Market Advisory Features

World Stockmarkets : Inflection point?
Global Crash Fears as German Bank Sinks
Investment Banks : In the Firing Line

Japan's Bank's : Biting the Bullet
Irrational Gloom?
US Plans Military Rule and Occupation of Iraq
Scramble for Iraqi Oil
Iraq and the (United) Divided Nations


World stockmarkets

Inflection point?

Oct 17th 2002
From The Economist print edition

After two-and-a-half years of falling share prices, markets appear to turn

OCTOBER is traditionally a bad time for stockmarkets: the crashes of 1929 and 1987 both happened in that month. This year could be different. In the four days to October 15th, many of the world's main stockmarkets saw their biggest four-day gains, in percentage terms, in over a decade. America's Dow Jones Industrial Average rose by 13%, Germany's DAX by 17%.

Worries about profits had helped to drive shares to their recent lows. So desperate have investors been for good news that sentiment seems to have been helped by better-than-expected results in the third quarter from Yahoo!, hardly the workhorse of the American economy, and Citigroup, even though tussles with regulators mean an uncertain future for the bank. Those results may have helped the Dow up by 5% on October 15th alone. Then dismaying profit figures from Motorola, Intel and J.P. Morgan Chase dampened spirits once again. Not, however, before investors had begun to wonder if the long bear market might at last be over.

A crucial question, for it is often in the first few months after a bear market ends that the most money is made. America's S&P 500 index took only six months to rise by 40% from its low in late 1974, and three months from its trough in early 1982. London share prices doubled in only two months after the bear market ended in early 1975. Some investors fancy themselves to be on the cusp of similar gains. Abby Joseph Cohen, Goldman Sachs's chief equity strategist, predicts that the S&P 500 will rise, over the next year, by almost 50% from its low.

One popular argument for why the bear market may be over is that, by last week, the S&P 500 had fallen by almost 50% from its peak, a slightly bigger decline than during the bear market of 1973-74—indeed, the biggest since the Depression of the 1930s. The end of 1974 turned out to be an excellent time to buy shares (see chart). Moreover, the argument goes, global economic conditions are now healthier than in the 1970s, when economies were in the grip of stagflation. If share prices recovered strongly then, they can surely do so again now.

Remember, however, that the 1970s saw double-digit inflation. Measured in real terms, share prices have fallen by less from their peak this time. Low inflation implies that prices may have to fall by more in absolute terms to return to fair value. Adjusted for the rise in consumer prices, the rebound in share prices in the 1970s was also a lot less impressive. After an initial bounce in 1975, share prices stagnated. In real terms, the S&P 500 did not regain its level of January 1973 until as late as 1987.

A second argument to support a recovery in share prices is that they are now close to fair value. As always, it depends which measure you pick. The S&P 500 stands at just under 30 times historical reported profits. This is down from over 40 at the peak, but well above the 50-year average of 15. Still, this exaggerates the overvaluation, since profits will presumably recover from today's depressed levels.

To correct for this distortion, Eric Lonergan at Cazenove calculates a cyclically adjusted price/earnings (p/e) ratio, using an estimate of trend profits. At its low point last week, this p/e ratio had fallen to 17, the average during the pre-bubble years of 1990-95. Yet in previous bear markets prices have undershot: in both 1974 and 1982 the p/e ratio dipped below 8. So American shares may yet have further to fall. Using the same measure, Mr Lonergan finds that British shares are cheap, with a p/e of 12; the rest of Europe has a ratio of 14.

Relative to bonds, on the other hand, American shares now look cheap. The dividend yield from shares is historically high, compared with government-bond yields. Yet this is partly because bond yields have tumbled on fears of sluggish growth and deflation. If these fears prove right, future profits will be severely dented. Even without deflation, analysts' average forecast of 18% growth in American corporate profits over the next year seems unrealistic, given that the growth in nominal GDP is unlikely to be more than 4-5%.

What is more, although most economists expect America's recovery to continue, the risk of a double-dip recession certainly cannot be ruled out. Business investment has fallen now for seven quarters in a row, but American consumers continue to spend. For how long? Consumer confidence, as tracked by the University of Michigan, fell sharply in early October, reaching its lowest level in nearly a decade. This partly reflects the plunge in share prices, however; if the stockmarket continues to rally, consumer confidence may return. On the other hand, if consumers cut their spending and the recovery stalls, share prices could easily drop a lot further.

Some investors would like to think that recent volatility is another sign of the end of the bear market. The S&P 500 rose or fell by at least 1% on 15 successive days up to October 11th, the longest such run in more than 60 years. Similar increases in volatility since the second world war, in 1950, 1974 and 1987, were followed by share-price gains of around 20% over the next six months. The snag is that in the 1930s such volatility was more common, and it was always followed by a further slide in share prices.

There is a clear risk that the market still has new lows to test. And even if one believes that share prices are no longer overvalued, the long-run prospects for equities are not dazzling. Over the long haul, share prices depend on profits, which cannot forever grow faster than nominal GDP—as they did through the 1990s. Real equity returns might average only 5% a year over the next decade, compared with annual returns of 25% over the four years to 1996.

Wild parties tend to lead to long hangovers. The 1990s witnessed the biggest bull market of all time, with share prices becoming more overvalued, by many measures, than ever before. By some measures, this is now the most severe bear market. Although share prices have fallen by less than in 1929-32, the total loss of global equity wealth as a percentage of GDP has already been more than it was during the Great Depression—and there may be further losses ahead.



US plans military rule and occupation of Iraq

Saddam would be replaced by General Tommy Franks

Julian Borger in Washington
Saturday October 12, 2002
The Guardian

The US has plans to establish an American-led military administration in Iraq, similar to the postwar occupation of Germany and Japan, which could last for several years after the fall of Saddam Hussein, it emerged yesterday.

The plans, which surfaced after President George Bush won a resounding congressional mandate to use force in Iraq, envisage the biggest "nation-building" effort the US has undertaken since the end of the second world war.

The occupation of the country would need an estimated 75,000 troops, at an annual cost of up to $16bn (£10bn), and would almost certainly include British and other allied soldiers. It would be run by a senior American officer, perhaps General Tommy Franks, who would lead the assault on Iraq, and whose role would be modelled on that of General Douglas MacArthur in postwar Japan.

The occupation regime would track down war criminals and remove members of President Saddam's Ba'ath party from power, comb the country for any hidden biological and chemical weapons, and guarantee Iraq's territorial integrity. It would also administer the country's huge oil deposits.

Ahmad Chalabi, leader of the opposition Iraqi National Congress who is visiting Washington this week, gave the plan a qualified welcome yesterday. He said he would prefer an interim Iraqi government to be established in the immediate aftermath of President Saddam's fall, but would accept a foreign administration as a temporary precursor to a true democracy.

"We are concerned first with the liberation of Iraq," he told the Guardian, adding that he had "no idea" how long such a transitional period would last. He said it was "very, very clear it is going to be a huge development in the Arab world".

Mr Chalabi denied that such a large-scale prolonged US military presence would destabilise the region, but an Arab diplomat in Washington said it could have an "explosive" impact in the Middle East, where the US military presence has already proven a rallying cry for militants including Osama bin Laden.

"Every day in Iraq would raise the cost," the diplomat warned.

The Iraqi project, outlined by Mr Bush's senior adviser on the Middle East, Zalmay Khalilzad, would involve running the entire country until a democratic Iraqi government was deemed ready.

A British official stressed yesterday that although contingency plans were undoubtedly being drawn up, London had not agreed to such a strategy. "It seems this is coming from the right end of the [political] spectrum. I don't know if this is mainstream thinking in the administration," the official said.

US officials said no final decision had been taken on the plan, but indicated that some form of direct American military rule was almost inevitable.

"The purpose of the military has not changed: to fight and win wars," Ari Fleischer, the White House spokesman said. "But at the end of the day, when the military conflict has come to an end, the question then becomes - in the post-Saddam era - how to make certain the country remains unified, is stabilised, the region has stability. The United States will not cut and run from that mission."

Mr Khalilzad provided a sketch of the plan at a meeting of diplomats and Middle East experts at the weekend. "We will not enter Iraq as conquerors. We will not treat the Iraqi people as a defeated nation," he insisted. He said the long-term US aim was to establish a "representative and democratic" government.

"In the short term, however, we will reunify Iraq, because at present Iraq is not united, and maintain its territorial integrity," he said.

"First, there will be the political reconstruction. This will involve thorough reform of the government, de-Ba'athising Iraq, removing elements used by Saddam to enforce his tyranny. Officials guilty of crimes against humanity will be prosecuted."

He conceded that "the costs will be significant", but added: "We would have the commitment of resources necessary, and we would have the will to stay for as long as necessary to do the job."

A military thinktank called the Role of American Military Power, has estimated that 75,000 troops would be neces sary to stabilise Iraq after any war. It is possible that funds would be stripped from US contributions to international efforts to stabilise other regions such as the Balkans, to help meet the costs.


Irrational gloom?

Oct 11th 2002
From The Economist Global Agenda

Pessimism in international credit markets is unsettling equity investors, and vice versa. Neither market has any ready answers or yet knows which way to turn

SOME six years ago, Alan Greenspan, the chairman of America’s Federal Reserve, accused investors of “irrational exuberance” in propelling the stockmarket to unjustified heights. Now the same investors are asking whether the same markets are suffering from irrational gloom. While investors have plenty to be glum about—insipid company profits, slowing economic growth, a rising risk of defaults among bonds and loans, and even the prospect of war—it has been tempting of late to conclude that the markets have lost their sense of proportion.

How else to explain the gyrations in the prices of shares and bonds issued by Ford Motor Company? Not only were its five-year bonds quoted this week at 89% of their face value but traders marked them down to the point where they were quoted as “junk”—ie, non-investment grade. This was despite reassurances from Moody’s and Standard & Poor’s, two rating agencies, that they had no plans to downgrade the company’s debt to below investment grade. True, Ford has suffered—as have its rivals, General Motors and DaimlerChrysler—from the price war that has dominated the lives of American car makers in recent months. True, too, Ford has $22 billion of outstanding secured debt that it will need to roll over during the next year—a mouthful even for America’s deep debt markets, especially in their current state. Yet neither problem on the face of it justifies the hammering that Ford’s shares and bonds have recently received.

Behind the treatment meted out to Ford, and to other companies in a similar plight, is the pessimism in the credit markets. The average junk bond is now trading at about a thousand basis points (hundredths of a percentage point) above the US Treasury bond of a similar maturity, says Bear Stearns, an investment bank. While $43 billion-worth of new bonds of speculative grade have been issued so far this year, more than twice that amount has been downgraded from investment grade to junk because of worries over the issuers’ ability to pay their way. This is unsettling investors.

So far this year, there have been 50 so-called fallen angels—companies with investment-grade bonds that have been downgraded to junk—only seven short of last year’s total. Indeed, the total number of defaults in the corporate bond market as a whole, investment grade as well as junk, has reached a record of $140 billion; that is already more than the total amount for the whole of 2001.

While the rate of default, at nearly 9% of corporate bonds outstanding, is still below the peak of 12% seen during the recession of 1990-91 (and, thankfully, a long way below that of the 1930s), it has nonetheless added to the sense of gloom. Making matters worse is the fact that it is not just companies with junk bonds (ie, those most at risk) that have been defaulting. Worryingly, a growing number of companies with investment-grade bonds—among them Enron, WorldCom, Swissair and Marconi—have also thrown in the towel. And things may get worse before they improve. According to Moody’s, the creditworthiness of American companies has now deteriorated for 18 consecutive quarters, one short of a record.

The equity markets are feeding on this apprehension, and vice versa. Understandably, the world’s largest companies have been most in the firing line: they have the biggest debts and are most affected by the worsening conditions in the credit markets. Not surprisingly, their shares have taken a beating. Indeed, investors who ditched the shares of global titans at the beginning of 2001 in favour of those of smaller fry have generally done better, although both have lost value during the period. Despite choppy markets, as the chart shows, smaller companies in general have outperformed the biggest ones by some 24%.

Nothing is certain in these markets. Who would have imagined even six months ago that, during September, the German stockmarket would have fallen by the most in local currency terms of any market anywhere in the world (with a drop of more than 25%)? Or that, according to the FTSE All-World stockmarket index, during the same month the best-performing sector—personal care and household products, usually a defensive industry when the economy sours—would actually fall in value by 1.8%? The worst-performing sector—information technology hardware—was down by ten times that amount.

It is perhaps not surprising that investors are confused or that sentiment is low. Markets have been so volatile of late that it has been hard to tell which way they would lurch next. The VIX index of volatility (produced by the Chicago Board Options Exchange) has jumped around like a yo-yo since the summer. In other words, even volatility has become more volatile. With the prospect of war in the Middle East and America’s economy seeming to stutter, the one certainty is that investors will be kept guessing for some time to come.



Global crash fears as German bank sinks

Faisal Islam, economics correspondent and Will Hutton
Sunday October 6, 2002
The Observer

Stockbrokers around the world are braced for a potentially calamitous week as alarm mounts over a looming, Thirties-style global financial crisis. A leaked email about the credit-worthiness of Commerzbank, Germany's third largest bank, yesterday increased fears of the international stock market malaise exploding into a fully-fledged banking crisis.

Commerzbank lost a quarter of its value last week, raising the spectre of Credit-anstalt, the Austrian bank that collapsed in 1931, sparking global depression.

US stock markets have fallen for six consecutive weeks, to their lowest levels in five years. European markets have collapsed even further, wiping out nearly half of the value of European corpora tions in this year alone. Japan is struggling to put together a plan to save its banking system, riddled with bad debt after a decade of recession and falling prices. Now the German economy threatens to follow.

'There are strong parallels to the Thirties after an unsustainable "new era" boom,' says Avinash Persaud managing director for economics and research at State Street Bank. 'Then, the stock market decline was not just steep, it was long, taking three years to reach the bottom.'

'Commerzbank being affected is a sign of the severity. But in today's crisis risks have been offloaded from the banks to the markets and ultimately our pensioners, which makes the problem more difficult to deal with,' he says. The leaked email about Commerzbank was in response to an inquiry from a US investment bank about rumours of huge losses on credit derivatives, which aim to spread risk.

Figures due to be published on Friday will show that a toll of stock market falls, rising joblessness and war fears is finally denting the spending habits of Americans. Economists fear that the result may be a 'double-dip' US recession, taking much of the world with it.

Europe's finance Ministers, including Chancellor Gordon Brown, will meet in Luxembourg on Tuesday amid deepening concern about the stability of the financial system. Tomorrow evening, the Eurogroup of finance ministers, excluding Brown, will discuss reforming Europe-wide tax and spending rules along the lines of the British system, taking stronger account of economic difficulties.

In the US, the concern is that Alan Greenspan, chairman of the US Federal Reserve, has insufficient room to cut interest rates if the economy falls into recession. 'The [Bush] Administration has two lines of action: tax relief for the rich [and] reliance on the Federal Reserve. Both are without effect,' says US economist JK Galbraith in an interview with The Observer.


Scramble to carve up Iraqi oil reserves lies behind US diplomacy

Manoeuvres shaped by horsetrading between America, Russia and France over control of untapped oilfields

Ed Vulliamy in New York, Paul Webster in Paris, and Nick Paton Walsh in Moscow
Sunday October 6, 2002
The Observer

Oil is emerging as the key factor in US attempts to secure the support of Russia and France for military action against Iraq, according to an Observer investigation.

The Bush administration, intimately entwined with the global oil industry, is keen to pounce on Iraq's massive untapped reserves, the second biggest in the world after Saudi Arabia's. But France and Russia, who hold a power of veto on the UN Security Council, have billion-dollar contracts with Baghdad, which they fear will disappear in 'an oil grab by Washington', if America installs a successor to Saddam.

A Russian official at the United Nations in New York told the Observer last week that the $7 billion in Soviet-era debt was not the main 'economic interest' in Iraq about which the Kremlin is voicing its concerns. The main fear was a post-Saddam government would not honour extraction contracts Moscow has signed with Iraq.

Russian business has long-standing interests in Iraq. Lukoil, the biggest oil company in Russia, signed a $20bn contract in 1997 to drill the West Qurna oilfield. Such a deal could evaporate along with the Saddam regime, together with a more recent contract with Russian giant Zarubezhneft, which was granted a potential $90bn concession to develop the bin Umar oilfield. The total value of Saddam's foreign contract awards could reach $1.1 trillion, according to the International Energy Agency's World Energy Outlook 2001.

The Russian official said his government believed the US had brokered a deal with the coalition of Iraqi opposition forces it backs whereby support against Saddam is conditional on their declaring - on taking power - all oil contracts conceded under his rule to be null and void.

'The concern of my government,' said the official, 'is that the concessions agreed between Baghdad and numerous enterprises will be reneged upon, and that US companies will enter to take the greatest share of those existing contracts... Yes, if you could say it that way - an oil grab by Washington'.

A government insider in Paris told The Observer that France also feared suffering economically from US oil ambitions at the end of a war. But the dilemma for Paris is more complex. Despite President Jacques Chirac and Chancellor Gerhard Schröder of Germany agreeing last week to oppose changing the rules governing weapons inspectors, France may back military action.

Government sources say they fear - existing concessions aside - France could be cut out of the spoils if it did not support the war and show a significant military presence. If it comes to war, France is determined to be allotted a more prestigious role in the fighting than in the 1991 Gulf war, when its main role was to occupy lightly defended ground. Negotiations have been going on between the state-owned TotalFinaElf company and the US about redistribution of oil regions between the world's major companies.

Washington's predatory interest in Iraqi oil is clear, whatever its political protestations about its motives for war. The US National Energy Policy Report of 2001 - known as the 'Cheney Report' after its author Vice President Dick Cheney, formerly one of America's richest and most powerful oil industry magnates - demanded a priority on easing US access to Persian Gulf supplies.

Doubts about Saudi Arabia - even before 11 September, and even more so in its wake - led US strategists to seek a backup supply in the region. America needs 20 million barrels of crude a day, and analysts have singled out the country that could meet up to half that requirement: Iraq.

The current high price of oil is dragging the US economy further into recession. US control of the Iraqi reserves, perhaps the biggest unmapped reservoir in the world, would break Saudi Arabia's hold on the oil-pricing cartel Opec, and dictate prices for the next century.

This could spell disaster for Russian oil giants, keen to expand their sales to the West. Russia has sought to prolong negotiations, official statements going between opposition to any new UN resolution and possible support for military action against an Iraqi regime proven to be developing weapons of mass destruction.

While France is thought likely to support US military action, and China will probably fall in line because of its admission to the World Trade Organisation, Putin is left holding the wild cards.

Russia recognises potential benefits of reaching a deal with the US: Saddam's regime is difficult to work with. Lukoil's billion-dollar concessions are frozen and profitless to Moscow and Baghdad under UN sanctions, leading to fears that Saddam might have declared the agreement null and void out of spite. Iraqi diplomats say Zarubezhneft won its $90bn contract only after Baghdad took it away from TotalFinaElf because of French support for sanctions.

Russia stands to profit if intervention in the Gulf triggers a hike in Middle East oil prices, as its firms are lobbying to sell millions of barrels a day to the US, at two-thirds of the current market price.

Moscow's trust of Washington may be slipping after what a Russian UN official calls 'broken promises' that followed negotiations over Moscow's support for the Afghan campaign.

Russia turned a blind eye to US troops in central Asia, on the tacit condition that US-Russian trade restrictions would be lifted. But they are still there, and other benefits expected after 11 September have also not materialised.

'They've been making this point very strongly,' a senior Bush administration official conceded to the Washington Post , 'that this can't be an all-give-and-no-get relationship... They do have a point that the growing relationship has got to be reciprocal.'


In the firing line
Oct 4th 2002
From The Economist Global Agenda

In a week when prosecutors have finally charged the former chief financial officer of Enron, New York’s feisty attorney-general, Eliot Spitzer, is joining forces with the Securities and Exchange Commission to root out corporate wrongdoing in America. Investment banks beware

THE might of Wall Street is under attack from all sides. In filing charges alleging fraud, money laundering and conspiracy against Andrew Fastow, the former chief financial officer of Enron and the first of the company’s “inner circle” of senior executives to be indicted, federal prosecutors have also pointed the finger at Merrill Lynch. A criminal complaint, filed in a Houston court on October 2nd, alleges that the investment bank helped Enron to conceal debt and hide its true financial position. One of the charges against Mr Fastow, who was given bail of $5m, involves a Nigerian company which Enron is said to have sold to Merrill and then repurchased in order, it is claimed, to inflate Enron’s earnings. The transaction was a “sham”, say prosecutors, in which Merrill assumed no risk.

Such allegations, which have been vehemently denied by Merrill, are an example of the whirlwind of claim and counterclaim that is engulfing Wall Street’s finest and many of its former clients. On the day that Mr Fastow gave himself up to FBI agents, a Congessional committee was chipping away at the reputations of Goldman Sachs and two other investment banks. The House Financial Services Committee accused Goldman, Credit Suisse First Boston and Salomon Smith Barney, part of Citigroup, of making preferential allocations of shares in sought-after initial public offerings (IPOs) to their favoured clients, so that the latter could make a quick profit by selling the shares on. In return, the banks are said to have received lucrative banking mandates. Among the executives named was Kenneth Lay, the former chief executive of Enron. The committee concluded that the practice, known as “spinning”, had not only led to the false pricing of IPOs but had harmed ordinary investors. “There is no equity in the equities market,” lamented the committee’s chairman, Michael Oxley, the Republican member for Ohio.

Congress is not the only body making accusations about the cosy relationship between investment banks and their clients. On September 30th, Eliot Spitzer, New York's attorney-general, filed a lawsuit seeking that once high-flying telecoms executives return over $1.5 billion in profits allegedly obtained illegally thanks to their links with bankers at Salomon Smith Barney. Most of the money was made when the executives sold stock in their own companies that was inflated by overly optimistic reports from Salomon’s recently departed star analyst, Jack Grubman. The executives also pocketed some $28m when they sold shares they were allocated in IPOs of “hot” technology clients of Salomon's, allegedly as a payback for giving investment-banking business to Salomon.

The executives involved include Bernie Ebbers, the disgraced former boss of WorldCom, which filed for bankruptcy in July and which has admitted overstating profits by $4 billion; Philip Anschutz, former chairman and founder of Qwest Communications; and Joseph Nacchio, Qwest’s former chief executive. Neither Salomon nor Mr Grubman were named, but correspondence that embarrasses them has been included in the evidence. In one e-mail, Mr Grubman wrote to the head of research, explaining why certain stocks had not been downgraded: “Most of our [investment] banking clients are going to zero and you know I wanted to downgrade them months ago but got huge pushback from banking."

Mr Spitzer is already investigating Citigroup's chief executive, Sandy Weill, to see if he pressurised Mr Grubman to up his stance on AT&T, a telecoms company on whose board Mr Weill sits, in order to win Salomon a role in the spin-off of AT&T Broadband. Citigroup is quickly making concessions in order to avoid further scrutiny. On October 1st, Mr Weill said that he would step down from the boards of both AT&T and United Technologies, “as part of our continuing effort to assure that our corporate governance reflects best practices.” On the same day, Citigroup announced that Michael Masin, currently vice-chairman of Verizon, a regional telecoms firm in the north-eastern United States and a Citigroup director, would become chief operating officer. Mr Masin is to chair a committee reviewing Citigroup's business practices.

Citigroup is also in negotiation with both Mr Spitzer and the Securities and Exchange Commission (SEC) over new arrangements that would remove conflicts of interest inherent in having analysts and investment bankers under the same roof. The SEC worries in particular that analysts are being rewarded on the basis of investment-banking mandates they help their bank to win rather than the quality of their research.

Citigroup is reported to have already offered to create a separate company to house its investment-banking research, though this would still be within the Citigroup empire. The spin-off would serve mainly institutional investors as well as the small number of retail investors who trade through Salomon. Its analysts would no longer be allowed to attend “pitch” meetings with investment bankers. Citigroup has resisted making any changes unless and until they can be imposed on other Wall Street firms as well. CSFB, which is under scrutiny itself over the alleged allocation of shares to “friends of Frank”—Frank Quattrone, its star technology banker—is known to be willing to go along with such changes. Merrill Lynch, which has already made some changes to the way its analysts are organised and paid, and which has paid a $100m fine following an earlier investigation by Mr Spitzer, is opposed to further reform.

In bringing his latest charges, Mr Spitzer has not only upset Wall Street’s big banks. He has also upstaged the SEC and its chairman, Harvey Pitt, a former securities lawyer who stands accused of being too soft on the big firms that used to count among his clients. The SEC, along with the New York Stock Exchange and the National Association of Securities Dealers, Wall Street’s self-regulatory organisation, have been looking into IPO spinning for years, but have yet to bring any actions. This may now change. Messrs Pitt and Spitzer have patched up their differences and are joining forces to press for changes in the way investment banks go about their business. Egged on by Mr Spitzer, his opposite numbers in other states have also divided up their investigations into the big investment banks: Utah is looking into Goldman Sachs, Texas J. P. Morgan Chase, and Alabama Lehman Brothers, for instance. This will not please those who believe that the zest for re-regulation is getting out of hand. Siren voices including that of Bill Harrison, chief executive of J. P. Morgan Chase, are beginning to warn that a raft of new regulations and moves to break up the industry could shackle investment banks at a time when their profits are already under strain.

Nevertheless, reform of how research is conducted by investment banks now seems inevitable. There are few examples on Wall Street—Sanford Bernstein is one—of truly independent research houses. It is notoriously difficult to get investors to pay for research, especially since academic studies suggest that it is extremely difficult to beat the market consistently. Still, observers increasingly believe that the collapse of the bull market will lead to the break-up of financial “one-stop-shops” such as Citigroup, because no firm will want to risk the sort of conflict-of-interest lawsuits to which it is now being subjected.

Quite apart from any fine, Citigroup’s share price has fallen by nearly 40% this year, despite healthy operating profits. Even if it does not come to break-ups, it is hard to see analysts retaining the status they enjoyed in the late 1990s. Briefly masters of the universe, they will return to being the backroom geeks they once were.



Divided Nations
Oct 4th 2002
From The Economist Global Agenda

America and Britain are still struggling to secure agreement from other members of the United Nations Security Council to a tough new resolution calling on Iraq to disarm. President George Bush has made it clear that if the UN will not do the job, then America and its friends will

MORE than 11 years after the end of the Gulf war, when the United Nations gave Iraq 15 days to declare all its illicit weaponry and destroy it under UN supervision, the world still cannot agree on how to complete the task. But there is a mounting expectation that Iraq’s disarmament will be accomplished through an American-led war, either with UN backing or with the UN condemned, in President George Bush’s repeated word of warning, to “irrelevance”.

As he has tried to do ever since 1991, Saddam Hussein, the Iraqi dictator, has managed to sow dissension and confusion among members of the UN Security Council. Of the five veto-bearing permanent members, three—France, Russia and China—insist the priority now is for the return of UN weapons inspectors. Two—America and Britain—argue that they should only return if armed with robust new powers and backed by the threat of overwhelming military force should they encounter any Iraqi obstruction or backsliding.

The latest spanner Mr Hussein has thrown into the Security Council’s efforts to achieve consensus was his government’s agreement, on October 2nd, to arrangements for the return of UN inspectors. This came at talks in Vienna between Iraqi officials and weapons inspectors from the UN Monitoring, Inspection and Verification Commission (Unmovic) and the International Atomic Energy Agency. An understanding was reached on some of the technical details for a first return visit by inspectors to Iraq for four years. An advance team would be ready to go in the middle of the month to resume the UN-mandated hunt for Mr Hussein’s chemical, biological and nuclear weapons programmes.

Not so fast, said American officials, almost at once. They argue there is no point the inspectors going back while the Security Council is still debating the terms on which it wants them to operate. Hans Blix, the head of Unmovic, has been forced to agree: “It would be awkward if we were doing inspections and a new mandate were to arrive.”

But the text of the resolution that would deliver that mandate remains highly controversial. America has two fundamental objections to the terms of existing UN resolutions covering inspection, the most recent of which dates from 1999. One is that, although the agreement in Vienna in theory allows “unfettered” access to all the places, people and documents that the inspectors might want to see in Iraq, there are limits on eight so-called “presidential palaces”.

These can only be visited if the inspectors make special arrangements and are escorted by diplomats. This, say the Americans, in effect rules out spot checks and gives the Iraqis time to mount a cover-up. Since the “palaces” are in fact vast complexes that might house all manner of illicit experimentation or manufacturing, this is a serious drawback. As Tony Blair, Britain’s prime minister, put it this week: “It is no good allowing inspectors access to 99% of Iraq, if the weapons of mass destruction are actually located and stored and worked on in the remaining 1%.”

Second, in light of the past history of prevarication, lies and harassment that the inspectors faced, America wants them in future to be under stronger international protection. A leaked draft of the Security Council resolution for which America, with British support, is pushing, suggests the inspectors would be accompanied by UN security forces, and have the right to declare exclusion zones backed by UN soldiers, or those of Security Council members.

America is insisting that the inspectors should not go back until after the UN has adopted such a resolution, and Iraq has started to implement its provisions, which give it seven days to accept the demands, and 30 to produce a complete inventory of its illicit weaponry. However, America is finding it hard to convince other members of the Security Council to agree to this no-nonsense approach. The difficulty lies only partly in the robust and intrusive powers demanded for the inspectors. More controversial is the threat of immediate military action if Iraq fails to comply with the resolution, or is found to be misleading the UN.

France, for example, insists that there should be two resolutions. A first one would set the terms of new inspections. Only if Iraq failed to comply would the Security Council debate a second, spelling out the consequences of Iraq’s breach. On October 3rd, France’s president, Jacques Chirac, reiterated his “utter hostility” to the American and British draft. The previous day, he had met Germany’s chancellor, Gerhard Schröder, who is even more adamantly opposed to military action—even if sanctioned by the UN.

Russia and China both argue for what a senior Russian official called “the soonest possible resumption” of weapons inspection, under the existing UN mandates. China is not expected to exercise its veto power, however, and there is speculation that Russian opposition might have a price tag attached, in the form of assurances about Russian commercial involvement in the post-war reconstruction of Iraq, and in its oil industry.

But critics of the American draft argue it is so tough that Iraq could never accept it, and suspect that is the point: the new inspection regime is designed to fail, providing a justification for a UN-authorised war. The suspicion has been fuelled by the doubts about the effectiveness of inspection repeatedly expressed by senior American officials.

This argument, about how easy it is for Mr Hussein to cover his weapons-making tracks, is part of a broader difference between American policy and that of every other country, including even Britain. America has been explicit that its goal in Iraq is “regime change”, whereas other countries see toppling Mr Hussein as one possible means to achieving the real goal, disarmament.

On October 3rd, however, Colin Powell, the American secretary of state, suggested to an American newspaper that the successful disarmament of Iraq would lead to a “different kind of regime no matter who’s in Baghdad”. This hints that America might not demand actual “regime change”. Mr Powell is the member of Mr Bush’s cabinet most associated with the drive to secure UN backing, and may be preparing to compromise: by, for example, accepting a two-stage process.

Others in the administration, however, will almost certainly be unwilling to settle for less than the ousting of Mr Hussein. Mr Bush is expected soon to receive Congressional endorsement for military action against Iraq if he decides it is necessary, and America has never dropped its threat to act outside the UN if it has to. In this sense, Iraq provides a test case for Mr Bush’s new national-security doctrine, submitted to Congress last month, which provides for “pre-emptive” American action against big potential threats. Many other countries are uneasy with this doctrine, and the impact it might have on the conduct of international affairs. But those who fear American unilateralism face an awkward difficulty: how to persuade America to act through the UN, without making the UN itself appear a tool of American policy.



Biting the bullet
Oct 2nd 2002
From The Economist Global Agenda

Japan’s prime minister, Junichiro Koizumi, has replaced the top bank regulator with someone more willing to put public money into the bad banks that lie at the centre of the country’s financial chaos. But reshuffling the cabinet is a far cry from cleaning up dud loans

THE cabinet reshuffle that he executed on September 30th had been promised months in advance, but the most important choice confronting Junichiro Koizumi, Japan’s prime minister, came into focus only days before he made his final decisions. Faced with growing speculation over the fate of the country’s top bank regulator, Hakuo Yanagisawa, Mr Koizumi chose to remove him. His replacement, Heizo Takenaka, had continually criticised Mr Yanagisawa for underplaying the mountain of bad loans on the balance sheets of Japan’s sickly banks. It was thus tempting to conclude that Mr Koizumi had at long last chosen to take the banks' problems seriously, prodded into action by America and others frustrated at the decade-long policy paralysis afflicting the world’s second-largest economy. But it is far too early to tell whether this is just another in a long line of fudges.

What does seem clear is that the cautious, deliberate and opaque policymaking for which Japan is known has gone into overdrive of late. The Bank of Japan, the central bank, which has long accused Mr Yanagisawa’s Financial Services Agency (FSA) of denying the scale of the banks’ problems, recently launched a bizarre scheme to buy equities from the banks’ portfolios. While the Bank of Japan made it clear that it did not intend to boost the banks’ capital, others wondered whether the government would try to do this itself through some other channel. Mr Yanagisawa responded by insisting yet again that capital injections are unnecessary. Officials from Japan’s finance ministry weighed in with comments that merely confused matters further; nor did it help that the finance minister, Masajuro Shiokawa, put in a shambolic performance at the G7 meeting in Washington, DC, this past weekend.

By the time Mr Koizumi announced his new cabinet, it was obvious that any attempt to retain Mr Yanagisawa would be met with derision by those who hope to deal seriously with the banks. But instead of just replacing him with another foot-dragger from inside the FSA, the prime minister turned heads by giving the job to Mr Takenaka, until this week the economics minister. This was the only change that Mr Koizumi made to his economic team. Mr Shiokawa will retain his post, as will the trade minister, Takeo Hiranuma. Mr Takenaka will also continue to oversee his portfolio as economics minister and head of fiscal policy, even as he takes on the bureaucrats at the FSA. The symbolic effect of all this, whether intended or not, was to highlight the central role that the banks’ bad loans play in holding the economy back—and the need to do something more to address the problem.

The focus on banks overshadowed the other changes to the cabinet, even though these had been Mr Koizumi’s original reason for promising the reshuffle. The other noteworthy changes took place in ministries beset by scandal or ineptitude. The agriculture minister, Tsutomu Takebe, was replaced after failing to handle an outbreak of mad-cow disease convincingly. The head of the defence agency was also booted out. All told, Mr Koizumi replaced five of his 17 ministers and added a new portfolio for disaster prevention.

Preventing an economic disaster, however, will prove far more difficult. Given the amount of bad loans, estimated at perhaps ¥150 trillion ($1.2 trillion), and public debt approaching 140% of GDP, there appears to be no way to resolve the mess without a great deal of pain, including widespread bankruptcies. Moreover, the economy remains fragile: the Bank of Japan's latest quarterly “tankan” survey of business sentiment, released on October 1st, suggested that the tentative economic recovery is losing momentum, and that company executives remain intent on cutting capital spending. After promising tough reforms when he took office, Mr Koizumi proceeded to drift along and struck a series of disappointing compromises, while his popularity ratings slid from 80% to the low 40s. Some tougher talk over the summer, combined with an historic trip to North Korea in mid-September, have boosted his support, making it easier to choose a cabinet to his liking. But he is yet to get tough with the banks, as he once promised he would.

On the face of it, that appears to be changing. The day after his appointment, Mr Takenaka announced that he would set up a task force as early as this week to look into ways to ease the banks' problems. The task force, which he himself will head, is expected to draw up a report by mid-October. But Mr Takenaka acknowledged that sorting out the mess will not be easy, and that it will be necessary to “change the political environment” before real progress can be made.

Mr Takenaka’s appointment seems to presage a push for more government funds to help recapitalise banks. But this was tried before, in 1998, and will do great harm again if fresh financing is not tied to dramatic changes in the way the banks are run. Many of the banks’ older managers need to be replaced, and their bad loans comprehensively restructured. Since this will involve liquidating debtors, including many small firms, it is unpopular with politicians, who will resist any money that comes with strings attached. After making an interesting choice this week, all of Mr Koizumi’s difficult decisions still lie before him.