GOI PLANS FOR DEALING WITH FINANCIAL CRISIS

UNCLAS SECTION 01 OF 02 TEL AVIV 000485 SIPDIS NEA/IPA FOR GOLDBERGER, SACHAR; EEB/IFD FOR JACOBY; TREASURY FOR BALIN E.O. 12958: N/A TAGS: ECON EFIN PGOV IS SUBJECT: GOI PLANS FOR DEALING WITH FINANCIAL CRISIS -------------- Summary -------------- ¶1. Yadin Entebbe, the head of the Capital Markets Division at the Ministry of Finance (MOF) says that Israel has not yet borne the full brunt of the worldwide economic crisis. The GOI has come out with a three-pronged plan to deal with the crisis -- providing loan guarantees to banks to make capital available more cheaply, participating in special investment funds to support the capital markets, and changing budget priorities to emphasize job-creation. Entebbe says that the firm principle guiding GOI actions is to keep investment decisions in the hands of professionals and out of government hands. He also noted the new "marked-to-market" rule which would help money managers avoid having to report the full extent of their short-term losses on poorly performing bond investments. Regarding the GOI's pension safety net plan, Entebbe said that it was neither necessary nor harmful. End Summary. -------------- Israel Not Yet Seeing the Worst -------------- ¶2. Entebbe told Deputy EconCouns at a recent meeting that the worldwide financial crisis has not yet really hit Israel's real economy in a big way, despite recent reports of rising unemployment. He said that while there have been pessimistic projections and some layoffs, the crunch -- business closings and massive layoffs -- is yet to come. Everything depends on how well Israel's major trading partners, the U.S. and the EU, weather the storm. Entebbe thinks that governments worldwide have been making the right decisions and that the extremely negative psychological atmosphere that pervaded the markets in October and November of last year had improved somewhat. In addition, the amount of money that Israelis were pulling out of their long-term investment plans on a daily basis had returned to pre-crisis levels. However, he did not think that this would result in a true amelioration of the serious financial crisis. He said governments will still have to struggle to convince financial institutions to resume normal business activities. -------------- GOI Has Three-Pronged Program -------------- ¶3. Entebbe stated that the GOI and MOF's handling of the crisis has been criticized on two fronts--that they were not doing enough and that they were reacting too slowly. While outlining the three basic steps the GOI/MOF has taken to deal with the crisis, he pointed out that no matter what a government does during an ongoing crisis of this magnitude, it will never be enough to satisfy critics. The MOF designed a program to help the banking sector raise capital via government loan guarantees. To help the capital markets, special investment funds are also being set up. In addition, there will be a need to change the priorities in the 2009 budget (after a new government takes office) to enable additional investment in infrastructure and other job-creating activities. -------------- Loan Guarantees for Banks -------------- ¶4. Entebbe said that Israeli banks cannot raise money in the market at reasonable rates. The MOF is offering the banks loan guarantees that will make it cheaper for them to raise capital. The program is designed to help them raise more money, not to force them to lend. Lending will only pick up when banks gain the confidence to reenter the markets. The mechanism for raising capital involves having the banks sell a financial instrument referred to as a "postponed bond." The government will guarantee the payments on the bond to the investor, substantially reducing risk. -------------- Unfreezing the Bond Market -------------- ¶5. Similarly, the corporate bond market is also frozen, with no new bond issuances coming on the market. Israel Discount Bank pulled a bond offering in January when the best rate it could get was about nine percent. To deal with the problem, the MOF has come up with a complex scheme to encourage investment. It is holding an "auction" for private investment managers bidding on the right to put together a syndicate to invest in new bond offerings. The government would then put up a certain percentage of the funds pledged by the syndicate. In return for the investment, the syndicate will receive an annual management fee of 0.8 percent and a "large success fee" after a number of years if annual returns continually exceed eight percent. The group which offers to put up the most money for each government shekel invested will win the auction and receive the TEL AVIV 00000485 002 OF 002 government matching funds to manage. Entebbe expects that the government will end up putting up about NIS five billion to match the NIS 15 billion that will ultimately be raised and invested by the syndicates, a ratio of ONE to three in government versus private investment. -------------- Keep Investment Decisions Professional -------------- ¶6. The plan is for this investment fund, open only to Israelis due to the government guarantee, to put at least NIS 20 billion into the bond market in 2009, and more later, if necessary. The MOF is determined to keep the government out of the investment decision-making process, and make sure that decisions about which bonds to buy will be left entirely to the professional money managers who will be handling the funds. Entebbe noted the irony of the government of a "supposedly socialist Israel" keeping a hands-off attitude towards investment decisions made with its money, while the government of the "capitalist U.S." is deeply involved in the decisions regarding how to deploy the bailout money made available to strengthen the economy. -------------- New Mark-to-Market Rule -------------- ¶7. Entebbe also commented on another measure the MOF took to ease the burden caused by the sharp bond market decline on money managers. He said that bond values are usually "marked to market" -- that is valued at the last traded price -- for reporting purposes. Money managers would now be allowed to value up to three percent of their bond holdings at their purchase prices instead. This would allow them to avoid reporting losses on selected bonds that have declined in value since they were purchased, on the assumption that most will not default but would ultimately pay off at full value when they come due. This small change is expected to make it a bit easier for money managers to be able to report somewhat more positive results to investors. -------------- - Pension Safety Net Unnecessary but not Harmful -------------- - ¶8. Regarding the government's plan to provide a safety net for pensions, Entebbe said that the program protects only a limited number of people and would likely not end up costing a lot of money. He said that Israel was ONE of the few countries in the world to focus on this issue, as most others were dealing with bigger issues such as the fundamental HEALTH of their banking and financial systems. Since the losses in Israeli pension and other retirement plans were at the low end of the average losses for most industrialized countries, he maintained that the program was superfluous. However, given that the public -- inflamed by newspaper pundits -- demanded it, he did not see it as particularly harmful. CUNNINGHAM