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In response to the mess in the world's financial markets, it is now common wisdom among economists, journalists and politicians to strongly support more market regulation.
It has been said that one of the leading causes of the collapse of the entire banking system was the US Republican-led government's preference for deregulation.
Former Federal Reserve chairman Alan Greenspan - in the eyes of many, one of the chief villains - has admitted that thinking that banks are better off regulating themselves was wrong. "I was naive," he admitted before a congressional committee, and joined his critics in a call to force more regulation - for banks and private institutions like hedge funds.
The basic flaw in Greenspan's belief in self-regulation was quite simple: As long as bankers could rake in short-term profits from offering dubious loans and complex derivatives, thereby increasing their personal bonuses, it was stupid to expect they would ever consider the long-term effects of their risky practices.
Moreover, the classic conception of free markets assumes that bad decision makers will be punished by market forces that destroy their businesses. But as was demonstrated very clearly, this is not the case when we are dealing with banks.
Since governments rarely allow a major commercial bank to fail, expecting them to eliminate incompetent banks that make bad loans is unrealistic. Bankers were counting on government bailouts when making their outrageous calls, knowing in advance that they would ultimately be saved - if not by Wall Street, then by Washington.
But instead of enforcing tighter regulation and more transparency, politicians and officials, especially in the US, are allowing banks to use shady accounting practices to cover holes in their books, such as letting them delay write-downs and register fake capital gains on debts.
Here in Israel, the regulation issue is not so much about banks and their lending practices, nor is it about poisonous derivatives, two plagues that the local banks were lucky enough to avoid. It is more about the nonbank credit markets - the institutions that run our pension savings (insurance companies and providence and pension funds that lent hundreds of billions of shekels to corporations from 2005 to 2008).
Investment managers in those institutions had tons of money flowing in from workers' salaries, the government was shrinking its part in the bond market and there was a limit to the amount of equity they could buy. So they invested most of it by lending it to business firms, which just needed to provide a nice presentation and a fat underwriting fee.
Dozens of these companies that raised that money now have no way of returning it, and the public is shocked to find out that the people who took care of their money were reckless in giving credit, took no collateral and didn't know where the money went.
Some in the local business community, mainly bankers, are blaming the Bachar reform that opened the credit market to institutional investors. But a more important factor was the adoption of new accounting rules, first and foremost IFRS (international financial reporting standards).
This new standard gave companies the option to abandon the classic conservative accounting principle whereby the value of an asset is written in the companies' books in the lower of two numbers: its actual purchase cost or current market value. IFRS changed all that and allowed companies to revaluate their assets to a higher value, usually fixed by "external" experts who were paid by the company itself.
That's when the truth was buried alive. Not even the sky was the limit to the stunts pulled by company executives. They were especially used by real-estate companies, which were revaluating projects that didn't even reach the groundbreaking stage. This caused huge fluctuations between financial results in different quarters, without any actual business development.
When the bubble finally burst, companies started to default, the value of the bonds issued by them plunged and the public saw its retirement savings crushed. Since ground zero in Israel was the corporate bond market, and not the banking system, the Israel Securities Authority confronted the problem on its own, while a nonfunctioning Treasury and the central bank focused entirely on depreciating the local currency.
The ISA tried bravely to fight the flood of risks and defaults, even if not altogether successfully. One of its last significant moves was forcing companies that borrowed money in the bond markets to disclose exactly what the money was going to be used for and how, where did it come from and what were the chances they would pay interest and principal.
A unique standard was created here, and we would not be surprised if it is adopted abroad. But we still think it is better to use it for all companies - not just those who show four designated signs of distress, as is the case now.
The ISA, leading the fight to stabilize the Israeli markets, must focus on returning to old-school principles and conservatism. This is the time for stricter regulation, but not the senseless kind that just makes more paper work. Not even the brightest minds in investment firms can understand the 500-page forecast attached to each IPO.
We would like to see the ISA require simpler, transparent and conservative reports. This would take time, but there is no other way to regain public trust in our relatively young and small financial markets.