1983 Israel bank stock crisis

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.[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.

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 "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.

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, 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.

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 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.

Failing to stop the banks, Finance Ministry officials wished to execute a large devaluation of the Shekel as an excuse to stop the adjustments. 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.

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. Most of the public assumed the minister would lie at any time, and paid 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.

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.

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]

• 1985 Israel Economic Stabilization Plan

• Blass, A.; Grossman, R. (2001). "Assessing Damages: The 1983 Israeli Bank Shares Crisis" (PDF). Contemporary Economic Policy. 19: 49–58. doi:10.1111/j.1465-7287.2001.tb00049.x.

• Gozansky, Tamar (2004). "The Roots of Israel's Economic Crisis". In Dan Leon (ed.). Who's Left in Israel. Sussex Academic Press.
• 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.