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Politics this week May 15th 2008 From The Economist print edition Reuters China suffered its biggest natural disaster for 30 years when an earthquake devastated Sichuan province killing some 50,000 people, according to official estimates. President Hu Jintao ordered an all-out rescue effort and the prime minister, Wen Jiabao, flew to the region to supervise it. See article In contrast, Myanmar's military regime continued to let in only dribbles of aid to the cyclone-ravaged country, where the estimated death toll rose to 130,000. The government resisted pleas from many quarters for it to open up. Meanwhile, the regime said more than 92% of voters had backed a new draft constitution in a referendum. Critics say it is a sham. See article Several bombs were set off in the Indian city of Jaipur, killing at least 61 people and injuring more than 200. A little-known group, Indian Mujahideen, claimed responsibility. See article Pakistan's coalition government fell apart, with Nawaz Sharif's party pulling out of its partnership with Asif Zardari's party in Islamabad. See article Japan's prime minister, Yasuo Fukuda, pushed a controversial road-construction bill through the lower house of parliament, overruling an opposition vote in the upper house. It is the last big piece of legislation in this session of the Diet (parliament). Mr Fukuda is likely to survive as prime minister for the G8 summit this summer, but another clash with the opposition and critics in his own party is expected this autumn. A shocking war on drugs Another senior policeman was shot dead by gunmen associated with drug-trafficking gangs in Mexico, bringing the number of high-ranking officers that have been assassinated recently to four. More troops were deployed to fight drug-related violence, which has resulted in more than 1,000 deaths this year. See article Colombia extradited 14 paramilitary warlords on drug-trafficking charges to the United States, where they could face 30 years or more in prison. President Álvaro Uribe said they had broken the terms of a deal with his government under which they would have received a maximum eight-year sentence. See article A computer hacker published on the internet confidential records belonging to 6m Chileans, including their ID-card numbers, academic records and telephone numbers. He said his aim was to demonstrate Chile's poor level of data protection. Bolivia's president, Evo Morales, set August 10th as the date for a referendum that will decide whether he and the country's regional governors should remain in office. He is embroiled in a battle with the governors over his plans for constitutional reform. Fans of the European Union Reuters Pro-European parties did unexpectedly well in Serbia's general election, suggesting that voters may care more about getting into the EU than about losing Kosovo. But coalition-building will take several weeks, and it is possible that the nationalists may yet scrape together a government. See article A new Russian government was announced by Vladimir Putin, the prime minister. Mr Putin continues to overshadow his successor as president, Dmitry Medvedev. See article One policeman was killed and four people were injured when a car bomb went off in the Basque country in Spain. The Basque separatist group, ETA, was assumed to be responsible. See article In a huge U-turn, Gordon Brown, Britain's embattled prime minister, cut income tax for 20m people to fend off a backbench revolt over the scrapping of a lower 10p rate. Mr Brown also set out his legislative programme, but against the backdrop of a weakening economy. See article The potential for violence Lebanon was racked by fighting across the country after its beleaguered pro-Western government tried to sack the head of airport security and to dismantle the communications network of Hizbullah, a Shia party-cum-militia. Hizbullah reacted by briefly capturing the centre of Beirut, the capital, and the television station of the main Sunni party. The Saudi foreign minister accused Iran, which helps Hizbullah, of “backing a coup”. See article A motorised rebel force more than 1,000-strong from Sudan's troubled Darfur region, apparently backed by neighbouring Chad, was fended off after attacking Omdurman, a suburb of Sudan's capital, Khartoum, shocking the government with its audacity. See article The leader of Zimbabwe's opposition, Morgan Tsvangirai, who was officially acknowledged to have defeated President Robert Mugabe in the first round of a presidential poll in March, agreed to come back from abroad and compete in a run-off, even though he insists that he won the first round outright. The electoral commission said the next round may not be held until the end of July. See article AFP George Bush visited Israel to celebrate its 60th anniversary. He said he would not conduct any peace-seeking diplomacy while there, but he praised the prime minister, Ehud Olmert, as “an honest guy”. A few days before, Israeli police renewed an investigation into allegations that Mr Olmert had taken bribes when he was previously mayor of Jerusalem and a minister. So much for wearing a flag pin As expected, Hillary Clinton won the Democratic primary in West Virginia by a whopping margin, 67% to 26%, underlining Barack Obama's lack of support among blue-collar voters. But the party began to unite behind Mr Obama and he secured the endorsement of John Edwards, who pulled out of the presidential race in January. See article John McCain was also out on the trail. He made a big speech on climate change and called for limits on America's greenhouse-gas emissions, putting more distance between himself and George Bush. See article The Republicans lost another congressional seat in a special election, this time in north Mississippi. The party had made every effort to stop the district from falling to the Democrats, including flying in Dick Cheney to stump for their candidate. The Republicans have lost three seats so far this year to the Democrats in once-solid “red” districts. America's interior secretary designated the polar bear a threatened species because of the reduction in Arctic sea ice, its primary habitat. The decision might also hamper oil drilling in the Arctic. Business this week May 15th 2008 From The Economist print edition Hewlett-Packard launched its biggest acquisition since its 2002 takeover of Compaq, when it agreed to buy Electronic Data Systems. The deal is valued at $13.9 billion. HP hopes its new purchase will enable it to compete better with IBM in a broad range of computer services. Investors are not so sure. HP's share price fell by 10% on news of the deal, knocking $12 billion off its stockmarket value. See article It emerged that General Electric is thinking about selling its appliances division, which has been supplying homes with refrigerators, air conditioners and the like for decades. The conglomerate is under pressure to improve returns to shareholders and the division is now a relatively small part of its business. Among the week's list of casualties in the subprime-loans crisis, MBIA, the world's largest bond insurer, reported a $2.4 billion quarterly loss and took write-downs of $3.6 billion; Crédit Agricole, a French bank, launched a euro5.9 billion ($9.1 billion) rights issue to offset mounting losses at Calyon, its investment-banking unit; and Freddie Mac, a government-backed housing-finance company, posted its third consecutive quarterly loss and unveiled a plan to raise $5.5 billion in new capital. Property crash The slump in American house prices will continue until at least next year, according to HSBC, which holds a sizeable portfolio of subprime loans and is thus seen as a good guide to where the market is heading. In a deal that creates Australia's largest bank by market value, Westpac agreed to merge with St George, paying A$18.6 billion ($17.5 billion) for its smaller rival. The decision by Yahoo! to reject Microsoft's takeover offer led to more grumbles from shareholders. But they took heart at the news that Carl Icahn, a veteran activist investor, has bought a stake in Yahoo! and will press the company to return to the negotiating table. Cablevision, a cable-TV operator, won the bidding for Newsday, a newspaper based in New York's Long Island suburbs, with an offer worth $632m. The sale represents a defeat for Rupert Murdoch's News Corporation, which wanted to combine the distribution operations of its New York Post with Newsday's. On the road With the price of oil hurtling towards $130 a barrel, the cost of petrol in America crept ever higher just before the start of the summer driving season, which begins on Memorial Day (the last Monday in May). Meanwhile, the International Energy Agency again cut its forecast for the growth in demand for oil this year, causing analysts to ponder whether rising oil prices would cause global energy consumption to fall. See article Canada's biggest energy company decided to split into two separately traded enterprises to take advantage of the high oil price. EnCana is hiving off its oilsands and refinery operations, which account for a third of its current assets, from its natural-gas business. Nissan forecast that its profit for the 12 months ending March 31st 2009 will fall by around 30% because of higher material costs, a stronger yen and the slowdown in America. Other Asian carmakers have produced similar gloomy outlooks. Airline wait times A delay to the “ramped-up” production of Airbus's A380 was announced. EADS, Airbus's parent company, confirmed that five super-jumbos would not be ready for delivery as promised this year and next. After previous delays because of manufacturing woes, the A380 finally entered commercial service last year. China established a state corporation to build commercial jets. With an expanding domestic market, the government wants to lessen its reliance on Airbus and Boeing with Chinese-made aeroplanes, but observers remain sceptical that China can compete globally. See article Finmeccanica, a defence company in which the Italian state holds a 34% stake, boosted its presence in the American market by agreeing to acquire DRSTechnologies for $5.2 billion. DRS makes night-vision equipment, among other things, and is part of a team led by Boeing working on border security with the Department of Homeland Security. BAA said that the managing director of Heathrow would step down from his job. Mark Bullock was responsible for the integration of the airport's Terminal 5, which endured a chaotic opening that led to hundreds of flight cancellations. His replacement is Mike Brown, chief operating officer of London Underground, another organisation in which passengers have a few quibbles about the service. KAL's cartoon May 15th 2008 From The Economist print edition Illustration by Kevin Kallaugher Banks Barbarians at the vault May 15th 2008 From The Economist print edition Modern finance is under attack. Yet the banking system has done much better than it is given credit for BANKS have endured a brutal nine months since credit markets froze in August. Losses and write-downs already total $335 billion; many of their best businesses have disappeared. In developed economies, almost all banks are facing economic and regulatory headwinds that will cut revenues and jobs. Yet the biggest danger facing Western finance is not a fall in its earning power but a loss of faith in how it works. Two criticisms assail the industry, one based on fairness and the other on efficiency. The first argues that finance is rigged to enrich bankers, rather than their customers, shareholders or the economy at large. Some worry about the way bonuses are calculated; others about moral hazard. Bankers will take wild bets because they know they will be bailed out by the taxpayer. Look at Bear Stearns or Northern Rock. The second, deeper question is whether a market-based approach to finance is efficient. Some Chinese officials claim the Western system has been shown up by the crisis (article HYPERLINK "economist:doc-id=20080517/F68HO3R" \t "_blank" see ). This week Germany's president demanded that the “monster” of financial markets “be put back in its place”: bankers had caused a “massive destruction of assets”. The critics do not lack ammunition. The lapses in credit-underwriting in the subprime-mortgage market hardly reflect a wise allocation of capital. The opacity of the shadow banking system and the mind-boggling complexity of those toxic asset-backed products have raised doubts about the discipline of the market. Forever blowing bubbles Be careful. It is not just that a rush to regulate is seldom wise: witness Sarbanes-Oxley, the governance act hurried through in the wake of the corporate scandals earlier this decade. The current assault is dangerous because it mixes a number of small truths with a big, alluring myth. The fiddly verities concern the ways in which finance can indeed be made a bit more efficient or fairer. But you can make those changes only if you dismiss the myth: that finance can somehow be stripped of its failures and perfected. Bubbles, excess and calamity are part of the package of Western finance. And still it is worth it. Some change is desirable and inevitable. Most of it will be supplied, belatedly, by the market itself—especially if it is bathed in the cleansing sunlight of transparency. America's mortgage business is already transformed. Hundreds of unregulated lenders have disappeared, as has the fatally lazy assumption that house prices do not fall. Demand for complex securitised products has shrivelled and the most complex may never come back. The safest forecast in banking is that the next crisis will not be rooted in America's mortgage market. Regulators also have lessons to learn. Most of them come in two categories. The first is to take a broader view of risk. That means looking at off-balance-sheet assets and at gross exposures (Jérôme Kerviel, accused of losing Société Générale $7.2 billion, went unnoticed because managers were watching only his net positions). For national supervisors, it requires a lead regulator with a remit to watch the system. Internationally, the global capital markets would ideally have global regulatory norms—or at least more co-operation between national authorities. Now that the investment banks know the central banks will stand behind them, they also need closer scrutiny and higher capital standards. For the moment supervisors need monitor only what banks lend hedge funds, but you could imagine some hedge funds becoming so central to the system that they too need direct attention. The second change in philosophy is to bully banks to build buffers when times are good so they have stronger defences when times are bad. The system has come to amplify the extremes of the cycle. Fair-value accounting, which pegs assets to current market prices rather than their historic value, leads to downward (and upward) spirals in asset prices, and hence leverage. Banks' risk models have been backward-looking, so no time appeared safer than the moment before the bubble burst. Working out when an asset boom has become a bubble is not easy—just as it is hard to use monetary policy to lean against asset-price bubbles. But rapid growth, whether in asset prices or market share, should be a signal to worry, not relax. And if banks are to be subject to the firmer discipline of fair-value accounting, it makes sense to have extra padding. These changes would certainly come at a cost—which is one reason to weigh them more carefully than the framers of Sarbanes-Oxley did. They would have the effect of increasing the amount of capital and liquidity that banks set aside when risks are building, and reducing the amount of leverage they can take on. That would reduce the size and capacity of the industry, although not the size of individual institutions: one result of the crisis is that universal banks are likely to become even more hulking as they seek the benefits of diversification. On balance, these costs are worth paying to make finance a little safer. Other reforms don't pass that test. For instance, limiting pay or forcing bankers to take equity stakes in their business will not stop moral hazard: Bear Stearns had high levels of employee share-ownership and it did not know it would be able to call on the Federal Reserve. Indeed, whatever you do, finance will not be “fixed” in the way critics are demanding. Rome or the barbarians: your choice As this week's special report on international banking makes clear, the main structural causes of trouble—the collective misjudgment of risk; a zealous search for yield; and the failure of oversight—are deep-seated. In financial history they crop up time after time. Financiers are rightly rewarded for taking risks, which by their nature cannot be entirely managed away or anticipated. The tendency for success to breed complacency and recklessness is as ingrained in financial markets as it is in any other walk of life. However bankers are paid, they cannot just sit out a credit boom; they have to keep dancing. Regulators lack the knowledge, the clout (and often the talent) to keep up with the banks' next brilliant scheme. That reads like an indictment, until you consider the alternatives. Western finance, to paraphrase Churchill, is the worst way to allocate capital, except for all those other forms. It is obviously better than the waste and dysfunction in China, where centrally planned capital is dished out to the well-connected. But it is also better than the financial system the West used to have. Thanks to the astonishing innovation of the past few decades, derivatives can help firms and investors to hedge risks (there are plenty of Chinese manufacturers who would be grateful for an easy way to soften the impact of exchange-rate shifts). Securitisation widens access to capital for borrowers and to assets for investors: it can finance everything from water utilities to film studios. Leverage brings more lazy companies within reach of determined investors and more homes within reach of poorer consumers. It is true that financiers have enjoyed vast profits—and the vast salaries that go along with them (pay at American investment banks has been nearly ten times the national average). But the collapse of the credit bubble will bring that down. And despite all the disasters, there are signs of finance's resilience. In the past few months the banks have commanded enough confidence to raise $200 billion in new capital from investors. Bear Stearns and Northern Rock were calamities, but rare ones, because the vast overall losses were spread far and wide. This time, there has been no industry-wide government recapitalisation. After 20 years of growth, the flaws of modern finance are painfully clear. Do not forget its strengths. Lebanon Keep it together May 15th 2008 From The Economist print edition Lebanon's problems reflect those of the wider region. They must be tackled all the same AP IT IS tempting to conclude that Lebanon never was, and never will be, a real country whose inhabitants have an overarching loyalty to their state. Historians have argued, with some cogency, that its inhabitants would have had a better chance of living in peace had it been incorporated into a Greater Syria, when the Ottoman empire collapsed at the end of the first world war. Being parts of a larger whole might—but only might—have given the Christians and Druze and perhaps even the Shia Muslims a good slice of autonomy in the areas where they predominate. But all that is academic. In the past few months, and especially in the past week, Lebanon has looked even less like a real country. It has had no president since November: the parliament is too divided to elect a new one. The opposition, led by