Economist: Finance and economics

A BIG but digestible mistake by a financial institution with abundant profits and capital should normally be viewed as the market equivalent of an electric shock, a jolt that leads to smarter behaviour. The response to JPMorgan Chase’s $2 billion (and rising) loss on a position taken by its chief investment office could not have been more highly charged.The loss has reinforced the political appeal of bashing banks, no matter what the facts. Barack Obama went on a TV chat show on May 14th and responded to questions about the loss by implying it would have been blocked under the Volcker rule banning proprietary trading. Given the proposed wording of the rule and the apparent nature of the trade, which seems to have started out as an attempt to hedge risk, that assertion is at best a stretch.Elizabeth Warren, a senatorial candidate in Massachusetts, also jumped on the bandwagon. “Wall Street isn’t going to change its ways until Washington gets serious about strong oversight and real accountability,” ran a campaign ad. Yet JPM is already among the most heavily regulated institutions in America, if not the world. Supervisors have employees climbing all over the bank; they routinely review its credit and business practices. Perhaps to pre-empt criticisms of inept oversight, a string of regulators has nonetheless announced investigations into the trade.Competing financial firms...

A RARE slip-up by lawyers has helped shed some light on a high-profile legal battle, the details of which some of the largest Wall Street firms have been fighting to keep under wraps. The case concerns allegations of illegal “naked” short selling, where the rules have been tightened several times over the past seven years.In 2007 Overstock sued 11 brokers, alleging that they had caused its share price to fall by helping their clients to naked-short the Utah-based retailer. In a normal short sale, shares are borrowed (or at least “located”) with a broker’s help before being sold. In the naked version, there is no attempt to borrow or locate the stock. This can create “fails to deliver”, where the trade is not settled when it should be, and messes with the laws of supply and demand, allowing shorting to take place beyond the natural limits set by the number of borrowable shares.As the pre-trial discovery period proceeded, Overstock narrowed its focus to two firms, Goldman Sachs and Merrill Lynch, now part of Bank of America. Before the case was set to go to trial in California, however, the judge dismissed it on jurisdictional grounds, ruling that not enough of the alleged wrongdoing had taken place in the state. Overstock appealed and pushed for all of the evidence to be unsealed. The defendants objected. Four media groups, including The Economist,...

IN 1900 America had around 500 carmakers; by 1908 it had 200. In 1960 Britain had 16 banks; ten years later it had just six. In both cases, this rapid consolidation came about because of a flurry of mergers. From soft drinks to steelworks, plenty of other industries have seen similar patterns. Mergers happen in waves, so the number of firms collapses suddenly rather than dwindling over time. And the next one may soon crest. The first merger wave in America peaked in 1899. During that wave, which lasted for five years, 700 mining and milling companies disappeared, along with 500 food retailers. The next four waves in America occurred in the 1920s and 1960s and again in the late 1980s and 1990s (see left-hand chart). Other countries have experienced the same phenomenon.Research suggests that shocks start merger waves. Some firms are quicker than others to respond to the disruption, or suffer less damage. This divergence allows the strong to mop up the weak. As far back as 1937 Ronald Coase, an economist, proposed that technological shifts like the telephone and the telegraph would lead to fewer, larger firms...

THE big global accounting firms are not having an easy time of it in China. They have been caught up in the accounting scandals that have engulfed many Chinese firms that listed on America’s stock exchanges: on May 9th, for example, America’s Securities and Exchange Commission (SEC) took legal action against Deloitte’s Shanghai arm in a case involving an unnamed Chinese client. The next day Chinese officials unveiled details of a plan that will force foreign partners to hand control of the “Big Four” firms—Deloitte, Ernst & Young, KPMG and PwC—to Chinese colleagues by the end of 2017.At first blush, the SEC seems to be overreaching by pursuing auditors based in China which are already regulated by local authorities. And the localisation scheme appears to be yet another example of the pitch being queered for foreign firms by an overweening Chinese state. But the snap judgments are misleading.The American regulatory mandate abroad arises because many Chinese firms choose to list on America’s exchanges while still using auditors based in China. One such example is Longtop, a Chinese business-software firm that...

THERE are two, potentially overlapping, ways in which Asia’s export-driven economies could suffer from the euro crisis. One is from the slowdown in trade to Europe. The other is the drying up of finance, from trade credit to syndicated loans, extended by euro-zone banks. On neither score is Asia as vulnerable as it was after the collapse of Lehman Brothers in 2008, argued Iwan Azis of the Asian Development Bank, at The Economist’s Bellwether conference in Tokyo on May 16th. One of the reasons is that Japan’s mega-banks have lumbered off their home territory to pick up some of the slack left by the departing Europeans (see chart).This is good news not just for Asia’s exporters. It also shows a rare stroke of boldness by Japan’s big three, Mitsubishi UFJ Group (MUFG), Sumitomo Mitsui, and Mizuho. After pulling back from lending to Asia following the 1998 financial crisis, and then suffering more than a decade of deleveraging by their deflation-sapped customers at home, they can almost smell the predicament of their European peers. Ken Takamiya of Nomura Securities says that in Australia, for...

The programme in West Bengal evaluated by Esther Duflo (Free Exchange, May 12th 2012) was implemented by Bandhan, not BRAC. BRAC devised the original scheme on which Bandhan's was based. In the same issue ("Frontier mentality"), we inadvertently relocated Lebanon to Africa. Sorry. These have both been corrected online.

THE odds of a Greek exit from the euro shorten by the day. An inconclusive result to a first election on May 6th has led to a caretaker government, and the scheduling of another poll in mid-June. The obvious trigger for a Greek exit would be an election result signalling rejection of Greece’s austerity programme. But events could move faster still if Greeks start voting with their mouses and begin a bank run. Runs these days start not with a queue of people lining up to withdraw cash but with clicks of a computer to transfer money abroad or to buy bonds, shares or other assets. The banking system has lost about a third of its total deposits over the past two years (see chart 1), some of this as people run down savings. There are worrying indications that this trickle of deposits has started to swell in recent days.Karolos Papoulias, the president of Greece...

Falcone has his wings clipped “BUYING 100% of companies, that’s where I think a great opportunity is.” So said Philip Falcone, a hedge-fund manager, at an industry bash on May 9th. His opinions will count for less now. On May 14th LightSquared, a wireless venture 96%-owned by Harbinger Capital Partners, his fund, filed for bankruptcy.Mr Falcone made his billions betting against subprime mortgages; in 2007, his fund was up by around 115%. In 2010 he took control of LightSquared, a firm with big plans to build a wireless-broadband network. The Federal Communications Commission initially gave the go-ahead, only to change its mind in February after tests showed LightSquared’s technology interfered with existing global-positioning satellites. With creditors pushing him to step aside, Mr Falcone put LightSquared into bankruptcy, hoping to buy a few months to come up with a new plan.The future looks dark. Mr Falcone has ploughed around $2.9 billion into LightSquared, and it now accounts for around 40% of his fund. At its peak in 2008 Harbinger Capital managed $26 billion, but that figure has...

THE pattern is eerily familiar. Investors start the year in a blaze of optimism, hoping that the euro zone has been stabilised and that the American economy is growing strongly. By the late spring, the latest example of euro-zone “make and mend” policies shows signs of fraying and the American recovery is proving less robust than hoped. The same description of events applies to both 2011 and 2012, even if last year’s market correction was also triggered by special factors—the terrible damage resulting from the Japanese earthquake and tsunami, along with the Libyan civil war.This year’s rally really began in late November, and got much of its impetus from the €1 trillion ($1.3 trillion) in three-year loans made by the European Central Bank to the region’s banking system. But the effect of the ECB’s liquidity package has quickly worn off. The MSCI World stockmarket index had gained 12.6% at one stage this year but has seen that advance cut to 2.7%. In Europe, the Euro Stoxx 50 has fallen by 6% in dollar terms; Spanish shares are off by 21%.Investors have retreated to the safety of selected government bonds. Since the start of 2012, the yields on British and German ten-year government bonds have fallen to levels that are pretty much unprecedented; French yields are a third of a point lower. American yields have fallen, too, but not by as much. The yields on ten-year Bunds are...

Correction to this articleTHE idea that an infusion of hope can make a big difference to the lives of wretchedly poor people sounds like something dreamed up by a well-meaning activist or a tub-thumping politician. Yet this was the central thrust of a lecture at Harvard University on May 3rd by Esther Duflo, an economist at the Massachusetts Institute of Technology known for her data-driven analysis of poverty. Ms Duflo argued that the effects of some anti-poverty programmes go beyond the direct impact of the resources they provide. These programmes also make it possible for the very poor to hope for more than mere survival.She and her colleagues evaluated a programme in the Indian state of West Bengal, where Bandhan, an Indian microfinance institution, worked with people who lived in extreme penury. They were reckoned to be unable to handle the demands of repaying a loan. Instead, Bandhan gave each of them a small productive asset—a cow, a couple of goats or some chickens. It also provided a small stipend to reduce the temptation to eat or sell the asset immediately, as...

FAREWELL to the Canadian penny. The last one-cent coin, in circulation ever since Canada developed its own currency in 1858, was minted on May 4th. The coin had become a nuisance, weighing down consumers’ wallets and costing more to produce than it was worth.The penny is just the latest in a series of coins to disappear after centuries of use. The British farthing was worth just a quarter of an old penny, or one-960th of a pound, but it still lasted almost 700 years before it disappeared from circulation in 1960. Remarkably enough, half-farthings were also issued in the 19th century, and even smaller coins (third- and quarter-farthings) were used abroad.Inflation killed the farthing just as it has killed the Canadian cent. Small coins are living on borrowed time once they become useless for buying individual items. A single penny could buy the first British postage stamp, the Penny Black, in 1840 and was still sufficient to buy a small ice cream for a short-trousered Buttonwood in the late 1960s. Nowadays you would struggle to find a humble ice lolly selling for less than a pound.By the time the farthing...

Ring of ire THE sight of a pack of adults shouting at each other is rarely edifying. Unless, that is, the set-to is in the “ring” of the London Metal Exchange (LME), whose old-fashioned system of open-outcry trading does much to set global prices for industrial metals and which is now itself the subject of a bidding battle. Only Hong Kong Exchanges and Clearing had publicly said that it would submit an offer for the world’s leading metals exchange by this week’s deadline of May 7th, but CME Group, InterContinental Exchange and NYSE Euronext are also widely reported to be in the frame.The member-owned LME, which started business 135 years ago in premises above a hat shop in the City of London, resolved last year to see what it might be worth to globalising rivals. As one of the world’s few remaining member-owned exchanges it is an inviting target, even at an estimated price of £1 billion ($1.6 billion). Acquiring it would give all the likely suitors a bigger global footprint, important for any ambitious exchange group, and a ready-made business in non-ferrous metals, demand for which...

IT HAS taken almost two years, but the debate over the restructuring of American finance has at last reached the issue at the heart of the industry’s reregulation: systemic risk. The idea is simple, the execution controversial. Policymakers want to help prevent the ailments of a single institution from infecting the system as a whole by limiting the exposures that firms have to any one counterparty. The implementation, typically of the mind-numbing Dodd-Frank act, is horribly complex.The core provision on “single counter-party exposure limits” comprises only 81 words among the hundreds of thousands in the act. The final rules were supposed to be in place by January 22nd, but the Federal Reserve issued its initial proposal just weeks before, on January 5th, and the comment period, prompting a deluge of letters, ended only on April 30th. Some of the comments were incoherent rants. The ones from trade groups and financial firms are far from objective. But the depth and the extent of the criticisms will require a detailed response.The law calls for institutions to limit their exposure to any single institution to no more than 25% of their capital, but the Fed has gone beyond this (as permitted in the act). It has proposed that large, important institutions should have no more than 10% exposure to a counterparty. It also wants lenders to provide it with ongoing credit-exposure...

SIMMERING anger over bankers’ pay was fuelled afresh on May 9th when a British court ruled that Commerzbank, a serially bailed-out German bank, had to pay bonuses promised to some of its investment bankers in London even though it subsequently posted colossal losses and collapsed into the arms of the state. The court ruled, reasonably enough, that a promise made was one that really ought to be kept. The answer of some policymakers is to restrict what can be pledged in the first place. On May 14th a committee in the European Parliament is due to vote on a proposal to limit bankers’ annual bonuses to no more than their base salaries. The proposed rule, which would be wrapped into a European regulation raising capital standards on banks, is thought likely to win parliamentary assent. How far it gets after that is not clear, but the banker lobby is desperately short of politicians who will publicly defend big bonuses. “You can talk to me about it but I won’t go anywhere near it,” was the response one lobbyist got from a sympathetic member of the European Parliament. Said another: “It makes absolutely no economic sense...

QUIET carriages on trains are a nice idea: travellers voluntarily switch phones to silent, turn stereos off and keep chatter to a minimum. In reality, there is usually at least one inane babbler to break the silence.A couple of problems prevent peaceful trips. First, there is a sorting problem: some passengers end up in the quiet carriage by accident and are not aware of the rules. Second, there is a commitment problem: noise is sometimes made by travellers who choose the quiet carriage but find an important call hard to ignore.The train operators are trying to find answers. Trains in Queensland, Australia, are having permanent signs added to show exactly what is expected; a British operator has invested in signal-jamming technology to prevent phone calls. Microeconomics suggests another approach: putting a price on noise.Fining people for making a din would surely dissuade the polluter and is a neat solution in theory, but it requires costly monitoring and enforcement. Another tack would be to use prices to separate quiet and noisy passengers—in effect, creating a market for silence. A simple idea would be to...

LONG benighted, Ethiopia is attracting attention for a better reason. It has become Africa’s fastest-growing non-energy economy (see chart). Investors have noticed. South Africa’s largest consumer-foods firm, Tiger Brands, expanded into Ethiopia last year with a big acquisition. Diageo and Heineken recently paid nearly $400m combined to acquire state breweries in the country.The latest proof came on May 9th, when Schulze Global Investments, an American investment firm and family office, announced that it had launched a $100m Ethiopia fund, the first private-equity fund focused exclusively on the country. Anchored by at least $15m from Britain’s CDC, a government-owned provider of development finance, and $10m of the family’s own money, the fund will invest in sectors from agribusiness and cement to health care and natural resources.Investing in Ethiopia is not for the faint-hearted, however. With a projected national income of $38.5 billion this year, its population of 85m still ranks among the world’s poorest. The government’s big spending carries risks, including high inflation (32.5% in March was near a nine-...

ON a local bus trundling round the south of the island, Mauritius does not feel like the centre of a balance-of-payments scare in India. Beaches slip by and a conductor sits puffing below a no-smoking sign. But remote Mauritius, over 1,000 miles (1,600km) from Africa, is no tinpot dot on the map. It is odder and more impressive than that. Mark Twain said it was so beautiful that God modelled heaven on it. Half its people are Hindus, descended from Indian labourers brought over when Britain ruled the island. France once ran Mauritius, too: hence its Gallic creole and baguette-munching office workers dressed to kill. Strangest of all, Mauritius is the world’s financial gateway to India (see chart 1). It is the tail that wags the elephant. But its status and the position of outside investors in India have been upended by a bewildering display...

HAVE Spain’s policymakers at last woken up? The news that Rodrigo Rato was leaving Bankia came at the start of Madrid’s siesta on May 7th. The abrupt departure of one of Spain’s most prominent bankers came hours after Mariano Rajoy, the prime minister, admitted that he might need to use public funds to shore up the banking system. Two days later, the government nationalised Bankia’s parent.Bankia, a merger of seven savings banks and the largest property lender in Spain, is not Mr Rajoy’s only banking problem, but it is a good place to start. In a report last month the IMF singled the lender out, urging it to strengthen its balance-sheet as well as to “improve management and governance practices”. Its auditor did not sign the 2011 accounts of Bankia and its parent company, Banco Financiero y de Ahorros (BFA).The bail-out heaps more pain on shareholders: the bank made its debut on Madrid’s stockmarket only last July and its shares have since lost 45% of their value. It is also an embarrassment for regulators. Most of the bad land assets of the seven original savings banks reside in BFA, a 45.5% shareholder in Bankia that had already received €4.5 billion in preference shares from the state. The idea was to detach Bankia’s banking business from the contaminated parent, but the fall in Bankia’s value made the whole structure vulnerable. The preference shares will convert to...

WITH their overnight-lending rates at zero for most of the past decade, the Japanese public long ago stopped caring about interest rates. Instead the yen is their focus. Shoppers may revel in its current strength against the dollar but in the news media, the financial markets and corporate Japan, it is a relentless source of woe. Carlos Ghosn, the boss of Nissan and Renault, publicly lambasts it as a “1,000-pound gorilla” that hurts his ability to sell Japanese cars abroad. Its strength is increasingly becoming a political issue, too.Both the Bank of Japan (BoJ) and the finance ministry have taken steps recently that analysts believe are surreptitiously aimed at the currency markets. On April 27th the BoJ increased the size of its asset-purchase programme by ¥5 trillion ($62 billion), and extended the maturity limit of government bonds it would buy from two to three years. That enhanced easing measures introduced in February which sharply weakened the yen.Days before, the finance ministry promised the biggest single contribution—a $60 billion slug—to a $430 billion increase in IMF funding which is largely aimed at alleviating concerns about the euro crisis. As a senior official admitted, Japan’s decision was not altruistic. When the euro crisis gets worse, it weakens Japan’s exports to Europe and strengthens the yen, which compounds the first problem. So Japan has a direct...

BANKS in China appear to be in rude health. The seven biggest mainland banks have just posted a 16% year-on-year increase in pre-tax profits between them for the first quarter. The level of non-performing loans (NPLs) remains low, at just about 1%. But trouble is being stored up for the future.There are two big worries: bad local-government debt and souring property loans. The infrastructure binge of the past few years saw a boom in local-government financing vehicles (LGFVs), off-balance-sheet entities used to get around prohibitions on borrowing. Regulators say these entities’ bank debts were worth $1.4 trillion at the end of September. Private estimates range much higher, and suggest that 20-30% may be non-performing. The government is trying to defuse the bomb. One experiment is the issuance of local bonds to replace these loans. Officials also published guidance in March pushing banks to roll loans over, in the hope that growth will solve the problem. Another wheeze is shoving these loans onto the books of “policy banks” like China Development Bank (CDB), whose balance-sheets are now suffering (see chart). Half...