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 support the prices. Bank share prices collapsed. The Tel Aviv Stock Exchange closed for eighteen days beginning October 6, 1983. As a consequence, these banks were nationalized by the state.
During the 1970s, Bank Hapoalim, and its dominant manager, Yaakov Levinson, began attempting to control the bank’s stock price on the Tel Aviv Stock Exchange. To this end they recommended to their customers to invest in the bank’s stocks by fraudulently providing guarantees that the prices of shares in the banks would rise indefinitely. 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.
Other banks joined the practice, called adjustments. Eventually all major banks manipulated their stock price this way, among them Bank Leumi, Discount Bank, Bank Igud, Bank HaMizrachi, and Bank Clali (General Bank, now U-Bank). The only prominent bank not to join the adjustments frenzy was 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’ 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 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 different insofar as management and control had not been ceded to outside managers.
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, 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. Also, the banks grew exponentially, building hundreds of new branches and hiring thousands of new employees.
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, 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 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 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.
In early 1983, the Tel Aviv stock exchange suffered share price weakness across all non-financial stocks. The banks invested heavily in all issues, hoping to maintain liquidity in the market. In 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 U.S. dollars.
Bank stocks remained under pressure. On October 2, 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 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 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 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 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 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 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 (the nation’s central bank) at an average loss of 17%. Eventually, 35% of the stocks’ value was lost.
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 (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. Recanati’s sentence was suspended on appeal when one of five charges was quashed. As part of the settlement, the controlling interest in Discount Bank, as well as the other banks, was ceded to the government.
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 Bejski. The commission presented its findings on April 16, 1986.
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 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.
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, 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.
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 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 Leumi bank in 2005, and of Discount in 2006.
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 Bach’ar commission, which reached the same conclusions regarding separating the banks’ depository and investment banking/fund management operations as the Beisky commission’s 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 late-2000s financial crisis – 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.
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- 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.
Ofer Abarbanel is a 25 year securities lending broker and expert who has advised many Israeli regulators, among them the Israel Tax Authority, with respect to stock loans, repurchase agreements and credit derivatives. Founder of TBIL.co STATX Fund.