Friday, July 9, 2010

US: Why Can’t We Fire Failed Regulators? – by Mark A. Calabria

As Congress returns from its weeklong July 4 break, the Senate is poised to vote on the Dodd-Frank financial regulation bill. With the recent House passage, a Senate vote is all that stands between the bill and the president.

While people continue to debate the causes of the financial crisis, there is one factor that appears to be widely agreed upon: the absolute failure of banking regulators to do their job.

The Dodd-Frank bill claims to address this failure by eliminating agencies, such as the Office of Thrift Supervision, or transferring regulatory responsibilities, such as consumer protection, from existing agencies. What the press releases leave out is that all of the same bureaucrats behind the failures also move to the new agencies along with their previous responsibilities.

In debating against the creation of an independent consumer protection bureau, Republicans argued that all of the existing bank regulators have warned against separating consumer protection from safety and soundness regulation. They pointed out that this reflected a concern of the regulators that such separation would undermine bank safety and soundness.

Rep. Barney Frank’s response was that the current regulators lack credibility on the issue. Frank went as far as to say that “the Fed has a terrible record of consumer protection.”

Frank’s solution is to therefore transfer the Fed’s consumer duties to a new regulator. However, the Dodd-Frank bill clearly states in Section 1064 that “all employees of the Board of Governors identified … shall be transferred to the Bureau for employment.”

If one believes that such employees have “a terrible record,” then what exactly is the rationale for keeping said employees?

Such transfers are not limited to consumer protection. Although there is little evidence that the Office of Thrift Supervision (OTS) performed any worse, or better, than other bank regulators, the Dodd-Frank bill eliminates the OTS, moving its powers to the Office of the Comptroller of the Currency.

But Section 322 of the bill guarantees that “all employees of the Office of Thrift Supervision shall be transferred to the Office of the Comptroller of the Currency” or to the FDIC. Once again, if the OTC is a failed regulator, then why are we not firing its employees? Or at least making them re-apply for their jobs.

Some might argue that firing regulators would erode the trade-off that government employees make between job security and salary. For this to be true, one would expect to find government salaries to be lower than those of the private sector. Yet what we find is the opposite, especially when it comes to financial regulators.

While the typical American household has to manage to get by on just over $50,000 a year (2008), the average compensation, not including benefits, for federal bank regulators is over $115,000, with some agencies, such as the Securities and Exchange Commission, seeing average annual compensation of over $130,000.

Not only do bank regulators get to keep their jobs regardless of their performance, they are rewarded with six-figure salaries. One of the most harmful aspects of the bank bailouts was the rewarding of irresponsible private-sector behavior. Ultimately more damaging, however, will be the continued rewarding of failure on the part of government.

There is probably no regulator who was more asleep at the wheel than the Federal Reserve Bank of New York. Yet, in what must be a new twist on the Peter Principle, the New York Fed’s leadership during the crisis, Timothy Geithner, was promoted to Treasury secretary and placed in charge of Obama’s financial reform efforts.

But then such a promotion, in the face of repeated failure, pales in comparison to the reappointment of Ben Bernanke as Federal Reserve chair.

The sad truth is that the Dodd-Frank bill is in keeping with a long tradition: that government exists to serve special interests rather than provide for the common good. And when it comes to special interests, there is perhaps no more powerful special interest than government employees.

In addition to ignoring the government policies that drove the financial crisis, the Dodd-Frank bill places protecting government employees over protecting both the taxpayer and our financial system. At a time when millions of Americans have lost their jobs, generally by no fault of their own, protecting the jobs of failed bank regulators only adds insult to injury.

Obama Vanity Runs Out Fast If Focus Is U.S.

Obama Vanity Runs Out Fast If Focus Is U.S. – by Charles Krauthammer

Remember NASA? It once represented to the world the apogee of American scientific and technological achievement. Here is President Obama’s vision of NASA’s mission, as explained by administrator Charles Bolden:

“One was he wanted me to help re-inspire children to want to get into science and math; he wanted me to expand our international relationships; and third and perhaps foremost, he wanted me to find a way to reach out to the Muslim world and engage much more with dominantly Muslim nations to help them feel good about their historic contribution to science and math and engineering.”

Apart from the psychobabble — farcically turning a space-faring enterprise into a self-esteem enhancer — what’s the sentiment behind this charge? Sure America has put a man on the moon, led the information revolution, won far more Nobel Prizes than any other nation. But then, a thousand years ago al-Khwar-izmi gave us algebra.

Bolden seems quite intent on driving home this message of achievement equivalence — lauding, for example, Russia’s contribution to the space station. Russia? In the 1990s, the Russian space program fell apart, leaving the United States to pick up the slack and the tab for the missing Russian contributions to get the space station built.

For good measure, Bolden added that the U.S. cannot get to Mars without international assistance. Beside the fact that this is not true, contrast this with the elan and self-confidence of President Kennedy’s pledge that America would land on the moon within the decade.

There was no finer expression of belief in American exceptionalism than Kennedy’s. Obama has a different take. As he said last year in Strasbourg, “I believe in American exceptionalism, just as I suspect that the Brits believe in British exceptionalism and the Greeks believe in Greek exceptionalism.” Which of course means: If we’re all exceptional, no one is.

Take human rights. After Obama’s meeting with the president of Kazakhstan, Mike McFaul of the National Security Council reported that Obama actually explained to the leader of that thuggish kleptocracy that we too are working on perfecting our own democracy.

Nor is this the only example of an implied moral equivalence that diminishes and devalues America.

Modesty Shortage

Assistant Secretary of State Michael Posner reported that in discussions with China about human rights, the U.S. side brought up Arizona’s immigration law — “early and often.” As if there is the remotest connection between that and the persecution of dissidents, jailing of opponents, suppression of religion routinely practiced by the Chinese dictatorship.

Nothing new here. In his major addresses, Obama’s modesty about his own country has been repeatedly on display as, in one venue after another, he has gratuitously confessed America’s alleged failing — from disrespecting foreigners to having lost its way morally after 9/11.

It’s fine to recognize the achievements of others and be non-chauvinistic about one’s country. But Obama’s modesty is curiously selective. When it comes to himself, modesty is in short supply.

Campaigned In Berlin

It began with the almost comical self-inflation of his presidential campaign, from the still inexplicable mass rally in Berlin in front of a Prussian victory column to the Greek columns framing him at the Democratic convention. And it carried into his presidency, from his posture of philosopher-king adjudicating between America’s sins and the world’s to his speeches marked by a spectacularly promiscuous use of the first-person pronoun — I.

Notice, too, how Obama habitually refers to Cabinet members and other high government officials as “my” — “my secretary of homeland security,” “my national security team,” “my ambassador.” The more normal — and respectful — usage is to say “the,” as in “the secretary of state.” These are, after all, public officials sworn to serve the nation and the Constitution — not just the man who appointed them.

It’s a stylistic detail, but quite revealing of Obama’s exalted view of himself. Not surprising, perhaps, in a man whose major achievement before acceding to the presidency was writing two biographies — both about himself.

Obama is not the first president with a large streak of narcissism. But the others had equally expansive feelings about their country. Obama’s modesty about America would be more understandable if he treated himself with the same reserve. What is odd is to have a president so convinced of his own magnificence — yet not of his own country’s.

Europe's future

Europe's future

Can anything perk up Europe?

Yes: the European Union will thrive if its leaders seize the moment in the same way they did 20 years ago

WHEN Europeans fear for their jobs and their savings, when their governments and companies cannot easily borrow money, when banks fail and the single currency trembles, then the European Union is facing not just an economic crisis, but a political crisis, as well. And, so far, Europe’s leaders have not been equal to the threat. Over the past 18 months they have mostly taken refuge in denial and bluster, punctuated by bickering and by heaping blame on financial markets. Despite a recent bout of austerity and the 11th-hour launch of a vast bail-out fund for its most fragile economies, Europe seems a diminished force in the world.

In Asia and America it has become fashionable to look upon these failings with disdain. Europe’s time is past, it is said. Its ageing, inward-looking citizens no longer have the resolve to overcome adversity. And yet an ailing Europe benefits nobody. Even now the European Union is the world’s biggest economy. Were it healthy, the worst of the global economic crisis would be over. Politically, everyone has a stake in the fate of Europe’s Big Idea, that rival nation states can do better by pooling some sovereignty instead of going to war. And socially, all democracies eventually have to grapple with Europe’s Big Problem, that governments and social protection tend to grow until they choke the economies that pay for them.

So rather than sneer at Europe’s impotence, the world should be asking whether Europe can rediscover its vigour—and if so how. This newspaper offers an unfashionably optimistic answer. There is nothing ordained about Europe’s failure. Indeed, if EU leaders show a little courage this crisis offers the best chance at revival since the 1980s.

Jacques the lad

In that decade, when central and eastern Europe were still part of the Soviet block, Europe suffered low growth and high unemployment caused by two oil shocks. “Eurosclerosis”, as it was called, led, under the European Commission presidency of Jacques Delors, a brilliant and irascible French politician, to the single market in 1992 and to a rejuvenation of Europe’s institutions. Those reforms laid the ground for one of the most dynamic periods in EU history. There is a lesson here for leaders today. Unfortunately, they seem to be missing the point.

Inspired by Mr Delors, some in Europe now grappling with the fate of the euro argue that crises always lead to a leap in EU integration. Championed by France, they argue that the chaos that has spread from Greece to southern Europe shows the euro zone needs a core of dirigiste powers to run Europe in a more political and less technocratic way. To limit “unfair” competition, they want things like Europe-wide labour standards and some harmonisation of taxes. They want to oversee transfers of communal cash to the euro’s weakest members.

An interactive guide to the EU's debt, jobs and growth worries

Yet the appetite for this sort of integration is not shared in other countries—not even in Germany which, mindful of its own history, does not trust politicians with monetary policy. Its people were assured that the euro would be run with the same discipline as their beloved Deutschmark and they are sick of paying for all of Europe’s new schemes. Instead Germany wants a harsh system of rules, enshrined by treaty if need be, that would ban countries from spending too much.

If the French idea is unacceptable, the German idea is unworkable. Politics has tended to trump economics right from the start of the euro, when indebted countries like Belgium and Italy were allowed in. You cannot simply decree that every one of 16 countries in the euro zone will always behave responsibly. Someone will break the rules and, as often as not, someone else will have reason to connive with them.

Tidy minds contemplating the contradictions between the euro’s two most important members foresee either integration or collapse. They argue that without a clear political mechanism to cope with wayward countries, the euro is doomed to repeat the sort of crisis it has suffered this year. One day this view may be proved right. But tidy minds underestimate the European art of compromise (see article). And they overlook the determination in Europe to make the euro stick—because to pull it apart would be ruinously costly and threaten the EU’s very existence. For the moment, therefore, the most likely outcome is neither collapse nor a dash towards integration, but for the euro zone to muddle through.

1992 and all that

Muddle avoids problems, it does not solve them. Instead of miring itself in internal mechanics, the EU should embrace the lesson from the other, more radical, half of Mr Delors’s programme—the bit that focused on freeing its economy and setting up the single market. By boosting economic growth the EU could ease its political difficulties and help its citizens. At the moment EU leaders are putting their effort into cutting spending: if only they were to add a dose of 1992-style reform.

The single market remains half-built. Mario Monti, an Italian economist and a former commissioner, has recently set out just how much more is left to do. The EU is 30% less productive than America in services. Because European services companies operate behind national barriers they innovate less and they tend not to gain the full economies of scale. Whole areas, such as health care, are exempted from EU-wide competition. Likewise some high-tech industries, such as telecoms, have been protected and others, such as e-commerce, barely existed in 1992. A single digital market could be worth 4% of EU GDP by 2020. The EU has a costly, fragmented patent system, so products (like far too many workers) cannot cross borders easily; energy supply has not been properly liberalised; debts are hard to collect across borders. And so it goes on. National to-do lists are just as long. In Spain and Italy privileged workers are protected, discouraging new permanent jobs. German entrepreneurs are immediately taxed on equity they put into a start-up. Europeans retire too early everywhere.

The barrier to reform has always been political, not economic. Jean-Claude Juncker, prime minister of Luxembourg, put it best in 2007: “We all know what to do, but we don’t know how to get re-elected once we have done it.”

But does that excuse still hold? The crisis has shifted the political landscape in Europe. The euro was supposed to spur reform by preventing governments from restoring competitiveness by devaluing their currencies. And it did. Not at first, when Greece, Spain and the others used the euro’s low interest rates as an excuse to party. But now they have woken up hung-over, to find that reform can be put off no longer (see article).

There are signs that Europeans understand this better than their timid leaders. Asked if they were better off in a free-market economy, 73% of Germans and 67% of French said yes, according to a survey released in June by Pew Research Centre. That compares with 65% and 56% respectively at the height of the boom in 2007 and it rivals America, with 68%, and eclipses Britain, with 64%, where support for free markets has fallen.

The moral case for reform has never been clearer. The European “solidarity” that protects jobs for life in Spain for the lucky few is hard to defend when it means that young people, who could only ever get work on temporary contracts, have been thrown onto the dole. In France it is irksome to see your taxes paying healthy people to retire at 60 when schools and hospitals need the money more. Cash-strapped households in Belgium might rather like the idea that competition can lower their bills. Were he speaking in 2010, a European leader seeking re-election as well as reform might just fancy his chances.

Listen to the people

In the past couple of decades Europe’s privileged “insiders” have blocked change. Mr Delors managed to take them on by building a coalition of the free-market liberals and believers in European integration. Today the crisis has given Europe’s leaders the chance to create their own coalition for reform, focused again on the single market. They should seize it.

Mexico's state elections

Mexico's state elections

Joining forces

A motley political alliance scrambles the presidential race

| mexico city

DURING the campaign ahead of Mexico’s state elections on July 4th, many feared that the gruesome run-up to the vote would overshadow the results. Two candidates were murdered, and countless others were intimidated: one would-be mayor found a decapitated corpse deposited outside his home. The atrocities, including four dead bodies hung from bridges on election day, were attributed to drug gangs reminding the country who rules the roost.

Yet the vote itself, in 14 of Mexico’s 31 states, provided a surprise that could redraw the country’s political map. The opposition Institutional Revolutionary Party (PRI), which ruled Mexico from 1929 to 2000, took over the lower house of Congress from Felipe Calderón’s conservative National Action Party (PAN) in 2009. It had been forecast to sweep all 12 of this year’s contests for governorships before winning the presidency after Mr Calderón steps down in 2012. Instead, it took just nine, the same number it held before the vote.

The three states it lost, Oaxaca, Puebla, and Sinaloa, had been ruled by the PRI for 81 years. They are bigger and more important than the three states the PRI snatched back in return: together, they represent 11% of the country’s population and 6.9% of its GDP, against 3% of the population and 2.3% of GDP made up by the PRI’s new acquisitions. Other PRI bastions also looked wobbly: the party clung onto Veracruz, the largest state in contention, by less than 3%, and held the smaller Durango by less than 2%.

The PRI lost its fiefs to an unlikely alliance between the PAN and the leftist Party of the Democratic Revolution (PRD). The pair have been bitter rivals since the PRD’s 2006 presidential candidate accused Mr Calderón of stealing the election. They are ideological opposites. But as Alejandro Poiré, the under-secretary for immigration and a former political-science professor, notes, the two teamed up in the past to end the PRI’s monopoly on power. Jesús Zambrano, a senior PRD leader, sees a marriage of necessity. “Some PRI members are prehistóricos”, he says of their longing for one-party rule. “We can’t just sit there with our arms crossed.”

The parties are likely to repeat the tactic in next July’s race for governor in Mexico state, the country’s most populous. It includes most Mexico City suburbs and is seen (often misleadingly) as a political barometer. In 2005 the PRI’s candidate there, Enrique Peña Nieto, won easily. Thanks to his popularity in the state, able advisers, engagement to a soap-opera star, and wide media exposure, he is now the front-runner for the PRI’s presidential nomination.

But the PAN and PRD’s combined vote in 2005 exceeded Mr Peña Nieto’s. If the two parties can find a candidate who could capture most of the anti-PRI vote next year, they might be able to stop him from installing his chosen successor in the governor’s mansion and sap his momentum. “The main thing he has going for him is his inevitability,” says Jorge Castañeda, a former foreign minister. “If he is knocked down, the PRI has no substitute, because they’ve bet the store on him.”

The new alliance could affect policy as well as the horse race. Almost all of Mr Calderón’s legislative initiatives have been diluted or defeated in Congress. With PRD support, Mr Calderón could almost scrape together a legislative majority. That would let him pass laws that do not entail constitutional amendments by picking off just a few PRI members or their allies.

Most big issues, such as allowing private investment in energy, involve changing the constitution. That requires a two-thirds majority, and thus the PRI’s backing. But Mr Calderón could also use the PRD as a bargaining chip, agreeing not to field alliance candidates in some states in exchange for the PRI’s votes in Congress.

Such a strategy might enable him to pass a political reform that would help prevent legislative gridlock in the future. He has proposed permitting limited re-election for legislators and mayors (currently capped at a single term), letting the president order Congress to vote on at least two of his bills in each session, and adding a run-off vote to presidential elections. The PRI is wary of these ideas: a run-off, for instance, would allow the PAN and PRD to field their own candidates and then unite behind whichever one did best.

That Mr Calderón’s “alliance against nature”, as some priístas term it, has beaten expectations does not mean he is out of the doldrums. As Mr Peña Nieto notes, “It was everyone against the PRI, and despite that the PRI triumphed in nine states [out of 12].” The PRI still holds Congress and 19 of the 31 governorships. But the July 4th vote has opened up new possibilities in a previously paralysed system.

Testing the European banks' stress tests

Testing the European banks' stress tests

by The Economist online | BERLIN

IT TOOK a while but Europe’s committee of bank supervisors has finally agreed on some basic criteria that should be applied in a series of co-ordinated tests of the ability of the region’s biggest banks to withstand a downturn. The idea of testing banks’ ability to withstand various scary scenarios is a sensible one. There is still some debate as to how much to credit the stress tests carried out in America for restoring trust in its biggest banks, but few people think they were a bad idea. Their big advantage is that they can help to address a fundamental flaw in the financial system: namely that it is difficult for outsiders to assess the health of a bank. In such circumstances it makes a lot of sense to invite outside examiners to rummage about in filing cabinets and ask difficult “what if” questions.

The trouble, however, is that stress tests only restore confidence if the questions are tough enough to be realistic but not so tough that too many banks fail them. They have to reassure markets that banks will survive not just the most likely of scenarios but also slightly less likely but still possible ones.

There is also a danger, however, in setting the bar too high, for markets would also be unnerved if many banks were to fail their tests. In America a reasonable balance could be found because markets were providing some indication of expected defaults and losses on toxic assets. In the case of Europe the issue is complicated by market interventions and politics. It is clear that the tests have to somehow take into account the possibility that one or more European countries may default on their debts. These may not be likely outcomes, but they are possibilities that have the markets on edge. Yet there is great reluctance across all European institutions to explore explicitly such a possibility.

Instead the committee of bank supervisors has suggested applying a discount, or “haircut”, to some European bonds that is supposedly based on market expectations of default. Yet because the European Central Bank is buying sovereign debt to help prop up prices, markets are not giving a clear indication of expected loss levels. As it stands the tests seem unlikely to offer much reassurance on the consequences for banks of one or more sovereign defaults. Without answers to that question, there seems little point then in doing the tests.

China's banks

China's banks

Great Wall Street

The rise of China’s state-backed banks is stunning. But success will force the model to change

THERE is no more potent symbol of the relative decline of Western finance than the revolution in Chinese banking over the past decade. While American and European banks have been busy blowing up, China’s have been transformed from communist bureaucracies crippled by bad debts into something resembling world beaters.

That metamorphosis has been completed by the flotation of Agricultural Bank of China, the last of the five big state-owned banks to list (see article). Even by Chinese standards it is colossal, with 320m customers, 441,000 staff and more branches than many Wall Street firms have desks. Four of the world’s ten biggest banks by market value are now Chinese. In 2004 none was. Better-known (and more global) lenders such as Deutsche Bank and Barclays look rather puny by comparison. It’s natural to wonder if more than just firms are being eclipsed: whether a freewheeling era is being superseded by a “Beijing consensus” of state-managed finance. Though neat, such a conclusion looks wrongheaded.

Whatever their colour, these cats catch mice

As all bankers know, league tables can mislead. Still, China’s rise is more solid than that of Japan’s banks in the 1980s. Finance has huge potential in China—less than 1% of AgBank’s retail customers have mortgages. And the country’s banks had a good crisis, largely because they never entirely left the government’s embrace. So although they make money and have the trappings of public companies, the state owns a majority stake and the Communist Party appoints the top brass, whose pay is a fraction of that of their Western peers. Those bosses, with their dual role as party bigwigs and chief executives, are beholden to a higher authority than the stockmarket. Their regulators, meanwhile, wield supposedly crude tools to control banks, such as lending caps and reserve ratios, long dismissed by “light touch” supervisors elsewhere. And the system is pretty closed. Some foreign banks have minority stakes in Chinese firms. But foreigners’ own operations on the mainland have a market share of less than 1% by profits, while Chinese banks make less than 4% of their profits abroad.

This patriotic model has done well. Rich countries tried to kick-start their economies by getting central banks to lend to banks, which, frustratingly, have hoarded the liquidity. As in 1999 after the Asian crisis, China’s politicians just cut out the middleman and told the banks to supply more credit. Loans grew spectacularly, from 102% of GDP in 2008 to 127% in 2009, funding everything from motorways through paddy fields to yuppie flats in Pudong. Growth stayed strong and China won many admirers. In India and Brazil it is no longer retrograde to argue that state-controlled banks should help counteract the economic cycle. Even in rich countries with privately owned banks, supervisors are eyeing the tools used by China’s regulators to control credit. Communist Party diktat has been relabelled as “macroprudential supervision”.

Even admirers, though, cannot fail to spot China’s bad-debt problem. Those who think capitalist democracies have an unrivalled talent for generating dud loans should consider the Middle Kingdom. After decades of mismanagement, by the late 1990s perhaps a third of all loans were sour, most of them owed by zombie state-owned enterprises. Cleaning that up left China a world leader in bail-outs. Since 1998 it has injected the equivalent of $420 billion into the biggest five banks alone, more than the outlays of America’s TARP bail-out fund. China’s reforms were meant to stop this ever happening again.

A repeat performance is exactly what some fear after the latest binge. Most worrying are loans to infrastructure projects sponsored by local governments (perhaps a sixth of outstanding loans) and, given a frothy property market, real-estate financing and mortgages (a fifth of the total, with some overlap with infrastructure loans). China’s bankers say they are relaxed but some investors are kept awake by visions of corrupt officials, roads to nowhere and deserted shopping malls.

Although potentially severe, these bad debts will not be the downfall of the Beijing model of banking. Even if a chunk of the loans is written off, the system can absorb the hit. That is partly thanks to an impressive regulator, which has prodded the banks to raise capital this year—by about an eighth, if all goes to plan. But it is mainly because of China’s high savings rate. With piles of excess deposits banks do not rely on fickle debt markets for funding. That buys them time to earn their way out of a bad-debt problem, using their high lending profits to replenish capital. As a backstop, China’s government, with little debt and large foreign reserves, has deep pockets.

Capitalism with fewer Chinese characteristics

Indeed, there is only one thing that will guarantee the demise of China’s present model of banking: success. If China manages to digest its recent lending boom without a slump and then rebalance its economy away from investment and towards consumption, banks will need to free up space on their balance-sheets for lending to individuals and small firms. The heavy lifting of financing infrastructure and state companies will shift to bond markets. As customers have more sources of finance, banks’ lending profits will be squeezed, forcing them to diversify into capital-market activities like underwriting. Banks’ buffers of deposits should also shrink, relative to loans, as the savings rate falls and as people move cash into higher-return shares and bonds (earning banks fees in the process).

China’s banks could then end up looking a lot like banks elsewhere, although the state will still have control. Yet even that could change gradually. At current growth rates China’s banks will need capital injections every few years. The government may tire of these shakedowns—its participation in this year’s equity raisings has been a little grudging—and allow its stake to be diluted instead. And, as China’s banks claim their rightful place among the global leaders, they will find doing big foreign deals is hard when the government has a hand on the steering wheel. The rise of China’s banks is stunning and a little frightening. Yet they are not the pallbearers of market-based finance, just a work in progress.

Spy swaps

Ex-communist Europe

Eastern approaches

Spy swaps

How to trade spies

by E.L. | LONDON

TIME was when spy swaps took place in icy geopolitical conditions. The "reset" between Russia and America has put a layer of political warmth over the spymasters' steely calculations and the spies are going home in aeroplanes rather than tiptoeing across the Glienicke Bridge between West Berlin and Soviet-occupied Potsdam.

The deal now under way is the first public spy swap for more than 25 years. It should be no surprise, given the public statements on both sides since the sensational arrests of 10 alleged Russian spies late last month. America had refrained from any triumphalist rhetoric. Russia had (largely) refrained from any bluster. It was in the interests of both sides to damp down an issue that might have led to blush-making revelations for all concerned. So the people on trial in America (seven "illegals", plus what look like two mainstream intelligence officers and a hapless spouse) have pleaded guilty and flown home.

Five of the suspects revealed their real names in court. All but the Peruvian journalist Vicky Pelaez also admitted that they were Russian citizens. The couple known as Richard and Cynthia Murphy said they were really Vladimir and Lydia Guryev, 44 and 39 years old. Donald Howard Heathfield was actually Andrey Bezrukov, 49, Tracey Lee Ann Foley was Elena Vavilova, 47, and Juan Lazaro was really Mikhail Anatonoljevich Vasemkov, 66. Anna Chapman never disguised the fact that she was originally Russian. Mr "Lazaro's" wife Vicky Pelaez, is a Peruvian-born journalist who appears to have been reluctant to leave with the rest. The fate of several children belonging to the deportees is still unclear.

Igor Sutyagin, a high-profile prisoner accused of spying for the west (which he denies) is one of four Russians pardoned by president Dmitry Medvedev and allowed to leave the country. Since 2004 he had been serving a 15-year sentence for espionage in a penal colony near Archangel (Arkhangelsk in Russian). But he is hardly an exact counterpart to the ten flying the other way. Many (including Amnesty International) regarded him as a political prisoner. The prosecution never proved that he had passed on classified information.

But Mr Sutyagin, however unwittingly, seems to have been involved in a botched Anglo-American spying operation: a nuclear-weapons specialist at a thinktank, he had been hired by a shadowy company called "Alternative Futures", working out of rented offices in London, to provide a review of open-source information about arms control. When he was in trouble, Alternative Futures disappeared.

Russia's spycatchers may have ransacked their cupboard to find some more items to trade, but they seem to have put little on the table. The Russian authorities regularly catch western intelligence officers working under diplomatic cover, such as the MI6 officers involved in the infamous "rock" incident. But they appear to have caught no western "illegals". One reason for that may be that there aren't any: western spy services find the idea of sending intelligence officers to live undercover in Russia for extended periods of time logistically formidable. Infiltrating people into the west is a lot easier.

That leaves Russians caught spying for the west. Leaving aside Mr Sutyagin, two big fish are heading back. One is Alexander Zaporozhsky, a former Russian intelligence officer who moved to the United States in 1998 and is believed to have handed over large amounts of secret material. For reasons that remain unclear (and against the advice of his American colleagues) he returned to Russia in 2001, on an American passport, and was sentenced to 18 years for treason. (Another Russian, Alexander Sypachyov, was convicted of spying for the CIA in 2002 for eight years but his lawyer said he did not wish to be traded. He would be due for release soon). Sergei Skripal, a retired intelligence officer, apparently from the GRU military intelligence service, was arrested in 2004 for spying for Britain and sentenced in 2006 to 13 years in jail.

The fourth man on the list, Gennady Vasilenko, is a bit of a mystery. He appears to have been jailed in Moscow for other offences. A Reuters report suggests that he may be the same Gennady Vasilenko who was arrested in 1988 in Havana and spirited back to Moscow by the Soviet intelligence services. He was charged with espionage for the West and jailed, having allegedly been recruited during a previous stint working for the KGB in Washington, DC

What is odd is the absence of some others:

In the shadows, disgruntled muttering is audible. Did America bargain too softly? It is bad for the image of western intelligence services if their spies are left to languish behind bars. David Kramer, a former Bush administration official, thinks that America has laid too much stress on the health of its relationship with Russia, and not enough on what it actually gets out of it. He said on a BBC interview this morning (sorry, no link) that America should have gained more cooperation from Russia on issues such as non-proliferation.

It may be that other elements are also in the deal, but undisclosed. But on the face of it, this is a puzzling outcome. Russia's spycatchers like to boast that they catch dozens of western spies every year. So why were none of them available for swapping? Did America not want them? Or did they in fact never exist?

Mideast Peace Is Possible

Obama Says Mideast Peace Is Possible Before His First Term Ends

By Louis Meixler and Jonathan Ferziger

July 9 (Bloomberg) -- President Barack Obama said after talks with Israeli Prime Minister Benjamin Netanyahu at the White House that a Middle East peace agreement can be reached before the end of his first term.

Obama gave his assessment of the prospects for resolving the Arab-Israeli conflict in an interview with Israel’s Channel 2 television that was shown yesterday as Netanyahu wrapped up a three-day trip to the U.S. The Israeli leader said he would prove wrong those who are skeptical about his commitment to peace.

When asked whether a Middle East deal could be concluded during his first four years in office, Obama said: “I think so.” The president’s term ends in January 2013. Netanyahu, speaking in New York, said: “I think we should seize the moment.”

Obama met with Netanyahu at the White House on July 6 and said direct Israel-Palestinian talks may get started within less than three months. Obama has been trying to persuade Netanyahu and Palestinian Authority President Mahmoud Abbas to move beyond the indirect talks they have been conducting through U.S. Middle East envoy George Mitchell and hold face-to-face negotiations.

Netanyahu is interested “in being a statesman,” Obama said in the broadcast. “The fact that he is not perceived as a dove in some ways can be helpful.”

Abbas and Palestinian Authority Prime Minister Salam Fayyad are “willing to make the concessions and engage in negotiations that can result in peace,” Obama said. The president said there “is a constant contest between moderates and rejectionists” in the Arab world.

Seize Opportunity

“We probably won’t have a better opportunity than we have right now and that has to be seized,” Obama said.

Obama said time may be running out for Palestinian moderates who are willing to make compromises “if they aren’t able to deliver for their people.”

Netanyahu, whose Likud party supports Jewish settlement in the West Bank, said yesterday in New York that Israel is prepared to make “far-ranging concessions” to achieve a political solution.

“I intend to confound the skeptics and critics,” Netanyahu said in a lunchtime speech to the Council on Foreign Relations. “ I’m prepared to do something. I’m prepared to take risks.”

Obama, who described his two hours with Netanyahu as “excellent” and detailed, described the Israeli leader as “somebody who understands that we’ve got a fairly narrow window of opportunity.”

Direct Talks

Still, Netanyahu indicated that he doesn’t want to extend the 10-month moratorium on settlement construction in the West Bank that ends Sept. 26 in the hope that Abbas will agree to meet face-to-face.

“So far seven months have passed and they haven’t come in,” Netanyahu said. “We should not waste any more time.”

Abbas, who met with Obama at the White House on June 9, has called for a halt to settlement construction in the West Bank and said he wants to see more progress in indirect talks before moving to the negotiating table with Netanyahu.

“The Israeli people are going to have to overcome legitimate skepticism, more than legitimate fears, in order to get a change that I think will secure Israel for another 60 years,” Obama said.

Nuclear Iran

Obama and Netanyahu also conferred in Washington on what they say is the threat of a nuclear-armed Iran.

“All indicators are that they are in fact pursuing a nuclear weapon,” Obama said in yesterday’s broadcast. “I assure you I have not taken options off the table.”

Netanyahu praised sanctions that Obama signed into law last week targeting Iranian gasoline imports and banking access as measures that “bite.” The United Nations Security Council imposed on June 9 a fourth round of sanctions on Iran over its nuclear development.

Obama, when asked in the Channel Two interview about the possibility of Israel launching a unilateral attack on Iran, said he did not believe Netanyahu would surprise him. “We try to coordinate on issues of mutual concern,” he said.

Asked about why some Israelis doubt his support for the country, Obama said “some of it may just be the fact that my middle name is Hussein and that creates suspicion, some of it may have to do with the fact that I have actively reached out to the Muslim community.”

“The truth of the matter is that my outreach to the Muslim community is designed precisely to reduce the antagonism and the dangers posed by a hostile Muslim world to Israel and to the West,” he said.

Singapore May Surpass China

Singapore May Surpass China as Asia’s Fastest Growing (Update1)

By Shamim Adam

July 9 (Bloomberg) -- Singapore may overtake China as Asia’s fastest-growing economy this year, increasing the attractiveness of the city state’s stocks and putting pressure on policy makers to check inflation with a stronger currency.

Gross domestic product of the Southeast Asian island will rise 10.8 percent in 2010, according to the median of 13 estimates in a Bloomberg News survey before the July 14 second- quarter GDP report. By comparison, Goldman Sachs Group Inc., BNP Paribas and Macquarie Group Ltd. have cut estimates for China to at most 10.1 percent in recent weeks.

An acceleration in pharmaceutical output and the opening of two casino resorts boosted growth in the first half, the result of Singapore’s efforts to diversify sources of expansion beyond electronics exports. The push to bolster services may sustain the economy and support investment that spurred the island’s benchmark stock index to outperform counterparts in China, Taiwan, Japan and Australia this year.

“Singapore has unique growth characteristics of its own as a function of having some new areas of growth,” said Manraj Sekhon, the London-based head of international equities at Henderson Global Investors Ltd., whose firm oversees about $94 billion in assets, including shares in Singapore companies.

Stock Performance

Henderson has “meaningful positions” in Singapore-based companies such as Wilmar International Ltd., the world’s largest palm-oil trader, and Keppel Corp., the biggest maker of shallow- water rigs, he said. Its holdings of Singaporean stocks, also including CapitaLand Ltd. and casino operator Genting Singapore Plc, are “close to the highest positions we’ve had,” he said.

Singapore’s benchmark stock index has climbed 28 percent in the past year, more than Hong Kong’s Hang Seng and Taiwan’s Taiex, while the Shanghai benchmark has fallen 22 percent. The Straits Times Index rose 0.3 percent as of 9:45 a.m. local time.

Faster growth may prod the Monetary Authority of Singapore to do more at its next policy review in October, according to Kit Wei Zheng, an economist at Citigroup Inc. in Singapore. Wage pressures are increasing and inflation may reach 5 percent by the end of 2010, from 3.2 percent in May, he said.

“There are now higher odds for the MAS to tighten further in October via a steeper appreciation” of the Singapore dollar, he said. Citigroup, which predicts Singapore’s GDP will advance 12.5 percent this year, says there are upside risks to its forecasts and the expansion may be as much as 15 percent.

Currency Revaluation

The central bank uses the Singapore dollar instead of interest rates to manage inflation, and on April 14 allowed a revaluation and shifted to a stance of gradual appreciation. The currency rose as much as 1.2 percent on the day of the MAS announcement, before slipping the following month as Europe’s debt crisis threatened to slow the global expansion. Singapore’s $182 billion economy is about 1/24 the size of China’s.

Against the U.S. dollar, Singapore’s currency rose 0.1 percent to S$1.3787 as of 9:45 a.m., a sixth day of gains and compared with a high for the year of S$1.3649 on April 30. It may advance to S$1.36 by year-end and S$1.33 at the end of 2011, according to the median forecasts in Bloomberg News surveys.

Singapore’s ties to the global economy mean it’s unlikely to escape the impact of any renewed slowdown. Governments in Europe are embarking on austerity programs to cut budget deficits and households in some of the world’s largest economies are holding back spending, clouding the outlook for the rebound.

Cracks Showing

“Some cracks are starting to show in the global economy,” said Alvin Liew, a Singapore-based economist at Standard Chartered Plc. “Drugs and tourists likely boosted second- quarter growth above the first quarter but a Jekyll-Hyde year may see a weaker second half. Life can become very unpredictable” if you rely on pharmaceuticals and “start dabbling in casinos,” he said.

The performance of Singapore’s pharmaceutical industry is volatile as production swings by companies such as Sanofi- Aventis SA can cause industrial output to fluctuate.

Prime Minister Lee Hsien Loong’s government has raised the island’s GDP forecast twice this year as tourists arrive in record numbers, companies increase hiring and vessels leave the city’s ports carrying more cargo. The economic rebound has caused inflation to accelerate as rising demand stokes home and car prices.

Asia’s Fastest

Singapore is likely to become Asia’s fastest-growing economy this year, according to Credit Suisse Group AG and Oversea-Chinese Banking Corp. Forecasts for the island’s expansion this year range from 9.7 percent to 13 percent among the economists surveyed by Bloomberg.

Estimates by Goldman, BNP Paribas, Macquarie and China International Capital Corp. for China’s 2010 growth range from 9.5 percent to 10.1 percent. The government in Asia’s second- largest economy is scheduled to release second-quarter GDP figures on July 15.

The last time Singapore’s GDP rose more than China’s was in 2000, according to data compiled by the International Monetary Fund.

Singapore’s manufacturing increased an average 45 percent in the first five months of 2010, after declining an average 13 percent in the same period last year. Pharmaceutical output has at least doubled every month from March to May.

U.S. Crash Looms Without Roadmap Directions

U.S. Crash Looms Without Roadmap Directions: Caroline Baum

Commentary by Caroline Baum

July 8 (Bloomberg) -- The U.S. debate over more government spending versus fiscal austerity is captivating the nation’s capital, dominating the airwaves and providing the best excuse in at least a millennium to recycle St. Augustine (“Lord, make me chaste, but not yet”).

What it has failed to do, with rare exception, is produce any viable alternatives. The choices are warmed-over Keynesian pump-priming or “passively waiting for disaster,” as Harvard University historian and business school professor Niall Ferguson put it on the July 4 edition of CNN’s “Fareed Zakaria GPS.”

There’s got to be a better way. And there is. Ferguson advocates “radical fiscal reform” to address America’s entitlement problem -- Medicare and Social Security will eventually consume the entire federal budget -- and simplify the tax code by introducing a simple flat tax and a lower corporate rate.

“It’s pretty radical,” Ferguson told Zakaria. “It has almost no congressional support. But it is an option that we should be discussing much more seriously.”

At least one congressman is doing just that -- and learning how lonely it can be crusading for real change. Paul Ryan, Republican of Wisconsin and ranking member of the House Budget Committee, introduced his “Roadmap for America’s Future,” version 2.0, in January. (He proposed his first Roadmap in 2008.) President Barack Obama called it a “serious proposal” when he dropped in on the House Republican retreat.

Solid Report Card

Compared with the current fiscal crash-and-burn trajectory, the plan reduces deficits and debt, putting the federal budget on a sustainable path; results in stronger per-capita economic growth; puts Medicare and Social Security on a sound footing; and lowers health-care expenses while reducing the number of uninsured.

And that’s not Congressman Ryan talking. That’s the assessment of the non-partisan Congressional Budget Office, which gave the Roadmap a test drive and found that it performed well.

Ryan calls his Roadmap a prosperity plan, not an austerity plan that slashes benefits to the sick and needy and imposes growth-killing tax increases. Anyone 55 and older will remain in the existing Medicare and Social Security programs. For those under 55, benefits will be means-tested and health-adjusted: The poor and sick will get more than the wealthy and healthy. Even an individual’s initial Social Security benefits would be “progressive,” with more generous wage-indexing retained for low-income workers. The retirement age would increase gradually, as it should with longer life expectancy.

Empowering Individuals

What’s more, individuals would have the option of investing a portion of their payroll taxes in personal-retirement accounts that they can pass along to their heirs.

Those qualifying for Medicare would be given a voucher to purchase health insurance, letting market forces create competition and lower costs.

The same goes for Ryan’s “patient-centered health-care reform.” Increased transparency would let consumers of health care get a better sense of what things cost and what they’re getting for their money -- before they get sick. The Roadmap provides a refundable tax credit and eliminates the tax exemption for employer-based health care.

The best part of Ryan’s plan relates to taxes. Taxpayers would get to choose between filing their taxes the old-fashioned way (devoting endless hours to complying with or gaming the tax code, or paying someone else to do it for you); or they can file their return on a post-card equivalent, paying one of two flat rates with virtually no deductions or exemptions. I know which one I’d choose.

The Roadmap would eliminate the alternative minimum tax and replace the corporate tax with an 8.5 percent business consumption tax, making the U.S. more competitive globally and spurring faster growth.

Room of No-Shows

Ferguson said when he was invited to a dinner in Washington for folks committed to fiscal reform, he wondered “how big a hotel” it would take to accommodate all the interested parties. Three congressmen showed up, he told Zakaria.

“I’m depressed how few people in Washington are prepared to talk about this option,” he said. “It seems to me actually our best hope.”

It is. So why is there so little inside-the-Beltway enthusiasm outside of Ryan’s 12 co-sponsors in the House and a handful of reform-minded individuals in the Senate? Where is the courage to confront, and solve, this country’s real, intractable fiscal problems? In its latest budget outlook, the CBO warned that federal debt could reach 185 percent of gross domestic product by 2035.

Status Quo Ante

Instead of engaging in meaningful discussion of Ryan’s or alternative Roadmaps, lawmakers are teeing up the same old debate over more government spending, the effect of which is highly questionable (and that’s being generous); and draconian spending cuts and tax increases, which are never fashionable in an election year, nor a good prescription for a weakened economy. (Come to think of it, there’s never a good time for the political class to impose discipline.)

Our elected representatives continue to sidestep a real fiscal fix, hoping U.S. Treasuries will be perceived as the least-bad option by international investors for a while longer.

The other conclusion is even less palatable. Congress may prefer the status quo, using a loop-holed tax code to reward favored constituencies in exchange for campaign contributions that ensure lifetime employment.

Can there be a better argument for radical fiscal reform?

Economy May Be Undergoing a ‘Pause’

Greenspan Says Economy May Be Undergoing a ‘Pause’ (Update1)

By Vivien Lou Chen

July 8 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said the U.S. economy may be undergoing what he called a “pause,” and that he can’t rule out the possibility of a so- called double-dip recession.

“Of course, there’s a possibility,” Greenspan said in an interview on CNBC today. “The trouble is there’s always a possibility in both directions.”

Greenspan, who ran the central bank from 1987 to 2006, said “it’s more than likely” that a “pause” is occurring in the world’s largest economy. Inventory accumulation “has stopped” and production “has flattened out,” the 84-year-old former central banker said.

Companies added 83,000 workers to their payrolls in June, less than forecast by economists, the Labor Department report said last week. The report capped a month of data on housing and manufacturing that point to a slowdown in the economy.

Stocks rose today, giving the Standard & Poor’s 500 Index its first-three day rally since April, after the Labor Department reported that claims for unemployment benefits fell last week more than forecast and the International Monetary Fund raised its estimate for global growth in 2010.

“Stock market behavior over the last several days” has been “encouraging,” Greenspan said after S&P 500 index rose 0.9 percent to 1,070.25 at 4 p.m. in New York, its highest close since June 28. “Banks are scared, but, then again, so are businesses.’

He added that there are “still huge imbalances in the flow of funds,” and that China’s currency remains “undervalued.” After he spoke, the U.S. Treasury Department released a report to Congress saying the yuan “remains undervalued,” while stopping short of branding the country a currency manipulator.

Russian Spies Plead Guilty

Russian Spies Plead Guilty in Swap Echoing Cold War (Update4)

By Patricia Hurtado

July 9 (Bloomberg) -- Ten convicted members of a Russian spy ring, some of whom posed as ordinary Americans for more than a decade, were exchanged with four men jailed in Russia, bringing a rapid conclusion to a case that began 12 days ago.

The members of network, broken up June 28 with arrests in the New York area, Boston and Arlington, Virginia, pleaded guilty yesterday in Manhattan federal court to conspiring to work as unregistered foreign agents.

“The Russian Federation agrees to release four individuals who are incarcerated in Russia for alleged contact with the United States,” U.S. District Judge Kimba Wood in Manhattan said at the plea hearing, referring to the deal.

Wood sentenced them to time served and ordered the accused deported. The U.S. won’t drop money-laundering charges against eight members of the ring until “the full terms of the intergovernmental agreement” between Russia and the U.S. are met, Assistant U.S. Attorney Michael Farbiarz said in court. Justice Department spokesman Dean Boyd confirmed today that the exchange was completed in Vienna. The Associated Press reported the plane with the 10 Russian spies landed in Moscow.

One by one, each of the foreign agents admitted carrying money or coded messages, secretly communicating with Russian officials and instructing others on how to find information useful to Russia. Their objective was to infiltrate U.S. policy- making circles after constructing false American identities in suburbs and cities along the East Coast, prosecutors said.

`Sends a Message'

The case “sends a message to every other intelligence gathering agency that if you come over here to spy, you will be exposed and arrested,” said Preet Bharara, the U.S. Attorney in Manhattan. The timing of the arrests wasn’t for the purpose of obtaining a “bargaining chip” to trade for Russian prisoners, Bharara said.

President Dmitry Medvedev pardoned four people convicted of spying in Russia, spokeswoman Natalia Timakova said. She identified them as Igor Sutyagin, Sergei Skripan, Gennady Vasilenko and Alexander Zaporozhsky.

U.S. and Russian aircraft taking part in the exchange of the 14 convicted spies left Vienna International Airport after parking nose-to-tail on a remote section of runway.

The Russian Foreign Ministry and foreign intelligence service declined to comment.

The exposure of a so-called deep-cover operation --followed by a prisoner exchange -- reprises a spy drama that has played out repeatedly since the 1940s.

Soviet Networks

The agents who pleaded guilty yesterday follow a line of networks the former Soviet Union planted to better understand American society as well as obtain military and policy secrets, intelligence experts said.

“This is exactly the same illegals program that has been in existence since the beginning of the Cold War,” Vincent Cannistraro, a former counter-terrorism chief with the Central Intelligence Agency, said in an interview. “The assumed names, their methodology is the same. It worked very well in the 1960s, but the world has changed. I think you have an old-fashioned mentality in Russia running things.”

The U.S. has conducted other spy swaps under similar circumstances.

In 1957, the U.S. charged Rudolf Ivanovich Abel with espionage, saying the artist known to his neighbors in Brooklyn, New York, as Emil Goldfus was really a colonel in the Soviet Union’s intelligence service, or KGB. Abel was tried and convicted of espionage and sentenced to 30 years in prison.

U-2 Pilot

Abel was exchanged in 1962 for downed U-2 spy-plane pilot Francis Gary Powers at Glienicke Bridge, the famed “Bridge of Spies” that linked Berlin to Potsdam in the former East Germany. Abel had been exposed by another “illegal” living in a small house in Peekskill, New York, as Eugene Maki, a name stolen from an American whose family had moved to Estonia. Maki defected to the U.S.

In August 1986, Gennadiy Zakharov, a scientist with the United Nations, was arrested on a Queens, New York, subway platform by agents with the Federal Bureau of Investigation, after paying $1,000 for secret documents about the design of jet engines. Zakharov was indicted on espionage charges by federal prosecutors in Brooklyn. A week later, the Soviet Union arrested American journalist Nicholas Daniloff and accused him of espionage.

After negotiations with the U.S. State Department, Daniloff was allowed to leave the Soviet Union without standing trial. The next day, Zakharov pleaded “no contest” to a count of conspiring to commit espionage and attempting to transmit national defense information to the Soviet Union.

Basement Garage

He was sentenced to time-served by U.S. District Judge Joseph McLaughlin and released immediately to the Soviet government in the courthouse basement’s garage.

Andrew J. Maloney, the Brooklyn U.S. attorney at the time, said Zakharov’s arrest on the eve of a summit meeting between former President Ronald Reagan and Russia’s then-President Mikhail Gorbachev in Iceland drew criticism.

“I remember a Washington D.C. columnist saying, ‘Who’s that madman in Brooklyn arresting this guy on the eve of the Icelandic meeting?” Maloney said in an interview.

He said the U.S. didn’t view the exchange as a “quid pro quo,” because as part of the agreement other Soviet dissidents were released later.

‘Very Hot’

“If you think back to the Cold War, even when things were very hot, what we’d do in the U.S. was catch these spies and they’d end up in an exchange situation,” he said.

Maloney, now in private practice, said the current ring nestled in affluent towns such as Montclair, New Jersey and Cambridge, Massachusetts, shouldn’t be dismissed as trivial.

“Who knows what they’re really doing?” he said. “It’s a very serious threat. In the future, if we have a problem with a new regime in Russia, these people could be called upon to do sabotage or harm the country,” he said. “I don’t dismiss this case at all.”

The case is U.S. v. Metsos, 10-cr-00598, U.S. District Court for the Southern District of New York (Manhattan).

For Related News and Information: To see the complaints: NXTW NSN L4S3NL0YHQ0Z and NXTW NSN L4S3KA0YHQ0X . Top stories: TOP Top legal stories: TLAW Bloomberg legal resources: BLAW

Higher Market Rates Won’t Hurt Economy

ECB Board Members Say Higher Market Rates Won’t Hurt Economy

By Gabi Thesing and Simone Meier

July 9 (Bloomberg) -- Two European Central Bank Executive Board members downplayed concerns about the recent increase in market interest rates, saying it won’t hurt the economy.

The gain in the overnight Eonia rate is “very small” and “we shouldn’t exaggerate this development,” Juergen Stark told reporters in Frankfurt today. His colleague Lorenzo Bini Smaghi told Bloomberg Television that “it’s not going to affect ultimately the interest rates banks charge customers.”

Market borrowing costs are rising after banks tapped the ECB for less funds than expected before paying back a record 442 billion-euro ($559 billion) ECB loan on July 1, reducing excess liquidity in the system. Some economists and investors are concerned that higher market rates may hurt Europe’s recovery amid the sovereign debt crisis and uncertainty about the health of the region’s banks.

The rate that banks charge each other to borrow for three months has increased to 0.82 percent, the highest in almost 11 months, from 0.63 percent at the end of March. The European Overnight Index Average rate, or Eonia, rose to 0.542 percent on June 30 from as low as 0.295 percent on June 3. It was fixed at 0.398 percent yesterday.

“We have seen only a slight increase in Eonia rates,” Stark said. “That’s an important signal for confidence that is given to the euro area and within the banking system.”

Bond Purchases

Stark also said that if bond markets continue to improve, the ECB should end its purchase program.

“We’ve always said that this is a temporary measure like other non-standard measures,” he said. “We monitor the situation and if the situation improves further, there’s no reason anymore to continue with this program.”

The International Monetary Fund this week said the ECB may have to step up its bond purchases to convince investors it won’t allow market tensions to escalate. It also cut its forecast for euro-region growth next year to 1.3 percent from 1.5 percent. The 16-nation economy will expand 1 percent this year, it said.

“The IMF is underestimating the strength of the recovery in Europe,” Stark said.

Bini Smaghi said he expects a “strong” second quarter and then more “moderate” economic growth. “One has to be reasonably optimistic,” he said, adding that “lending from banks is picking up.”

U.S. Says China Should Let ‘Undervalued’ Yuan Rise

U.S. Says China Should Let ‘Undervalued’ Yuan Rise (Update1)

By Rebecca Christie and Ian Katz

July 9 (Bloomberg) -- The U.S. pledged to monitor China’s “undervalued” yuan in the next three months for signs that Asia’s fastest-growing market is living up to its commitments to help rebalance the global economy.

China took a “significant step” last month when it ended its peg to the dollar and allowed markets to drive the currency higher, the Treasury Department said yesterday. The report, initially due April 15, concluded that no major U.S. trading partner manipulated its currency and said it’s not yet clear whether China’s policy shift will correct the yuan’s undervaluation. The Treasury promised another review in October.

“What matters is how far and how fast the renminbi appreciates,” Treasury Secretary Timothy F. Geithner said, using another name for China’s currency. “We will closely and regularly monitor the appreciation of the renminbi and will continue to work towards expanded U.S. export opportunities in China that support employment in the United States, in close consultation with Congress.”

The report reflected Geithner’s effort to avoid a confrontation with China over currency issues. The Treasury chief has repeated that it will be “China’s choice” when to let the yuan rise, deflecting pressure from lawmakers including Senator Charles Schumer who call for more appreciation and threaten to legislate trade sanctions.

Bought Time

“China has bought themselves some time by allowing the yuan to become unstuck a few weeks ago,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “Despite its critics, China will be careful with its exchange-rate policy because the stakes are simply too great if they get it wrong, both for China itself and increasingly it could be a disaster for the world economy as well.”

The yuan traded at 6.7737 per dollar at 4:52 p.m. in Shanghai. It has gained 0.8 percent since Chinese policy makers’ announcement June 19 that they would allow greater fluctuation.

U.S. lawmakers weren’t convinced that Geithner made the right call. Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said he planned to hold a hearing on the report, and Schumer said the Treasury missed its opportunity to hold China accountable.

“This report is as disappointing as it is unsurprising,” said Schumer, a New York Democrat. “It’s clear it will take an act of Congress to do the obvious and call China out for its currency manipulation.”

Lawmakers’ Calls

Other lawmakers reiterated calls for the Obama administration to bring the currency issue to the World Trade Organization. House Ways and Means Committee Chairman Sander Levin and Senator Charles Grassley, the Senate Finance Committee’s top Republican, both called for the U.S. to file a trade complaint.

China’s currency has “appreciated only modestly” since last month’s policy shift, he said. “There is no real question that China’s exchange-rate policy is unfair, contributes to global trade imbalances, and costs the United States jobs and economic growth, particularly in the manufacturing sector.”

The report increases the chances of an October showdown, while also pushing off calls for action until January, when a new Congress may be less likely to press the issue, said Derek Scissors, a research fellow at the Heritage Foundation in Washington.

“The administration can more easily opt to call manipulation in October, saying they gave Beijing every chance to implement real policy change,” Scissors said. “But the manipulator tag itself does nothing but trigger talks.”

Full Document

The Treasury said the report covers the second half of 2009 and includes some information from the first half of 2010. The department said a full document on the first half of 2010 will be included in the Treasury’s next report to Congress, which is due in October.

Until last month’s shift, China had been holding its currency at about 6.83 to the dollar since July 2008 to help exporters. Authorities had allowed the yuan to rise 21 percent in the three prior years.

“China’s exchange-rate reform must be reinforced by macroeconomic policies that support domestic demand and other structural reforms to create a strong foundation for consumption-led growth,” the Treasury said. “Exchange-rate appreciation should play an important role in rebalancing China’s economy.”

U.S. Criticism

Companies in Asia and in the U.S. have called on China this year to let the yuan rise. Chinese executives including Yang Yuanqing, chief executive officer of Beijing-based computer maker Lenovo Group Ltd., and Qin Xiao, chairman of China Merchants Bank Co., said in March that China could benefit from an appreciation of the currency.

U.S. companies have criticized what they view as favoritism of Chinese firms over foreign competitors.

A January letter to the White House from the U.S. Chamber of Commerce, the Business Software Alliance, and more than a dozen other groups representing companies such as Microsoft Corp., Boeing Co., Motorola Inc., Caterpillar Inc., and United Technologies Corp. warned of “systematic efforts by China to develop policies that build their domestic enterprises at the expense of U.S. firms.”

Geithner opted to delay the report until after a series of meetings between U.S. and Chinese officials in Beijing and as part of Group of 20 policy discussions. After last month’s G-20 summit in Toronto, President Barack Obama said the U.S. will be monitoring markets to make sure that China follows through.

Market Forces

“We do expect that as more and more market forces come to bear, that given the enormous surpluses that China has accumulated, that the renminbi is going to go up and it’s going to go up significantly,” Obama said.

In its previous report in October, the Treasury criticized China for the “lack of flexibility” of the yuan and a buildup of foreign-exchange reserves while declining to call the nation a manipulator of its currency. It said China’s yuan policies were a “serious concern” and pledged to negotiate with China at the G-20 and the bilateral meetings.

China’s reserves rose to a record $2.447 trillion in the first quarter of 2010, according to the People’s Bank of China. Holdings jumped $22.5 billion in March, after gaining $9.4 billion in February and $16 billion in January, data posted on the central bank’s website in April showed.

Under a 1988 law, the Treasury is required to report to Congress twice a year on international economic conditions and exchange-rate policies. The Treasury is required to enter direct talks with a country deemed to be manipulating its currency, and also seek redress through the International Monetary Fund. The last country labeled a manipulator was China, in 1994.

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