stock exchanges often function as "continuous auction" markets with buyers and sellers consummating transactions via open outcry at a central location such as the floor of the exchange or by using an electronic system to process financial transactions.
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Bank Leumi is an Israeli bank. It was founded on February 27, 1902, in Jaffa as the Anglo Palestine Company as subsidiary of the Jewish Colonial Trust Limited formed before in London by members of the Zionist movement to promote the industry, construction, agriculture, and infrastructure of the land hoped to ultimately become Israel. Today, Bank Leumi is Israel's largest bank, with overseas offices in Luxembourg, US, Switzerland, the UK, Mexico, Uruguay, Romania, Jersey, and China.
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Israel Discount Bank, Ltd. is an Israeli banking institution that offers a range of financial services, including retail banking, commercial banking, private banking, and financial services. The bank, headquartered in Tel Aviv, operates 112 branches throughout Israel.
The following outline is provided as an overview of and topical guide to finance:
Banking in Israel has its roots in the Zionist movement at the beginning of the 20th century prior to the establishment of the State of Israel in 1948.
Stocks consist of all the shares by which ownership of a corporation or company is divided. A single share of the stock means fractional ownership of the corporation in proportion to the total number of shares. This typically entitles the shareholder (stockholder) to that fraction of the company's earnings, proceeds from liquidation of assets, or voting power, often dividing these up in proportion to the number of like shares each stockholder owns. Not all stock is necessarily equal, as certain classes of stock may be issued, for example, without voting rights, with enhanced voting rights, or with a certain priority to receive profits or liquidation proceeds before or after other classes of shareholders.
On March 23, 2009, the United States Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, and the United States Treasury Department announced the Public–Private Investment Program for Legacy Assets. The program is designed to provide liquidity for so-called "toxic assets" on the balance sheets of financial institutions. This program is one of the initiatives coming out of the implementation of the Troubled Asset Relief Program (TARP) as implemented by the U.S. Treasury under Secretary Timothy Geithner. The major stock market indexes in the United States rallied on the day of the announcement rising by over six percent with the shares of bank stocks leading the way. As of early June 2009, the program had not been implemented yet and was considered delayed. Yet, the Legacy Securities Program implemented by the Federal Reserve has begun by fall 2009 and the Legacy Loans Program is being tested by the FDIC. The proposed size of the program has been drastically reduced relative to its proposed size when it was rolled out.
The Bejski Commission was a National Commission of Inquiry established by the Israeli government on January 7, 1985. Headed by the Supreme Court justice Moshe Bejski, its remit was to examine events surrounding the 1983 Tel Aviv stock market crash, which led to a financial crisis and the nationalization of most of Israel's major banks. It issued a report on April 16, 1986, which concluded that major Israeli banks had been rigging the price of bank shares over a long period and called for the dismissal or resignation of many of the heads of the Israeli banking system.
The Kibbutz crisis was an acute economic crisis many of the kibbutzim in Israel experienced during the 1980s and that many still experience today. The crisis began in the early 1980s and intensified after the Israeli economic stabilization program of 1985 during which the rate of inflation dropped dramatically, and was characterized by the accumulating of large debts from the kibbutzim and low return. The economic crisis in many of the kibbutzim was also accompanied by a social crisis and a demographic crisis. In 1989 and 1996 the Israeli government, the Israeli banks, and the kibbutz movements agreed upon two debt arrangements to help resolve the economic crisis. The demographic and social crises were the major catalysts for the processes that numerous kibbutzim underwent since the 1990s.
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Nochi Dankner is an Israeli businessman and a board member of the Jewish Agency for Israel. He was the controlling shareholder of the IDB Group. Dankner is also the founder and chairman of the Ganden Group - which led him to personal bankruptcy of 400 Million NIS. In 2017 he was convicted of Securities Fraud for a scheme to inflate his company's stock price in order to raise money when it was struggling financially.
Blass, Asher A.; Grossman, Richard S. (April 1998). "Who needs Glass-Steagall? Evidence from Israel's Bank Shares Crisis and The Great Depression". Contemporary Economic Policy. 16 (2): 185–196. doi:10.1111/j.1465-7287.1998.tb00511.x.
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