We have learned nothing

Are low interest rates and corporate bonds creating a credit bubble that could burst?

lots of money 88 (photo credit: )
lots of money 88
(photo credit: )
The voices predicting that the recession is behind us are growing louder by the day. We all hope they are right. But even so, after such turmoil we must ask ourselves what we have learned from the worst financial crisis since World War II and what can we do to prevent the next one. The answer we get from the rallying local financial markets to the above question is: simply nothing. Since the beginning of 2009 the TA-25 Index - currently getting closer to 1,000 - has gained back almost all the losses it mounted since last September, when giants like AIG, Lehman Bros. and Merrill Lynch collapsed and the global tsunami finally hit Israel. Even if you believe the market overreacted on its way down, and even if you agree with the experts who think the worst is behind us, the real situation in the real economy doesn't justify a return to precrisis levels. The main factors that caused the financial storm were quite simple: An unprecedented giant credit bubble was created by the financial system; when it finally burst, it almost caused a complete failure of the world's financial infrastructure, sending shock waves deep into the real markets - businesses, households and even sovereign entities. The bubble was fueled by artificially low interest rates and lousy lending practices. Money was abundant, traditional safety measures like appropriate securities and credit history were abandoned, risks were ignored and greed was the name of the game. The heart of the problem was the US real-estate market, which is still far from recovering and may not return to the price levels of 2006 in decades. One of the reasons our economy wasn't hit as badly as others was that the local real-estate market wasn't suffering from the many diseases so common in the US and European markets. Interest rates at the beginning of the millennium were fairly high, the Frankenstein derivatives of mortgage-backed securities were illegal here and the banks were much more conservative than their peers abroad. But that was true then. Now, it looks as if the Israelis are so jealous of their American friends they decided to develop their own blue-and-white bubble. The Bank of Israel's practically zero interest-rate policy is tempting more and more people to take mortgages in an adjustable-rate format. Banks are marketing these loans to customers by highlighting the low payments. But it is clear the central bank can't keep the rate so low forever, so the borrowers are facing much higher payments in the future. This is very similar to what had happened five years ago in the US when people were tempted to borrow money at low rates in the first years and then face a giant leap in their monthly payments several years later. These irresponsible loans eventually haunt the banks and add to the burden they already have from bad loans in the business sector and foul investments abroad. But the real scandal is what's going on in the corporate-bond market. This arena seemed to be the Israeli ground-zero last fall. After three years of wild fund-raising - when all you had to do to get millions from our generous pension funds was to arrange a nice power-point presentation about a real-estate venture in western Romania - bond prices crashed, yields jumped to double and triple figures and many of yesterday's tycoons were on the verge of complete destruction. But that is ancient history, and the people who manage our retirement money have a shorter memory than goldfish. Once again we see companies approaching the market and recruiting hundreds of millions of shekels with no securities and with ridiculous yields. A. Dori, a local small-cap real-estate firm has recently raised NIS 150 million in bonds, with no collateral and with a non-index yield of 7 percent. Elbit Imaging, a much bigger real-estate entrepreneur raised NIS 200m., again with no collateral and a CPI-indexed yield of 5%. But this is nothing compared to a 5% non-indexed yield that Delek Israel, one of the many companies under the control of local mogul Yitzhak Tshuva, has recently offered local investors. Only six months ago Tshuva's company bonds were traded in high double-figure yields. We understand that the sentiment is better now, but the mogul's group still suffers from very high leverage and large exposure to deteriorating conditions in the real-estate markets in which it operates. So what's going on here? We have nothing to say to the owners of companies who were smart enough to use the improved market conditions for piling up cash. We have a lot to say to the insurance companies, pension, provident and mutual funds that gave this money away. Let us remind them what we all thought is so clear after the painful lesson of 2008: This is not your grandmother's money you are playing with. All this money that keeps pouring in and leads to dangerous investments was earned by hard-working people who put it in your pockets (it's time to hurry up IRA reform). Lending it so easily without proper collateral and guarantees and will such poor yields is a crime against those people. A final word to my fellow citizens. I know it is difficult to sit at the Shabbat table and listen to your brother-in-law brag about how much money he made since he entered the stock market a day after it bottomed. It is difficult to ignore aggressive advertising campaigns in which your money is crying to get out of boring, zero-interest short-term bank deposits. But you have to remind yourselves that markets are still dangerous, risks are abundant, opportunities are scarce and the pain from a loss is so much higher than the joy of a success. So it's better to be extremely careful about investing right now. If you are among the many who diverted their pension portfolio to a more-risky type after you identified a bottom, maybe it's time to consider a more-conservative allocation of your money.