BONDS OF AFFECTION

BONDS OF AFFECTION

When It Comes to Investing,
Israel's Friends Lose Interest

IN THE MID-1970s, the Teamsters Union, under fire for its alleged ties to organized crime, was looking to brush up its public image. As part of that effort, the Teamsters became a major purchaser of Israeli government bonds, eventually investing more than $26 million in the low-interest securities.

The bonds had "great PR value" for the Teamsters, an Israel bonds spokesman told reporter Steven Brill. "[The Teamsters] are people looking for respectability and this is one way to get it."

In his book about the union, Brill described a 1975 dinner held in Cleveland to honor Jackie Presser, the Teamster's President- to-be, for his extraordinary work in supporting Israel.

"Just about everyone who was anyone in Cleveland politics or business turned out," Brill wrote. "At the dinner, Israeli Ambassador Simcha Dinitz inducted the guest of honor into the Prime Minister's Club, a group made up of people who personally (or in Presser's case, through his union) bought more than $25,000 worth of bonds."

At one point, the Teamsters owned more than a quarter of all Israel bonds held by U.S. unions. The union, however, was not alone in its fondness for the notes. Despite below-market yields and unusually high risk, some of America's largest unions, pension funds and major corporations have collectively loaned billions of dollars to the Israeli government.

Israel's violent repression of the Palestinian uprising in the West Bank and Gaza--and the threat the uprising poses to Israel's shaky economy--appears not to have affected investor confidence. Nathan Zirkin, comptroller for the Retail, Wholesale and Department Store Union, told the Multinational Monitor that his union "absolutely" plans to continue purchasing Israel bonds, despite the repression in the occupied territories. "The

Palestinians didn't have a damn thing until Israel came in," Zirkin said.

Israel bonds are marketed by a U.S. firm, the Development Corporation for Israel (DCI). DCI, in turn, is owned by a non- profit organization, the American Society for the Resettlement and Rehabilitation of Israel. Since its creation in 1950, the corporation has sold an estimated $8.6 billion in bonds worldwide, about 85 percent of them in the United States.

Making a Market
Israel bond sales in the United States have soared in recent years--from $417 million in 1984 to $504 million in 1985 to $603 million last year, according to Morris Dwek, DCI's national publicity director.

Israel bonds are "privately placed," meaning they are sold directly to individual investors and cannot be traded on the open market. Under U.S. securities laws, DCI and other private placement dealers can avoid many of the disclosure requirements imposed on companies that trade in the public financial markets.

According to a recent DCI prospectus, bond proceeds are used to fund roads, factories and other projects in Israel. What the prospectus does not mention, however, is that such "development" projects also include Israeli settlements in the West Bank and Gaza.

Other bond revenues are transferred from the Israeli government's development account to its ordinary budget, to be spent on the military, the Israeli intelligence services, and other agencies, according to the statistical abstract published each year by the Israeli government.

In recent years, DCI has made a major effort to find new markets for the bonds among non-Jewish investors. According to Dwek, one-third of the corporation's sales are now to non-Jewish institutions, such as pension funds and banks.

"We sell to major banks all around the country, and to a lot of smaller community banks as well," Dwek said. However, he refused to reveal the names of any organizations. "It's not that it's private, but it's not something we advertise," Dwek told the Monitor.

American labor unions have been some of the heaviest investors. According to Dwek, "most major U.S. labor unions" hold at least some Israel notes. A 1982 survey identified no less than 40 major unions who collectively held about $250 million in Israel bonds in their portfolios.

At least one union-controlled pension fund, the International Ladies Garment Workers' Union, also has purchased Israel bonds. The garment workers' plan currently holds some $23 million in such notes, according to Labor Department records.

In her book, American Jewish Organizations and Israel, writer Lee O'Brien wrote that "the purchase of substantial sums in Israel Bonds is probably the most important form of financial assistance that U.S. labor has rendered Israel."

This assistance has continued despite Israel's continued repression of Palestinian trade unionists in the West Bank and Gaza (See story, page 31). The number of U.S. organizations who own Israel bonds now totals in the thousands. According to O'Brien, some 9,500 pension funds, 3,500 banks, 1,500 labor organizations and 500 insurance companies have invested in the notes.

DCI also has attempted to interest major U.S. corporations in the securities. In April 1982, as part of its Israel Bonds Corporate Program, DCI awarded Lord & Taylor, a major department store chain, with its "State of Israel Peace Medal" for its heavy investment in Israel bonds.

Pensions for Israel
Israel bond sellers also have sought the retirement dollars of teachers, police and other public employees. The pension funds for these workers are among the largest sources of institutional investment capital in the country.

In recent years, a number of states have moved to ease legal restrictions on how this money can be invested, allowing some public pension funds to invest in foreign securities, including State of Israel bonds.

According to Greenwich Associates, an investment research firm, more than half of all public pension funds now have the discretion to invest in securities issued by foreign corporations or governments. At least two funds, the Michigan State Employees' Retirement System, and the Illinois Teachers' Retirement System, have used that discretion to purchase Israel bonds.

Purely from an ethical point of view, Arab-American groups argue, Americans should not purchase Israeli bonds. Israel, they contend, is engaged in an illegal occupation of the West Bank and Gaza, and enforces that occupation by imprisoning, torturing, deporting, beating and shooting those who protest it.

And unlike many unethical activities, buying Israeli securities also happens to be a poor investment decision. The bonds pay interest rates below those of other available securities and well below what most investors would expect from loans to a foreign government, especially one as economically troubled as Israel.

Even Israel bonds salespeople admit that better yields can be earned elsewhere. "We are always a little bit low," Dwek said. "We're almost competitive."

The yields and investment terms for Israel bonds have varied greatly over the past 48 years. Currently, DCI offers two different types of notes--one for individuals and another for institutional investors. The individual bonds mature in 15 years, are sold in denominations of $500 or more and pay 4 percent interest--less than even today's modest inflation rate.

The institutional bonds also are 15-year notes, sold in $25,000 denominations. They pay a floating interest rate that fluctuates between a minimum of 7.5 percent and a maximum that is half-way between 7.5 percent and the current prime rate.

This means that Israel, in essence, is now raising institutional capital at 8 percent interest--a half point lower than what America's largest banks are charging some of world's most profitable corporations.

By contrast, bond buyers now can earn nearly 9 percent on comparable U.S. Treasury notes--one of the world's safest investments. This yield spread may sound minor, but over a 15- year period, the difference can be considerable. According to one calculation, the Teamsters could have earned an additional $7.8 million in the 1970s if they had purchased Treasury notes instead of Israel bonds.

And unlike most bonds, State of Israel securities are not easily converted into cash. The institutional bonds cannot be traded on the open market, and can only be sold to pension funds, charities or other non-profit organizations.

Israel bonds not only pay a poor return, they carry a high risk as well. Although Israel bonds, like other privately placed securities, are not given a credit rating, if they were they would almost certainly be considered a poor investment.

Current yields on Israeli government securities "don't really reflect the true market perception of Israel's credit- worthiness," said Helena Hessel, a bond analyst with Standard and Poor's, (S & P) the giant investment rating firm.

"These bonds are sold to Israel's supporters, who treat them not exactly like a gift, but at least partially with that in mind," she added.

S&P recently developed a "shadow rating" for Israeli government notes when it analyzed corporate bonds marketed publicly in the United States last year by Koor, Israel's largest industrial conglomerate. Because S&Y's rating rules decree that no corporation can have a bond rating higher than its government, the firm also had to rate the State of Israel, even though its debt is not sold on the open market.

Hessel declined to reveal that "shadow rating," but said S&P has a generally poor opinion of Israel's fiscal condition. The firm's official risk assessment, she said, is that Israel's "debt servicing capacity is only adequate, with minimal protection likely during unfavorable circumstances."

S&P's treatment of Koor highlights the unique advantages enjoyed by the Israeli government. Koor's $105 million offering-- underwritten by Drexel Burnham Lambert Inc., Wall Street's premier junk-bond broker--received a rating of BB, one grade below S&Ps definition of an "investment grade" bond. The notes paid 12 percent interest.

A Brush With the Law
Although exempt from many U.S. securities laws, DCI ran into trouble with the Securities and Exchange Commission, (SEC) in 1983. The SEC accused the corporation of violating a federal money-laundering regulation by not recording some large cash transactions.

Between January 1982 and April 1983, the SEC charged, the corporation failed to report to the Internal Revenue Service (IRS) large sums of cash it received as payment for bonds. An IRS rule required financial institutions to report any cash transactions involving more than $10,000.

DCI quickly settled the charges by agreeing to a consent decree, without admitting or denying the SEC charges. As part of the settlement, the firm agreed to tighten its internal supervision of cash transactions.

Two years ago, Congress bailed individual Israel bond holders out of a dispute with the IRS. Citing a 1984 tax law, the IRS had contended that the 4 percent interest rate on Israel bonds was "artificially" low, and thus a partial gift to the State of Israel. Gifts to foreign governments are not tax deductible, and the IRS proposed to tax bondholders for the difference between the 4 percent rate they were earning and the prevailing market rate.

Protests from DCI and the Israel lobby, however persuaded Congress to tuck a special exemption for the bondholders into the sweeping tax reform bill it passed in 1986.

Where's the Percentage?
In light of the drawbacks, the continued purchase of Israel bonds by public institutions raises a major question about how well the interests of pensioners are being served by such investments. Most public and private pension funds are covered by laws requiring them to select investments on the basis of what is best for their beneficiaries, not what is best for bond sellers.

For example, the Employee Retirement Income Security Act, which covers nearly all private pension funds, requires fund managers to "discharge [their] duties ... solely in the interest of the ... beneficiaries and for the exclusive purpose of providing benefits ...." Most public funds are covered by similar laws.

Because of these and other restrictions, DCI has had only isolated successes in selling to public funds. The corporation, however, continues to try. Pension fund managers in several states said they have been approached by DCI salesmen.

"We have said we would be willing to consider making purchases if they could provide suitable rates and guarantees," said Steve Mathews, a spokesman for the New York City comptroller, who handles the city's giant pension funds. "So far they have been unable to do so."

Other pension managers, however, appear less concerned about the financial risks involved. Robert Bowman, the Michigan state treasurer, defended the decision to purchase $10 million in Israel bonds for the state employees' pension fund by noting that Israel is a "strong ally" of the United States.

Bowman said he would "listen" to any beneficiaries who wanted to make a "statement" about Israel's human rights violations in the occupied territories. But according to an official of the Arab- American Anti-Discrimination Committee, Bowman and other state officials ignored such complaints when they purchased the bonds in 1985.

A spokesperson for the Illinois Teacher Retirement Fund, which has also purchased Israel bonds, declined repeated requests for comment. According to Corporate Profiles, Inc., a New Jersey publishing house, the fund currently owns $5 million in Israeli government notes.

Labor union officials show a similar lack of concern about the financial and ethical questions posed by their large holdings of Israel bonds. In a survey conducted by the Monitor, several seemed unaware of the substandard interest rates they are receiving, or the risk factor associated with the bonds.

Zirkin, the comptroller for the Retail, Wholesale and Department Store Union, for instance, insisted that State of Israel bonds are "as good as U.S. bonds." Tom Needham of the Laborers International Union contended that the union's $500,000 in Israel notes are "competitive with market rates."

In light of the U.S. Iabor movement's long history of support for Israel, it is perhaps not surprising that the Palestinian uprising--and the Israel Army's violent efforts to crush it-- have not shaken that political commitment.

Needham told the Monitor the Laborers Union has "never given a thought" to whether the union should continue subsidizing Israel's policies. "If the AFL-CIO said the policy was to divest ourselves [from Israel] then we would follow that policy," he said.

Russell Mokkiber is a frequent contributor to the Monitor. Research assistance for this article was provided by Jim Donahue and Andrew Morehouse.