Hello businessman - Do you feel you've been struggling to breathe in recent months? That the air has grown thin? Are your bankers sending you nasty letters?

You do? You're in good company, sir. Bank of Israel data published yesterday makes that feeling of asphyxiation official: the economy is suffering from a credit crunch.

According to the Bank of Israel, total credit shrank by NIS 11 billion, or 1.5% - the steepest drop in years.

But businesses have been feeling the squeeze for months now. The only reason Bank of Israel data continued to show growing total credit was because the shekel's contraction versus the dollar inflated the shekel equivalent value of foreign currency-denominated loans.

If the effect of the shekel's devaluation and high accrued interest are deducted, we find that the pace of credit growth has slowed over the past year, and is approaching zero.

If we now factor in that Israel's, and the world's, capital markets have been all but hermetically sealed for the last year, making the banks the only source of financing we understand why businessmen have been feeling choked.

As the door says, we're closed
The credit crunch is the result of the essentially shuttered capital markets, the deepening recession that reduces companies' capability of returning loans - but mainly, the collapse of the banks' profits, which has brought most to the limits of their permissible capital adequacy, hindering them from extending more credit.

The banks' financial statements for the second quarter of 2002, due for publication in the next two weeks, will be the sorriest we've seen in a decade. The two giants, Hapoalim and Leumi, will present a 50% drop in net profit. The medium-sized duo, Discount and First International, will reveal a loss, as will midget Union Bank.

We can leave United Mizrahi Bank out of the equation, as it never was a key power in corporate credit, being more focused on mortgages.

Briefly: the only two sources of credit still around are banks Hapoalim and Leumi. But Hapoalim's controlling shareholders badly need to withdraw dividends, so we may assume they won't wax lavish with credit for strangers.

The credit crunch is fated to reach the public's economic agenda. Brace for an inundation of weird and wonderful solutions from the government and businessmen. As the straightforward, correct ideas always get shot down by politicians, leaving only a slogan floating in the ether. That leaves us with the terrible ideas.

There are no magic solutions to the credit crunch, certainly not given the delicate situation of Israel's economy, with the government's burgeoning deficit and the high inflation. Any solution involving a drop in the deficit, interest rate cuts, or relaxation of the banks' capital adequacy ratios will threaten Israel's financial stability, or at least that of the banking system.

There are solutions
The solutions, we fear, lie in structural reforms of the capital market, which have been popping up in central bank and Finance Ministry papers for a decade now. The budget must be cut. Pension monies must be diverted to the capital market, which must lose its subsidies. The provident funds must be split off from the banks, and the pension funds from the Histadrut labor federation.

Lately voices have been heard calling on the Histadrut pension funds to stream money to the capital market, or to finance infrastructure projects. Sounds great, but it's nonsense. When long-term interest on CPI-linked government bonds stands at 5% to 5.5%, there is no reason in the world for the pension funds to risk their money in risky projects, or shares.

So, we are left with reducing the deficit, and guiding the marketplace back to price stability because without those two factors, short- and long-term interest rates will stay high. And as long as interest on the capital market remains high, nobody including pension funds has any incentive to risk money on chancy projects or deals.

Naturally, as long as there are people out there managing other people's money, there will be some resources for perilous projects, despite the easy access to high risk-free interest rates. Yesterday, for instance, Ma'ariv reported that Mivtachim's pension funds are mulling participation in the group taking over IDB Holding Corporation (TASE:IDBH).

That, of course, is pure essence of absurdity. The deal in question involves an offer of IDB Holding Corporation shares at a 50% premium over their market value. Meaning, Mivtachim which could pick up IDB Holding Corporation shares at bargain-basement prices on the stock exchange is looking at buying them off the floor at a 50% premium.

We can understand why Nochi Dankner, the Livnat family and the Manor clan are buying IDB Holding Corporation at a hefty premium. It gets them control over one of Israel's biggest holding corporations. They believe that only control will give them the power to rehabilitate it properly, for their greater profit in the future.

But Mivtachim would be a financial investor. There can be no logic behind its even "mulling" such a deal, except to bring more clout to its managers.

There are no IDB-Mivtachim type shortcuts to solve the credit crunch strangling the marketplace. To stream oxygen to the business sector, the government has to free up resources, cut the deficit, reduce bond issues, lower long-term lending rates, transmit a message of stability that will facilitate rate cuts, and privatize and separate the provident and pension funds.

The chance of the government doing all that in the coming months is roughly zero, so all we can hope is that it does the minimum: that it cuts its budget and restores stability to the financial markets. Because if it doesn't, Israel's sovereign credit rating will be downgraded, which will set off a domino effect throughout the entire financial establishment and then, only then, will we see what a real credit crunch is.

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