The Danger of Israel Bonds

Since its inception in 1951, Israel has issued bonds through the Development Corporation for Israel, its U.S. securities underwriter, with sales approaching $40 billion. Israel later established branches in Canada and Europe, known as Canada-Israel Securities and Development Corporation for Israel (U.K.), respectively. Initially, the Israeli government issued bonds to members of the Jewish community who wanted to help Israel, with those bonds issued as plain vanilla bullet bonds. In time, Israel bonds diversified its product, which now includes a floating rate LIBOR bonds. As a result of product diversification, Israeli bonds achieved investor diversification, which includes banks, insurance companies, and U.S. municipalities. In fact, both 2013 and 2014 saw Israel have banner years with bond sales, with sales both years over $1 billion. While bonds provide a Israel with liquidity and an ability to borrow, bonds may be compromising Israel’s precarious security position.

Sovereigns use debt markets to raise capital to cover expenses and invest in infrastructure. That is, sovereigns issue bonds, which are debt instruments, that provide a higher payout upon maturity. In essence, a bondholder is lending money to the sovereign in exchange for a higher payback in the future. Sovereigns utilize the bond market as investment tools and even use bonds for debt service, meaning that a sovereign issues bonds today to pay for corresponding maturing bonds sold years before.

Investors have demonstrated a large appetite for sovereign bonds by constantly purchasing such bonds. Despite increasing global national debts, investors continue snapping up bonds, probably due to the liquidity of sovereign bonds. These bonds are liquid because initial investors can easily sell bonds on the secondary market prior to maturity. In addition, investors have demonstrated a seemingly dismissive attitude toward potential sovereign default on those bonds.

Israel, relative to other economies, carries low national debt. The U.S. carries approximately 125% of debt to its GDP; Greece is over 130%; China is at an astronomical 287%; in contrast, Israel carries a comparatively law 67% of debt to GDP. As such, investors in both Israeli bonds and the Israeli economy find Israel as an attractive economical bet.

However, Israel bonds are not without drawbacks. The lack of bond liquidity creates a stark contrast between Israeli bonds and other sovereign bonds. U.S. bondholders can easily sell their investments on the secondary market, making U.S. bonds a highly desirable investment. On the other hand, Israeli bonds expressly prohibit its sale to other investors, which limits its value.

Furthermore, Israeli bond payout at maturity is less than other industrialized nations. The lower payout disincentives investors from purchasing the bonds, despite Israel’s growing economy and recent acceptance into the prestigious Organization Economic Co-operation and Development. If Israel’s surging economy, which entices investors to purchase bonds, hits a bump, those investors would likely cease their Israel bond purchasing activity. As a result of both its lack of liquidity and low payout and an event of a slowing economy, Israel’s ability to raise capital on the bond market would be severely limited

The current bondholders’ point of view may also clash with Israel. As mentioned, Israel bonds initially targeted Jewish investors who emotionally invested in the bonds with little regard for the payout rate. This has changed. Press releases touted the increased Israel bond sales due to an increased customer base, who increasingly invest in those bonds as investors, not as mere members of the Jewish community who hold Israel near and dear. If Israel acts in a way those investors deem “drastic” then Israel would lose the significant capital raised through bond sales to those investors. While this is true of any country, the definition of “drastic” for Israel is different from the rest of the world.

If Israel concerns itself with the opinions of Israel bond investors, it may seek ways to placate those investors. Ideally, a country’s survival should trump all other considerations. If, however, a country’s economic growth is a centerpiece of its policy decisions, those decisions will relegate security issues to a secondary or tertiary status. Israel, whose enemies continually challenge its survival, should be concerned that economic policy may compromise security. Based on the surging bond sales and the subsequent investment of those proceeds into the Israeli economy, it seems the Israeli establishment may be prioritizing economic policy over security.

Israel continues to issue bonds while its economy continues to roll. However, this may be a double-edged sword as the excitement of bond sales and subsequent economic growth may be threatening Israeli security. Israel bonds needs a reality check.

About the Author
Ari Mushell works in the banking industry.
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