U.S. Hopes Assad Can Be Eased Out With Russia’s Aid

WASHINGTON — In a new effort to halt more than a year of bloodshed in Syria, President Obama will push for the departure of President Bashar al-Assad under a proposal modeled on the transition in another strife-torn Arab country, Yemen.

The plan calls for a negotiated political settlement that would satisfy Syrian opposition groups but that could leave remnants of Mr. Assad’s government in place. Its goal is the kind of transition under way in Yemen, where after months of violent unrest, President Ali Abdullah Saleh agreed to step down and hand control to his vice president, Abdu Rabbu Mansour Hadi, in a deal arranged by Yemen’s Arab neighbors. Mr. Hadi, though later elected in an uncontested vote, is viewed as a transitional leader.

The success of the plan hinges on Russia, one of Mr. Assad’s staunchest allies, which has strongly opposed his removal.

In the past year, Russia has blocked any tough United Nations Security Council action against Mr. Assad, arguing that it could lead to his forced ouster and the kind of fates suffered by Col. Muammar el-Qaddafi of Libya, who was killed, or Hosni Mubarak of Egypt, who was imprisoned and put on trial. But Russia is facing intense international pressure to use its influence to bring about the removal of Mr. Assad as the killings in Syria continue unabated, including the massacre of more than 90 people in a village near Homs that was reported by United Nations officials on Saturday.

The Yemen example has been widely discussed in Moscow, so much so that the option has become known by its Russian term, “the Yemenskii Variant,” even in the United States. In part, that reflects Russia’s desperation for a solution to the crisis in Syria, where, the United Nations says, thousands of civilians have been killed since protests began there in March of last year.

Mr. Obama, administration officials said, will press the proposal with President Vladimir V. Putin of Russia next month at their first meeting since Mr. Putin returned to his old post on May 7. Thomas E. Donilon, Mr. Obama’s national security adviser, raised the plan with Mr. Putin in Moscow three weeks ago.

When Mr. Obama brought it up with Prime Minister Dmitri A. Medvedev of Russia at the Group of 8 meeting at Camp David last weekend, Mr. Medvedev appeared receptive, American officials said, signaling that Russia would prefer that option to other transitions in the Arab upheaval. During the meeting, “Medvedev raised the example of Mubarak in a cage,” a senior official said, referring to Mr. Mubarak’s confinement at his trial. The official, who requested anonymity because of the delicacy of the discussions, said Mr. Obama had then “countered with Yemen, and the indication was, yes, this was something we could talk about.”

In a region convulsed by political uprisings, Russian leaders are fearful that Syria is their last bastion of influence. Syria is Moscow’s main Middle East ally, home to a Russian naval base and extensive Russian oil and gas investments. It is also a major trading partner and buyer of Russian arms.

“The Russians now consider President Assad a liability,” said Dimitri K. Simes, a Russia expert and president of the Center for the National Interest in Washington. “But Putin doesn’t like having his clients removed one after another by the United States, and he considers Assad his client.”

American officials say they are ready to reassure their Russian counterparts that Moscow would be able to maintain its close ties in a post-Assad Syria. “Look, we recognize that Russia wants to have a continued influence in Syria,” one official said, speaking on condition of anonymity. “Our interest is in stabilizing the situation, not eliminating Russian influence.”

While Mr. Medvedev did not knock down Mr. Obama’s recent suggestion to seek a political transition based on the Yemen model, he did not exactly sign on, either. In any case, Mr. Putin will almost certainly make the decision, particularly given the flak that Mr. Medvedev has received in Moscow. Critics there contend that when Mr. Medvedev was president, he should never have given in to pressure from Western countries last year to refrain from blocking the United Nations resolution that established a no-fly zone in Libya, which the critics assert led to the NATO airstrikes that helped topple Colonel Qaddafi.

Mr. Putin has already gotten off to a bumpy start with Mr. Obama, who waited several days to call and congratulate him on his election after a campaign in which Mr. Putin accused the United States of helping to orchestrate protests in other countries, including Russia. And even if Mr. Putin does agree to the Yemen model, it is unclear if he and Mr. Obama have the same definition of what that model is — or how to put it into effect.

“For Washington, the most important aspect of the Yemen model is its assumption, from the outset, that the leader — in this case, Bashar Assad — will exit,” said Robert Malley, head of the Middle East and North Africa for the International Crisis Group. “For Moscow, its most important feature is the endorsement of a very gradual process that preserves the basic structures of the regime and in which the leader is not unceremoniously kicked out.”

While that is not an unbridgeable gap, said Mr. Malley, who was recently in Moscow for talks on Syria, “it’s one that hasn’t been bridged so far.”

Russia’s openness to the Yemen model, skeptics said, is motivated less by a desire to remove Mr. Assad than to forestall American-led military action. Some experts warned that the biggest risk to the proposal is that it becomes too closely identified with the Obama administration.

“There’s a deep strain of anti-Americanism at the heart of Putin’s Kremlin,” said Carroll Bogert, a deputy executive director of Human Rights Watch, who has also discussed the Yemen option with Russian officials. “When a proposal is perceived as something the Americans want, it can automatically become less desirable to the Russians.”

Still, she and other human rights activists said the plan was worth trying, even if the odds are against winning wholehearted Russian backing, much less the acquiescence of Mr. Assad.

An agreement could also help Mr. Obama and Mr. Putin present at least the appearance that their relationship is not in a downward spiral after Mr. Putin skipped the Group of 8 summit, which Mr. Obama hosted. The move was widely viewed as a slap at the Obama administration.

The biggest problem with the Yemen model, several experts said, is that Yemen and Syria are starkly different countries. In Yemen, Mr. Saleh kept his grip on power for three decades by reconciling competing interests through a complex system of patronage. When his authority collapsed, there was a vice president, Mr. Hadi, who was able to assert enough control over Yemen’s splintered security forces to make him a credible transitional leader.

In Syria, by contrast, Mr. Assad oversees a security state in which his minority Alawite sect fears that if his family is ousted, it will face annihilation at the hands of the Sunni majority. That has kept the government remarkably cohesive, cut down on military defections and left Mr. Assad in a less vulnerable position than Mr. Saleh. Even if he leaves, American officials conceded, there is no obvious candidate to replace him.

So much for transparency. Ever since the Federal Reserve started giving explicit interest-rate guidance last August, the bond market has become more sensitive to any surprises in the closely watched monthly employment report, whose May numbers are due out Friday.

That's according to Priya Misra, head of rates research at Bank of America Merrill Lynch. Contrary to her assumption that yield volatility after payroll surprises would have declined since the new regime began, she found a marked rise in one-day moves in five- and 10-year yields, for both negative and positive surprises.

Enlarge Image

William Waitzman for Barron's

Actionable: Bond-yield volatility in the age of Fed transparency has actually increased after payroll surprises.

Misra found the average one-day response to positive payroll surprises on the 10-year Treasury in the year before transparency was 2.9 basis points, or hundredths of a percentage point, while post-transparency it was 4.2 basis points. Similarly, the pre-transparency response to negative surprises was 1.6 basis points, versus 8.4 basis points after last August.

Economists expect May nonfarm payrolls to rise about 150,000. At the margins, "you can get a pretty big market reaction" in the 10-year, which yields about 1.7%. Indeed, if payrolls rise by just 50,000, chances for QE III rise to 80 or 90%, from current even odds.

Next Week: Preview

Monday 28

U.S. markets are closed in observance of Memorial Day. Among other closings: Switzerland and South Korea.

Italy begins the first of several bond auctions this week.

IPO lockup curbs expire on Zynga .

Tuesday 29

S&P/Case-Shiller home prices for March are reported.

Consumer confidence for May, and the Chicago Fed manufacturing report for April, are on tap.

The International Securities Exchange lists options on Facebook (see Striking Price, "Set for Another Facebook Debut?").

Wednesday 30

Dallas Fed President and contrarian Richard Fisher gives a speech.

Finish Line and BGC Partners hold meetings with analysts.

The Realtors' association reports pending sales for April.

Thursday 31

Challenger, Gray & Christmas issues its job-cut announcement report.

Retail chains report May sales.

Although little change is expected on the revision to the initial 2.2% read of first-quarter GDP growth, the report will contain the first report on first-quarter profits, says AllianceBernstein's chief economist, Joseph Carson.

Ireland holds a referendum on the European Union fiscal pact.

Clorox, Flextronics , meet analysts.

The CFTC holds a forum on the Volcker rule to limit big-bank trading.

Friday 1

"A somewhat stronger" job gain for May is likely, says Carson. He predicts payrolls to have risen by 175,000 to 200,000. The start of a pickup in the labor force could be evident.

China posts its purchasing managers' index for April.

Medtronic meets with analysts.

U.S. vehicle sales should register a strong annual rate in the mid-14 million area, Carson says.

The ISM manufacturing index for May is reported, with personal income.

Oneok splits its shares, 2-for-1.

A showdown is brewing at Wal-Mart Stores' annual meeting. The California State Teachers' and the New York City Pension Funds vote against the board after Mexico bribery allegations.

IPO lockup restrictions expire for online coupon purveyor Groupon .

Week's Highlight

Friday 1: The employment report for May will take center stage. Also of note: Pension funds take on the board of Wal-Mart, and China posts its PMI.

E-mail: editors@barrons.com

More Military Spies

Jean Pisani-Ferry

Jean Pisani-Ferry is Director of Bruegel, the Brussels-based economic-policy think tank, and Professor of Economics at Université Paris-Dauphine. He was an adviser to the European Commission’s Directorate-General for Economic and Financial Affairs, and was Director of CEPII, France’s leading international economics research institute. He has also served as Senior Economic Adviser to the French finance minister, Executive President of the French prime minister’s Council of Economic Analysis, and Senior Adviser to the director of the French Treasury.

Is the Euro Ending or Beginning?

24 May 2012

BRUSSELS – When the architects of the euro started drawing up plans for its creation in the late 1980’s, economists warned them that a viable monetary union required more than an independent central bank and a framework for budgetary discipline. Study after study emphasized asymmetries within the future common-currency area, the possible inadequacy of a one-size-fits-all monetary policy, the weakness of adjustment channels in the absence of cross-border labor mobility, and the need for some sort of fiscal union involving insurance-type mechanisms to assist countries in trouble.

Beyond economics, many observers noted that European Union citizens would accept tight monetary bonds only if they were participating in a shared political community. The former president of the Bundesbank, Hans Tietmeyer, liked to quote a medieval French philosopher, Nicolas Oresme, who wrote that money does not belong to the prince, but to the community. The question was, which political community would support the euro?

Some of these warnings were inspired by deep-seated doubts about European monetary unification. But others merely wanted to emphasize that Europeans needed a better-equipped and stronger vessel for the journey that they were contemplating. Their message was simple: national governments must make their economies fit for the strictures of monetary union; the euro must be supported by deeper economic integration; and a common currency needs political legitimacy – that is, a polity.

In the end, the leaders at that time – especially German Chancellor Helmut Kohl and French President François Mitterrand and his successor, Jacques Chirac – set forth to sea in a light vessel. On the economic front, they agreed on only a bare-bones Economic and Monetary Union built around monetary rectitude and an unenforceable promise of fiscal discipline. On the political front, they did not agree at all, so the creation of a European polity remained stillborn.

Some at the time, like then-European Commission President Jacques Delors, openly deplored this narrow approach. Though political constraints prevailed, the euro’s architects were however not naive. They knew that their brainchild was incomplete. But they assumed that, over time, monetary unification would create momentum for national reforms, further economic integration, and some form of political unification. After all, that piecemeal approach is what had helped to build the EU ever since its origins in the coal and steel community of the 1950’s. Few among the euro’s proponents expected that there would be no significant change after its launch.

But this assumption was mistaken. From the signing of the Maastricht Treaty in 1992 to the tenth anniversary of the euro in 2009, the expected momentum for creating a common European polity was nowhere in sight.

Indeed, very few countries have bothered to spell out, let alone implement, a euro-inspired economic-reform agenda. Having agreed to delegate responsibility for monetary policy to the European Central Bank, most governments put up fierce resistance to any further transfer of sovereignty. In 2005, a timid attempt to foster political integration by adopting a constitutional treaty was defeated in popular referenda in France and the Netherlands.

So, contrary to expectations, things stayed put. Soon after the introduction of the euro in 1999, it became clear that the scenario favored by the common currency’s architects would not be realized. Everybody accepted – if grudgingly – that the bare-bones EMU was the only game in town.

Now, however, what did not happen through smooth evolution has started to happen through crisis. Since 2009, the Europeans have already put in place the crisis-management and resolution apparatus that they initially refused even to discuss. Simultaneously, governments, under merciless pressure from the bond markets, are introducing labor- and product-market reforms that they deemed politically inconceivable only a few quarters ago.

But the bond markets want more. The questions that they are asking more loudly with each passing day demand answers. Will Europeans agree to mutualize part of the cost of the crisis? Greece’s creditors (mostly eurozone residents) have already accepted some of the burden by accepting a “haircut” on their assets. But, if another country finds itself unable to bear the fiscal cost of the crisis, will it also shift the burden to its external creditors in some form or another?

And, beyond transfers, will Europeans, or some of them, agree to create a banking union (that is, Europeanization of banking supervision, deposit insurance, and crisis resolution)? Will they agree to pool tax revenues so that EU-level institutions can credibly take charge of financial stability?

These questions are vital for the future of the common European currency. In spite of their desire not to raise them, European leaders face the uncomfortable prospect of having to answer them – and without much delay.

The historical irony is that an environment of crisis is forcing Europeans to make choices that they did not want to envisage, much less confront, in quieter times. The Greek debt crisis forced them to create an assistance mechanism. The Spanish crisis may well force them to create a banking union. And the threat of a Greek exit from the euro may force them to decide how far-reaching a fiscal union they are prepared to embrace.

For many, recent developments mark the beginning of the end for the euro architects’ bold creation. But, depending on how Europeans answer these questions, today’s crises might one day be remembered as the end of the beginning.

05/24/2012 02:29 PM

Defective Joy Gene

Study Finds Germans Incapable of Enjoying Life

By Maria Marquart

With low unemployment and solid economic growth, things are going better than ever for Germans. But a new study shows they're practically incapable of enjoying it. Not only do they find it difficult to cut loose and experience pleasure, but their "joy gene" is broken, researchers say.

At a certain point, Sven just lost it. Other members of the discussion group had gone into great detail about how they spent their after-work hours with their companions and enjoyed the end of the day. "That's great for you!" Sven fired back to one speaker. "But first one needs the chance! My boss often plops something on my desk right before it's time to clock out, and when I arrive home late, my wife is pissed off because she was forced to take care of our kid and the housekeeping by herself." By that point, he adds, all thoughts of a relaxing evening have vanished.

If anything can comfort Sven, it's the fact that he isn't alone with this problem. The 36-year-old took part in a study released this week by Rheingold, a market-research and consultancy institute based in Cologne, which found that 46 percent of Germans say they are increasingly unable to enjoy anything due to the stress of everyday life and the feeling of being constantly reachable. The difficulty was even more pronounced among the study's younger participants, 55 percent of whom claimed to feel they have lost their ability to feel good.

Whether it's with food, alcohol, vacation or relaxing -- Germans apparently don't have the leisure to enjoy things. In fact, they can't even let go when they're having sex. According to the researchers, the bottom line is: "Our joy gene is increasingly defective -- we've forgotten how to enjoy ourselves."

Work Before Play

The results conform to the image that many Europeans have of Germans in this era of economic crisis as self-denying overachievers who can't even turn off the fun-brakes when vacationing at the beach. The positive image that they enjoyed during the 2006 soccer World Cup in Germany seems gone.

"At that time, Germans really radiated a zest for life," says Rheingold psychologist Ines Imdahl. "But this mood shifted beginning in 2008." The problem, she believes, is that Germans feel weighed down by the ongoing European debt and currency crisis. "It's more than simple complaining," she adds. "People have the feeling that we have to shoulder the entire crisis here."

But the Germans aren't just burdened with the crisis. The main thing standing in their way is their own perfectionism. During hours of individual and group interviews, the researchers analyzed how 60 subjects felt pleasure. They also scrutinized the results of a representative survey of 1,000 men and women commissioned by the liquor companies Diageo and Pernod Ricard.

Among survey respondents, 81 percent said that they experience pleasure best when they have managed to achieve something first. "As the saying goes, business before pleasure," said 61-year-old female participant Wiltrud.

Pleasure Pressure

But this maxim doesn't seem to serve the Germans well -- they even feel burdened by the pressure to enjoy things. "People often told us that they would come home after a stressful day, but were unable to even say what they'd accomplished," Imdahl reported. "And then the people around them say, 'Hey, just relax.' Enjoyment then turns into an obligation."

Meanwhile, chances to create a sense of well-being lurk everywhere -- a glass of wine, a relaxing bubble bath, or a nice restaurant with delicious food. These, of all things, also rankle the Germans. "This glut of offerings pressures people into thinking, 'I must enjoy everything'," Imdahl says.

During the course of the study, the researchers managed to unlock a typically German sequence of steps to enjoyment, which they named "pleasure DNA." The first step involves the feeling of having earned something. This is followed by preparation for the longed-for pleasure, such as booking a day of wellness treatments. But then comes the biggest hurdle: letting go and clearing the mind. Only when a surprising positive moment supervenes can a fully integrated sense of enjoyment follow.

However, many Germans apparently lack crucial components to this "pleasure DNA." Though some 91 percent of the study participants said that pleasure makes life worthwhile, only 15 percent could recall moments in which they were able to forget their worries and feel truly happy.

Two-thirds of the respondents imagined that they might arrive at such a feeling by doing something provocative. One example? A motorcyclist reported experiencing delight when he blew exhaust fumes in the direction of a convertible driver as he accelerated at a green light.

The Jealousy Factor

Yet another phenomenon also comes into play in the German culture of pleasure -- jealousy of others' well-being. "Many think, 'man, how does he do it,'" psychologist Imdahl said. It's a Teutonic mentality one can also see in the euro crisis. "When we get agitated about the Greeks' high pensions and ample vacation days, naturally pleasure-jealousy plays a role," she says. But would Germans rather be Greek? "That doesn't suit us," she says.

Perhaps the Germans could never achieve a Southern European kind of ease, but one might think they could at least relax during their most intimate moments. Not true, the study found. The highly personal interviews revealed that Germans can't even let go during sex. Many reported constantly having film and advertising images run through their minds. "This results in the requirement to cut a good figure even during sex," Imdahl says. That is, to hold in their bellies instead of enjoying the moment.

A Taste of Prohibition as Liquor Stores Go Private

CASHMERE, Wash. — What is a Memorial Day weekend start-of-summer party without a trip to the liquor store for that special gin Aunt Martha insists upon? Or an extra bottle of whatever-has-a-kick in case the get-together goes into extra innings?

This rural corner of central Washington might find out.

A change in the state’s 78-year-old sales system for liquor, from state-controlled stores to private retailers — approved by voters last fall and now in the home stretch of a chaotic, deadline-driven start on Friday, the first day of June — is pushing some places toward a palate-parching glimpse of Prohibition.

Consider this eye-opener: Of the six liquor outlets in Chelan County, about 150 miles east of Seattle, one closed earlier last week for inventory checks in anticipation of the state handoff and three others, including the only one here in Cashmere, population 3,063, will close on Monday.

For the three days after that, the closest bottle for many people in a county of 72,000 could be half an hour or more away, assuming anything is left. Retailers were anticipating a run.

“We’re going dry,” said Stacey Hoefner, the owner of the Cashmere store, formally known on state rosters as store No. CLS540.

Ms. Hoefner said she had been unable to place any new liquor orders since mid-May. And with people driving in for miles around in recent days to buy by the case — as insurance against shortages or price increases — and the summer camping and festival season in the towns of the Cascade Range beginning in earnest this weekend, some shelves were already bare.

Popular midpriced vodkas and tequilas? Entirely gone. “I’m doubling up on the Baileys Irish Cream shelf to make it look full,” Ms. Hoefner said.

The shortage is temporary. At midnight on June 1, the alcohol spigot will be turned back on with a jolt as retailers that were long barred from the liquor trade, including large grocery stores, will be allowed to stock their shelves with higher-proof beverages, and state-owned stores that were sold at auction turn their lights back on under new ownership. Wine and beer sales were unaffected by the change, called Initiative 1183, and are already allowed to be sold in most shops.

But for three days this week, the system in transition will be shaken and stirred, with all but 35 of the state’s 331 liquor stores, which serve a population of 6.8 million, going dark.

“I imagine there will be places where people will have a drive,” said Mikhail Carpenter, a spokesman for the Washington State Liquor Control Board. “There was an aggressive schedule for us to be out of the liquor business,” he added. “It comes down to a question of manpower and scheduling.”

Washington is one of eight states left, at least for the moment, with a state-run monopoly on retail liquor sales, according to federal figures. In the aftermath of Prohibition — the 18th Amendment to the Constitution, repealed in 1933 after 13 years of bathtub gin and gangland lawlessness — most states immediately or gradually transitioned to the private market, or a state-private mix, and never looked back.

But here in Washington, historians say, a utopian if not quite bluenosed spirit — prominent in the early wave of pioneer settlement and still present today — kept a hint of the temperance spirit alive.

State stores were clean but never very plentiful, and almost entirely free of charm: a sign out front declared in unadorned block type what was available within. The system made Washington State second only to Utah, where the Mormon faith frowns on drinking, in having the fewest liquor outlets per capita, according to Washington State figures.

State control, in turn, made generations of civil servants tastemaking critics — their decisions on what to stock dictating what people could order in bars or buy in the stores.

In 2010, for example, a tiny distiller here in Cashmere, called It’s Five O’Clock Somewhere, made a grape brandy that the owner, Colin Levi, was quite proud of. Liquor Control Board officials came by for a tasting and did not much care for it, Mr. Levi said, and that was that — it never went into distribution.

Mr. Levi said he was expecting greater exposure in the private market, especially in light of the so-called locavore movement — eating and drinking products produced close to home — which is very popular in the Pacific Northwest.

The end of state liquor distribution will also mean that Mr. Levi’s brandy can travel the four blocks or so across Cashmere, directly to Ms. Hoefner’s place. Under the state system, every bottle was shipped to a warehouse in Seattle before going back out to stores or bars, even if the final destination was just down the street.

There will be pain. Mr. Carpenter, the Liquor Control Board spokesman, said he would be among the more than 1,000 state employees, in a department of about 1,300, who will lose their jobs when the privatization is completed. Some could get jobs with the new privately owned stores, he said, but no figures were available yet.

Many Washingtonians call 1183 the “Costco Initiative” for the big national retail chain — whose headquarters are near Seattle — that aggressively pushed for its passage. Costco and allies argued that the plan would generate $400 million or more in state and local revenues over the next six years through lower costs and new licensing fees on retail sales — sorely welcome cash in a state that, like most others, is still struggling financially.

And while some shoppers said they thought competition would be good for choice and price, others said they feared that big business could swamp the little stores that had flourished under a state monopoly, whatever its flaws.

“I love Costco, but I won’t buy alcohol there,” said Judy Martin, who drove 20 miles to Cashmere on Thursday to buy a bottle of Crown Royal.

With Personal Data in Hand, Thieves File Early and Often

MIAMI — Besieged by identity theft, Florida now faces a fast-spreading form of fraud so simple and lucrative that some violent criminals have traded their guns for laptops. And the target is the United States Treasury.

With nothing more than ledgers of stolen identity information — Social Security numbers and their corresponding names and birth dates — criminals have electronically filed thousands of false tax returns with made-up incomes and withholding information and have received hundreds of millions of dollars in wrongful refunds, law enforcement officials say.

The criminals, some of them former drug dealers, outwit the Internal Revenue Service by filing a return before the legitimate taxpayer files. Then the criminals receive the refund, sometimes by check but more often though a convenient but hard-to-trace prepaid debit card.

The government-approved cards, intended to help people who have no bank accounts, are widely available in many places, including tax preparation companies. Some of them are mailed, and the swindlers often provide addresses for vacant houses, even buying mailboxes for them, and then collect the refunds there.

Postal workers have been harassed, robbed and, in one case, murdered as they have made their rounds with mail trucks full of debit cards and master keys to mailboxes.

The fraud, which has spread around the country, is costing taxpayers hundreds of millions of dollars annually, federal and state officials say. The I.R.S. sometimes, in effect, pays two refunds instead of one: first to the criminal who gets a claim approved, and then a second to the legitimate taxpayer, who might have to wait as long as a year while the agency verifies the second claim.

J. Russell George, the Treasury inspector general for tax administration, testified before Congress this month that the I.R.S. detected 940,000 fake returns for 2010 in which identity thieves would have received $6.5 billion in refunds. But Mr. George said the agency missed an additional 1.5 million returns with possibly fraudulent refunds worth more than $5.2 billion.

Florida, with its large population of elderly residents and health care facilities, provides a wealth of opportunities for swindlers. South Florida, which had the highest rate of identity theft in the nation, and Tampa have been hit hardest.

The United States attorney for the Southern District of Florida, Wifredo A. Ferrer, called identity-theft tax fraud an “epidemic.” He formed a task force of 18 federal and state agencies, including the I.R.S., to combat the problem. Despite those efforts, it is worsening, Mr. Ferrer said.

“The I.R.S. is doing what they can to prevent this, but this is like a tsunami of fraud,” Mr. Ferrer said. “Everywhere I go, every dinner, every function I attend, someone will come up to me and tell me they are a victim — people in this office, police officers, firefighters.”

In the past two years, the I.R.S. has recognized the severity and rise of this type of fraud, and its vulnerability to it. The ease of electronic filing and the boom in identity theft have outpaced the agency’s technological ability to detect this sort of fraudulent claim, senior agency officials say. The I.R.S. receives 100 million tax returns a year, most filed within a short period of time and a vast majority legitimate.

From 2008 to 2011, the number of returns filed by identity thieves and stopped by the I.R.S. increased significantly, officials said. Last year, it was at least 1.3 million, said Steven T. Miller, deputy commissioner for services and enforcement at the agency.

This year, with only 30 percent of the filings reviewed so far, the number is already at 2.6 million. The bulk are related to identity theft, Mr. Miller said.

The agency, prodded by lawmakers and the public, is moving more aggressively to stop the avalanche. It has increased the number of investigators, put in place better technology that flags more returns, distributed personal identification numbers to victims for the next filing season and hired more workers to help taxpayers get their refunds. The agency, which had $300 million cut from its budget this year, has invested the same amount in combating the problem.

The agency is also working with local law enforcement officials in Florida, allowing them to obtain information on tax returns with the permission of the rightful taxpayer, an important tool for investigators.

“We have gotten much better at it,” Mr. Miller said, “and still have a ways to go.”

At the same time, members of Florida’s Congressional delegation have introduced legislation to increase penalties on tax-fraud identity theft. A wide-reaching bill sponsored by Senator Bill Nelson, a Democrat, would also bolster protections for victims, help secure some Social Security numbers and make it easier for law enforcement agencies to work together.

“There is almost no disincentive, because the penalty is so low for a thief to do this repeatedly,” said Representative Debbie Wasserman Schultz, another Democrat who has introduced a bill. She said her South Florida office had been inundated with complaints about tax-fraud theft in the past year.

Flora Goldberg, an 80-year-old Broward County resident, provided one of them. Last year, she did what she has done for decades: she filed, or tried to file, her tax return, this time electronically. But she quickly received a message saying her claim had already been processed. One month later, she got a letter informing her that she had been a victim of identity theft.

Impatient with the bureaucracy and the delays in getting answers, she called her congresswoman. She received her $4,000 refund in December.

“After I got the letter, then I was a little hysterical,” Ms. Goldberg said, adding that the I.R.S. eventually assigned her a personal identification number for future use.

In South Florida and Tampa, the problem has gotten so bad that police officers conducting unrelated searches or simple traffic stops routinely stumble across ledgers with names and Social Security numbers, boxes of stolen medical records and envelopes with debit cards.

The Tampa Police Department set up a special unit last year related to this kind of fraud after officers continued to find an “ungodly amount” of identity-theft material, said Detective Sal Augeri, a veteran on the unit. Last year, the department handled nearly 1,000 incidents; this year, the number is “way, way above that,” he said.

Fraudulent filers first used names and Social Security numbers of the deceased to file claims. The numbers become public by law and, until recently, were easily available on popular genealogy Web sites. Swindlers also used the Social Security numbers of prisoners.

When officials cracked down on those two avenues, the theft migrated to anywhere Social Security numbers are collected. Most vulnerable are records from health care facilities, assisted-living centers, schools, insurance companies, pension funds and large stores that issue credit cards. The police say employees steal the information and sell it, an increasingly common practice here.

Everyone is susceptible. Two dozen Tampa police officers, including one whose job it is to investigate identity-theft fraud, had their identities stolen and their tax refunds diverted this year.

Career criminals know easy money when they see it. The police say they run across street corner drug dealers and robbers who have been in and out of prison for years now making lots of money by filing fraudulent returns. Some have been spotted driving Bentleys and Lamborghinis.

“A gentleman, a former armed robber, said: ‘I’m not doing robberies anymore. This is much cleaner. I don’t even have to use a gun,’ ” said Sgt. Jay J. Leiner of the economic crimes unit in the Broward Sheriff’s Office, which has formed a multiagency task force.

Mr. Ferrer, the United States attorney, said he had seen tax fraud overtake violent crime in Overtown, a poor, high-crime section of Miami. He said criminals there were holding filing parties, at which they would haul out laptops and, for a fee, teach others how to run the swindle.

Putin’s Dark Lord Keeps Power in Oil Patch

Russia's leaders have unveiled a new government that is notable in the absence of one prominent figure: Igor Sechin, the dark lord responsible for dismantling the oil empire of oligarch-turned-prisoner Mikhail Khodorkovsky.

Sadly, Sechin's departure does not augur a fresh start. Rather, it demonstrates where the true power in Russia lies. Hint: It’s not in the government.

When newly inaugurated President Vladimir Putin and his predecessor, now Prime Minister Dmitri Medvedev, announced the new cabinet, Medvedev proudly noted that he had changed three quarters of its members. The fresh appointments are supposed to signal Medvedev's desire to promote younger, more modern professionals without Soviet experience.

Newer, though, doesn’t always mean better. Consider Culture Minister Vladimir Medinsky, who earned his position as an activist for the ruling United Russia party: The self-styled historian received a doctorate last year despite well-documented plagiarism in his thesis.

The appointment attracted much ridicule in the blogosphere. “I am ecstatic at Mr. Medinsky's appointment because it confirms my hypothesis: The closer the system is to collapse, the crazier its decisions,” opposition journalist Yulia Latynina wrote.

Two other newcomers stand out in a more positive light: Interior Minister Vladimir Kolokoltsev and Arkady Dvorkovich, deputy prime minister in charge of trade, energy, industry, transport and agriculture.

Kolokoltsev is reputed to be that rare animal in Russian law enforcement: an "honest cop," according to Kirill Kabanov, head of a nongovernmental organization called the National Anti-Corruption Committee. He replaces a minister who had done little to combat corruption in Russia's vast police force (9.7 officers per 1000 residents, compared with 2.7 in the United States). As Moscow's police chief during the recent anti-government protests, he demonstrated his loyalty to Putin. Although his record has been marred by the street fighting that broke out on May 6 and the subsequent chaotic arrests of opposition activists, he has generally kept the use of force to a minimum. The protests have not resulted in a single casualty apart from the death of a photographer who fell off a fire escape trying to line up a good shot.

The choice of Dvorkovich, Medvedev's erstwhile economics adviser, cheered investors who saw the 40-year-old intellectual as a good trade for Sechin, whose post he will occupy. Analysts at Citibank called the switch the “most important piece of positive news” in the cabinet announcement. Dvorkovich is decidedly a Medvedev man. He was the former president's sherpa in Group of Eight negotiations, and the two are said to be close.

The cabinet retains quite a few familiar faces. First Deputy Prime Minister Igor Shuvalov was back in charge of economics and finance, despite recent revelations concerning his joint business dealings with some of the nation's wealthiest businessmen. Vladislav Surkov, the man who helped Putin build United Russia, remained deputy prime minister in charge of science, culture and innovations. Nationalist Dmitri Rogozin kept his job as deputy prime minister in charge of the defense industry. Millionaire Alexander Khloponin stayed on as the top official in charge of the rebellious Caucasus region.

The relevance of the cabinet appointments, though, is limited. Putin looks set to govern from the Kremlin, using Medvedev's government as a foil. Many of the new ministers look disposable, and most of the former cabinet's top brass have joined the presidential staff. They include Tatyana Golikova, who was responsible for health and social issues in the old cabinet, ex-economics minister Elvira Nabiullina, former education minister Andrei Fursenko and Yury Trutnev, until recently in charge of natural resources. “The heavyweights of the old cabinet are moving to the Kremlin, and they are not going to let go of the levers” of power, wrote commentator Mikhail Fishman.

What, however, of Sechin, the gray cardinal who has been Putin's right-hand man since their time together in the St. Petersburg city government in the 1990s? He became head of Rosneft, the state-owned oil company that swallowed up the assets of Khodorkovsky's oil company, Yukos. “I think you have the right to enjoy the results of your work,” Medvedev told Sechin. Just days before Sechin's appointment, Putin quietly made the government's controlling stake in Rosneft immune from privatization.

Sechin's move offers a glimpse of the true nature of power in today's Russia. Being a minister does not count for much in a country run by a close-knit group of Putin's friends and business associates. It is the resources one commands, and the phone numbers one can call, that determine one's true influence.

"Power lies where oil lies," wrote columnist Dmitry Butrin in the daily Kommersant. "Where is the oil? We won't tell you, but all the right people know.”

(Leonid Bershidsky, an editor and novelist, is Moscow and Kiev correspondent for World View. Opinions expressed are his own.)

To contact the writer of this column: bershidsky@gmail.com.

To contact the editor responsible for this column: Mark Whitehouse at mwhitehouse1@bloomberg.net.

Quick Getaways, at the Divorce Hotel

Reports on the death of the public stock investor may only be slightly exaggerated. But these reports have certainly gotten loud, shrill and rife lately.

The Financial Times last week, in a much-discussed page one tease for a long article about investors' disdain of stocks, asked, "The Death of Equities?" Like the infamous August 1979 "Death of Equities" Business Week cover it echoes (which eventually proved a vivid contrary indicator), the FT piece is more descriptive of risk-averse institutional attitudes than an argument for why stocks ought to be shunned.

A day earlier, the tech entrepreneur, investor and basketball-team owner Mark Cuban wrote on his blog: "Say goodbye to the individual investor on Wall Street. Whatever positive impression they had of the IPO market and the stock market in general was just torched to the ground."

Striking the match, in this view, was the botched debut of Facebook shares (ticker: FB), which featured allegations of selective disclosure to favored Wall Street clients. (A week earlier, Cuban had blogged that the Facebook deal "could lead to individual retail investors coming back into the market"; note that absent among his numerous titles is "public intellectual.")

Meantime, leading electronic trading network Liquidnet this week is staging a conference panel called "Crisis in Confidence: What is the future of equities investing?"

While all of the attention on individuals' virtual boycott of stock investing is logical, the discussion tends to produce faulty conclusions. Specifically, that this phenomenon is somehow news, that it is poised to reverse soon, and that it is somehow central to the market's performance prospects.

It's a stale observation by now that Main Street prefers bonds. Something like a net $1.4 trillion swing in money flow from stock to bond mutual funds began in 2007, not last month. The notion that such a preference is likely to reverse before long, simply because it's gone this far for this long, is sketchy. This is the common but untrustworthy "cash from the sidelines" reasoning.

Such a shift from a state of risk aversion brought on by two 50% market drops in a decade and more scandals and scare headlines than you can count, won't occur spontaneously, no matter how many uninformative charts tracking Treasury yields versus earnings yields are waved in the air. For the last year, headline-fearing, stock-avoiding households have done just fine. Maybe the bond holdings they consider "safe" will have to produce losses for them to reconsider their stance, suggests Jason Trennert of Strategas Group. But that could take a while.

A longer, calmer climb in the market is likely what will be required. Currently, the 10-year trailing annualized return (excluding dividends) has risen from below zero to a bit over 2%, a level and trajectory that in the past has implied pretty good multi-year returns to come. Upon request, Strategas calculated that if the S&P is at today's level on Oct. 9, the tenth anniversary of the 2002 bear-market low, the ten-year trailing return would be 5.5%. That's similar to post-bear periods in the late '40s and late '70s -- decent times to lay patient bets on equities, but not the start of bull-market manias.

Finally, both optimistic and downbeat commentators wrongly use the public's wariness toward stocks as support for their market outlook.

Bears, who claim broad investment flows are needed to hold up stocks, should note that the U.S. market just doubled in three years with retail selling into the move. Bulls are crowing about the contrarian implications of all the "death of equities" talk a bit too much; even the FT's own FT Alphaville blog assumed this posture. And they might recall that a dearth of popular excitement about the market hasn't prevented nasty downturns the past couple of years.

Squaring the bear and bull positions, perhaps equities are unlikely to see the upside that comes from much-higher valuations without eager Main Street money and can still remain vulnerable to financial shocks, yet the longer-term forces of mean reversion should make for decent five- and 10-year results.

Ronald O'Hanley, president of asset management and corporate services at Fidelity, ventured in a speech recently that "the next decade could look like the 1950s. It was a great decade for equities, but market participation was low."

Doug Ramsey of Leuthold Group wrote this month that "a new market high could potentially occur with no help at all from the public." He cites the '74-'80 market, which in total rose 120% with small caps doing far better. "The sharp market declines of mid-2010 and mid-2011 have probably served the same purpose as the 1976-1977 decline -- flushing out retail investors just as they were finally preparing to tiptoe back in."Imagine that. Finding ourselves in a time when likening the present market moment to the malaise-stricken late '70s passes for an upbeat sentiment. 

E-mail: michael.santoli@barrons.com

Rethinking the ‘war on drugs’: Insights from the US and Mexico

America’s most loved economics textbook (Mankiw 2012) uses the ‘war on drugs’ to illustrate how restricting supply when demand is inelastic increases the total cash spent on illegal drugs. Every anti-smuggling tactic makes each consignment more profitable. No wonder the US war on drugs is not going so well. Yet despite 40 years of violence, corruption and continuing addiction, the US is in no mood to alter course.

At the Summit of the Americas last month, the Colombian and Guatemalan Presidents called for a new approach. The US flatly rules out any change. Dan Restrepo, the National Security Council's senior director for Latin America, said in a press conference on the summit: “US policy on this is very clear. The President doesn't support decriminalisation, but he does consider this is a legitimate debate. And it's a legitimate debate because it helps to demystify this as an option”. (Rogin 2012)

US and Mexico

The US is the world’s largest consumer of illegal drugs. It makes up just 5% of the global population, yet according to most estimates accounts for over 25% of global demand for illicit drugs. At the same time, Mexico is the US’s largest supplier, and an increasingly significant supplier of drugs to many European countries. Moreover, in recent years Mexico has been hit by an unprecedented epidemic of violence stemming from organised crime that is leading to ominous comparisons with Colombia.

Over the years there have been many studies of drug policy in the US, Mexico and their trade partners. This was the starting ground for a conference held by the Yale Center for the Study of Globalization. The subsequent eBook distils the lessons from work presented by 20 leading experts (see Zedillo and Wheeler 2012).¹

Why this debate now?

Drug policy in the US has remained essentially unchanged for over 40 years – ever since US President Richard Nixon announced a “national war on drugs” in the late 1960s.²  The persistence of a ‘law enforcement approach’ is remarkable, especially when we consider that experts doubted its validity even before it was fully enacted. In fact, in March 1972 a National Commission on Marijuana and Drug Abuse established by Nixon himself issued its report contradicting the essence of the official policy. Indeed, the Commission recommended that marijuana use should be decriminalised. This recommendation apparently “so angered President Nixon that he refused to receive the report publicly, in spite of the fact that the chair of the commission was a Republican governor, Raymond P Shafer” (for a discussion see Musto and Korsmeyer 2002). And just as the policy stance has persisted, so have the criticisms.

Yet this should not be taken to suggest that drug policy in the US and other countries has totally lacked a rational foundation all along. The debate is really over the weight that medical and public health concerns – not to mention basic human rights or even economic rights – should receive in the formulation of policy. For whatever reason – and many would point to political necessity – the goal of reducing crime and condemning ‘disruptive behaviour’ has dominated the rationale behind drug policies, leaving little space for health strategies and paying little attention to the knock-on effects. Of course, the architects and subsequent followers of the ‘war on drugs’ strategy believe that they were acting on behalf of the public interest, but that is hardly a reason not to examine the basis for, and the results of, their policies.

Will Mexico repeat Colombia’s misery?

Contributing to the sense of urgency in this debate is the high cost already paid by Mexico. The violence caused by organised crime in the Mexican drug trade has approached Colombian proportions in recent years. Political scientist Eduardo Guerrero Gutiérrez (2012) estimates that between end-2006 and end-2012, the number of deaths related to the activities of organised crime will reach 64,000 in Mexico.

There can be little doubt that if Central America is bound to become the next key battleground for the “war on drugs”, it will be nothing short of devastating. Joaquín Villalobos (2012) argues that if the trend continues Central America could see its economies and political systems crumble under the pressure, returning the countries to the instability of the cold war years.

What to do about US demand?

Although all agree that demand from the US is a chief cause of the troubles in Mexico and Central America, there are differences in how to address this.

Jonathan Caulkins is not only sceptical of the political feasibility of legalisation of illegal drugs, for example, but also argues that this position should be sustained (Caulkins and Lee 2012). Caulkins is convinced that prohibition drives prices up far above legal levels; that the taxes necessary to prevent a price collapse, if drugs were legalised, are uncollectable. Moreover, he is not alone in seeing legalisation as an “irreversible game” in that some drug use induced by legalisation would remain even if that policy change were later undone.

Other authors argue that political support for the status quo remains strong. For example, Keith Humphreys, a former senior advisor at the White House Office of National Drug Control Policy in the Obama administration, places at zero the probability of seeing a radical change in the policy towards cocaine any time soon, the drug whose US market provides at least half of the Mexican drug gangs’ total revenue. Part of the reason for this is that present policies, for all their flaws, have coincided with a relative stabilisation in the overall levels of use in the US (see also Kleiman 2012 and Donohue 2012).

Yet despite this, Peter Reuter (2012) shows that there is very little evidence to suggest that enforcement raises prices or reduces availability. Between 1980 and 2005, the number of people imprisoned for drug offences in local jails and state and federal prisons increased by a factor of 10, yet during this period of increased policing, the price of heroin and cocaine fell around 70%.

Jeffrey Miron, meanwhile, reiterates the classical economic case for a laissez faire approach. It stems from the uncontested fact that prohibition does not eliminate drug markets, but simply drives them underground and the money into the hands of criminals (Miron 2012). Miron proposes legalisation with a sin tax on drugs sufficiently stiff to yield a price as high as under prohibition. While not endorsing outright legalisation, other authors nevertheless do provide sensible arguments for moving away from the status quo.

Without endorsing outright legalisation, other authors nevertheless do provide arguments for moving away from the status quo in a direction that would address the consequences of black markets. After reporting that 56.6% of the estimated cost of illegal drug use in the US (estimated for 2002 as $217 billion in 2008 dollars) was due to crime-related costs and only 8.7% was caused by health costs, Stanford Law Professor John Donohue admits serious concerns about the balance of overall US drug policy. He insists on the fundamental question of how it can be possible to have falling prices of illegal drugs in the face of intense enforcement efforts – carrying an annual cost of more than $40 billion. Interestingly, he invokes an earlier study by Caulkins and others that found that an additional $1 million spent on treatment and demand reduction reduced net cocaine consumption by 103.6 kg while the same amount of money spent on longer sentences reduced consumption by just 12.6 kg.

What to do about Mexican supply?

On the other side of the market is the supply from Mexico. Mark Kleiman criticises the US government’s long-standing demand that Mexico act to reduce the flow of drugs across the border so that US drug consumption will be reduced. He claims that even if Mexico were successful in crippling that traffic, the effects on drug abuse in the US would be modest at best because shipments of drugs would simply be shifted to other routes.

Moreover, somewhat surprisingly, some of those who are sceptical of the possibility or even the convenience of any significant drug-policy changes in the US argue that Mexico should change its strategies and policies to align them more with its own interests and less with those of its northern neighbour. Both Kleiman and Caulkins suggest that the objective of minimising violence should have a higher priority in the Mexican strategy – a suggestion that no doubt would make more than one law enforcer raise an eyebrow.

A change is needed

Despite their differences, the arguments and evidence presented in the eBook point very strongly in the direction of a serious reconsideration of drug policy. The economic and human costs paid both in the US as well as in the countries where the drugs come from, cast doubt over the validity of such policies. Our US colleagues who tell us that any significant change in the strategy is unlikely to happen in the US essentially for political reasons may be right. But it doesn’t mean that those concerned about this problem, for good reason, should give up. On the contrary, the resistance to change should encourage more and better research and a bigger effort to foster a rational discussion of the drug problem. Our eBook aims to contribute towards these ends.

Spent Nuclear Fuel Drives Growing Fear Over Plant in Japan

TOKYO — What passes for normal at the Fukushima Daiichi plant today would have caused shudders among even the most sanguine of experts before an earthquake and tsunami set off the world’s second most serious nuclear crisis after Chernobyl.

Fourteen months after the accident, a pool brimming with used fuel rods and filled with vast quantities of radioactive cesium still sits on the top floor of a heavily damaged reactor building, covered only with plastic.

The public’s fears about the pool have grown in recent months as some scientists have warned that it has the most potential for setting off a new catastrophe, now that the three nuclear reactors that suffered meltdowns are in a more stable state, and as frequent quakes continue to rattle the region.

The worries picked up new traction in recent days after the operator of the plant, Tokyo Electric Power Company, or Tepco, said it had found a slight bulge in one of the walls of the reactor building, stoking fears over the building’s safety.

To try to quell such worries, the government sent the environment and nuclear minister to the plant on Saturday, where he climbed a makeshift staircase in protective garb to look at the structure supporting the pool, which he said appeared sound. The minister, Goshi Hosono, added that although the government accepted Tepco’s assurances that reinforcement work had shored up the building, it had ordered the company to conduct further studies because of the bulge.

Some outside experts have also worked to allay fears, saying that the fuel in the pool is now so old that it cannot generate enough heat to start the kind of accident that would allow radioactive material to escape.

But many Japanese have scoffed at those assurances and point out that even if the building is able to withstand further quakes, which they question, the jury-rigged cooling system for the pool has already malfunctioned several times, including a 24-hour failure in April. Had the failures continued, they would have left the rods at risk of dangerous overheating. Government critics are especially concerned, since Tepco has said the soonest it could begin emptying the pool is late 2013, dashing hopes for earlier action.

“The No. 4 reactor is visibly damaged and in a fragile state, down to the floor that holds the spent fuel pool,” said Hiroaki Koide, an assistant professor at Kyoto University’s Research Reactor Institute and one of the experts raising concerns. “Any radioactive release could be huge and go directly into the environment.”

Senator Ron Wyden, Democrat of Oregon, expressed similar concerns during a trip to Japan last month.

The fears over the pool at Reactor No. 4, amplified over the Web, are helping to undermine assurances by Tepco and the Japanese government that the Fukushima plant has been brought to a stable condition and are highlighting how complicated the cleanup of the site, expected to take decades, will be. The concerns are also raising questions about whether Japan’s all-out effort to convince its citizens that nuclear power is safe kept the authorities from exploring other — and some say safer — options for storing used fuel rods.

“It was taboo to raise questions about the spent fuel that was piling up,” said Hideo Kimura, who worked as a nuclear fuel engineer at the Fukushima Daiichi plant in the 1990s. “But it was clear that here was nowhere for the spent fuel to go.”

The worst-case situations for Reactor No. 4 would be for the pool to run dry if there is another problem with the cooling system and the rods catch fire, releasing enormous amounts of radioactive material, or that fission restart if the metal panels that separate the rods are knocked over in a quake. That would be especially bad because the pools, unlike reactors, lacks containment vessels to hold in radioactive material. (Even the roof that used to exist would be no match if the rods caught fire, for instance.)

There is considerable disagreement among scientists over whether such catastrophes are possible. But some argue that whether the chances are small or large, changes should be made quickly because of the magnitude of the potential calamity.

Senator Wyden, whose state could lie in the path of any new radioactive plumes and who has studied nuclear waste issues, is among those pushing for faster action. After his recent visit to the ravaged plant, Senator Wyden said the pool at No. 4 poses “an extraordinary and continuing risk” and the retrieval of spent fuel “should be a priority given the possibility of further earthquakes.”

Attention has focused on No. 4’s spent fuel pool because of the large number of assemblies filled with rods that are stored at the reactor building. Three other reactor buildings at the site are also badly damaged, but their spent fuel pools held fewer used assemblies.

According to Tepco, the pool at the No. 4 reactor, which was not operating at the time of the accident, holds 1,331 spent fuel assemblies, which each contain dozens of rods. Several thousand rods were removed from the core just three months before so the vessel could be inspected. Those rods, which were not fully used up, could more easily support chain reactions than the fully-spent fuel.

Mr. Koide and others warn that Tepco must move more quickly to transfer the fuel rods to a safer location. But such transfers have been greatly complicated by the nuclear accident. Ordinarily the rods are lifted by giant cranes, but at Fukushima those cranes collapsed during the series of disasters that started with the earthquake and included explosions that destroyed portions of several reactor buildings.

Tepco has said it will build a separate structure next to Reactor No. 4 to support a new crane. But under the plan, released last month, the fuel removal will begin in late 2013.

The presence of so many spent fuel rods at Fukushima Daiichi highlights a quandary facing the global nuclear industry: how to safely store — and eventually recycle or dispose of — spent nuclear fuel, which stays radioactive for tens of thousands of years.

In the 1960s and 1970s, recycling for reuse in plants had seemed the most promising option to countries with civilian nuclear power programs. And as Japan expanded its collection of nuclear reactors, local communities were told not to worry about the spent fuel, which would be recycled.

The idea of recycling fell out of favor in some countries, including the United States, which dropped the idea because it is a potential path to nuclear weapons.

Japan stuck to its nuclear fuel cycle goal, however, despite leaks and delays at a vast reprocessing plant in the north forcing utilities to store a growing stockpile of spent fuel.

“Japan did not want to admit that the nuclear fuel cycle might be a failed policy, and did not think seriously about a safer, more permanent way to store spent fuel,” said Tadahiro Katsuta, an associate professor of nuclear science at Tokyo’s Meiji University.

The capacity problem was particularly pronounced at Fukushima Daiichi, which is among Japan’s oldest plans and where the oldest fuel assemblies have been stored in pools since 1973.

Eventually, the plant had to build an extra fuel rod pool, despite suspicions among residents that increasing capacity at the plant would mean the rods would be stored at the site far longer than promised. (They were right.)

Tepco also wanted to transfer some of the rods to sealed casks, which have become a popular storage option worldwide in recent years, but the community was convinced that it was another stalling tactic.

Chipotle's Undocumented-Worker Problem Resurges

(Updates quote from Emily Tulli in the last paragraph.)

Chipotle (CMG), the fast-growing, burrito-slinging chain, has become the government’s highest-profile target in its campaign against employers of illegal immigrants. For the past two years, Chipotle has been subject to a probe by the U.S. Attorney’s office in Washington and the U.S. Immigration and Customs Enforcement. Now the Securities and Exchange Commission is looking into Chipotle’s statements and disclosures for possible criminal wrongdoing, the company revealed in a regulatory filing on May 22.

President George W. Bush’s administration specifically targeted workers in raids that traumatized communities and companies. (I wrote about a raid on a Swift [JBSS3:BZ] meatpacking plant in 2008.) President Barack Obama’s administration has gone after employers, forcing them to take more responsibility for whom they hire.

As a result of ICE’s investigation, which began in 2010, Chipotle fired about 450 Minnesota workers who couldn’t confirm the validity of their work documents. It also conducted audits in other states. Chipotle provided more than 300,000 pages of documents to the government agencies. And it had begun using the Department of Homeland Security’s E-verify program which, as its name suggests, verifies the documents provided by potential employees. “We thought it was winding down, so we were surprised last Wednesday when the SEC called our lawyers and said they would be subpoenaing documents,” Chipotle’s Co-Chief Executive Officer Montgomery Moran said at a Morgan Stanley (MS) conference on Wednesday.

So why now? And why the SEC? “The SEC likes to flex its muscles in areas that are hot buttons for the administration and this may be one of them. I don’t think Chipotle has been flagrantly violating any laws. I suspect this has more to do with the SEC trying to get a little more aggressive,” says Richard Fearon, managing partner of Accretive Capital Partners, a fund that invests in the industry but not in Chipotle. The agency declined comment via e-mail.

Meanwhile, the workers who were fired have been pushed into the underground economy, where companies don’t conduct background checks–or pay minimum wage or taxes, either. “Audits actually create worse working conditions overall because their scrutiny of employers who keep everything above board has the perverse effect of letting off-the-books employers off the hook,” says Emily Tulli, an attorney with the National Immigration Law Center. (Tulli backed off her earlier comment to us about Chipotle being an industry leader on compensation, saying she doesn’t have any personal knowledge of Chipotle’s employment practices.)

As Bank Loans Dry Up in Spain, Small and Medium Businesses Fight for Life

ZARAGOZA, Spain — There was a time when Ivan Moreno, 34, felt he was on the verge of something big — when it seemed right to settle his rapidly expanding skateboard company into a modern warehouse on the outskirts of this city, when orders piled up from stores around the world.

Those days are gone.

Like the owners of many small and medium-size companies in Spain, he is just struggling to stay alive now, a victim, he says, of the vast restructuring of Spain’s banking sector after the collapse of the real estate bubble in 2008. Mr. Moreno said his bankers closed his roughly $250,000 credit line step by step, imposing harsh repayment plans and effectively strangling his young business.

“So many times, I went to the bank and said, ‘What did I do wrong?’ ” said Mr. Moreno, who recently had to lay off almost all of his employees, including a childhood friend. “But they just said they wanted their money back.”

Experts say that what happened to Mr. Moreno is happening to small companies all over Spain, as many of the regional savings banks that such businesses once relied on are being eliminated or swallowed up, in a series of steps intended to deal with the hundreds of billions of dollars in bad loans from the real estate meltdown.

Whether the strategy is working remains an open question. Moody’s recently downgraded more than a dozen Spanish banks, including the two largest, and on Friday, a major bank warned that it would need an additional $23.9 billion in aid, far beyond what the government estimated when it seized the bank this month.

But experts say there is little doubt that the loss of credit is hurting smaller businesses, contributing to Spain’s troubles by raising unemployment and cutting tax revenues, making it harder to bring its budget deficit down to manageable levels. The credit loss hits particularly hard in Spain, where more than 60 percent of the economy, and 80 percent of the jobs, come from small and medium-size companies. More than 500,000 small businesses have shut down in the last few years.

Mr. Moreno said that one year his company, Nomad Skateboards, sold more than $1.3 million worth of skateboards and accessories in 20 countries. These days he is looking for a buyer for his warehouse and trimming his product line to just skateboards and T-shirts. “If you cannot buy, you cannot sell,” he said. “If you cannot sell, you cannot make a profit.”

Many are done in by their inability to get the credit they need to run day-to-day operations. “The savings banks that these people got their loans from don’t even exist anymore,” said Alfonso García Mora, director general of AFI, a Madrid-based financial consultancy. “Those banks have been taken over by bigger banks that aren’t interested in these kinds of loans. Or they have been taken over by banks in another region, where the local businessman is not known.”

Such changes might be felt for years to come.

“We have lost that local knowledge,” Mr. Mora said, “and it was crucial to deciding whether or not to make a loan. It is a problem we will have for a long time.”

A few years ago, Spain had 45 regional savings banks. Today, there are only 13 and even their future is uncertain. Some have been merged with other banks and others have been taken over by bigger, more robust banks as part of efforts to reassure global markets.

Many business owners say the regional bankers they worked with, sometimes for decades, may still be sitting in their chairs at the local office. But they no longer have the power to approve loans, even if they wanted to, and usually they are just delivering bad news.

That means trouble in a country with 25 percent unemployment and no signs of an economic recovery. The warehouse district that is home to Mr. Moreno’s company is virtually deserted these days. Charo Albás Vives, who owns a children’s shoe company, Colores, is in similar straits. Her bank withdrew her $65,000 credit line two years ago.

At first, she said, the bank wanted her to return only half of it. But after she managed that, the bank told her that she would have to repay the rest, starting immediately.

Ms. Albas, who has six children, said the payments forced her family to make all sorts of economies. “We stopped going to the good grocery store,” she said. “We cut back on everything, even the heating.”

It also meant that she could no longer afford the brightly colored inventory her stores were famous for. “We concentrate on white and blue now,” she said.

She has survived, she said, thanks to loans from her family, though 13 of 25 stores have closed.

Before the crisis, experts say, it was probably too easy to get loans; banks operated with too little equity and lent too much. Regional banks, in fact, made many of the most problematic loans to real estate developers. Now, as the banking sector struggles for survival, lending to private companies and households has dropped precipitously.

“The cuts in credit have been so abrupt that some businesses not only lost specific projects they were working on,” said Carlos Ruiz Fonseca, the director of economy and innovation at Cepyme, Spain’s association of small and medium-size companies. “Some companies have just gone out of business.”

Despite the mergers and injections of capital from the banking bailout and reconstruction program begun by the government in 2009, there has been no improvement in lending. According to the Bank of Spain, credit to the private sector fell in March, as it has virtually every month since the fall of 2009. Some businesses say they do not even bother asking for loans anymore.

Getting loans to start a company may be even harder. “How are you going to get new businesses going if there is no one willing to take a risk and lend you money?” said Edward Hugh, an economic guru who blogs on Spain’s economy. “The problems become circular and self-perpetuating.”

 Banking officials agree that the restructuring has made credit harder to come by, but they say they can do little about it. “The banks here are asked to provision more capital to guard against loan losses,” an official from CECA, the Spanish savings bank association, said. “And if they are asked for more capital, then the possibilities of giving credit are limited.”

Some companies have found innovative ways to do business without credit. Emilio Díaz, for instance, who founded a bus and train window factory in Zaragoza in 1969, said that rather than borrow to cover the cost of glass for a big contract, he recently made an agreement with his supplier to pay for the glass after he is paid for the windows.

Other companies have found that doing business with several different banks helps. Olga Rioja Navarro, the financial director of Lacasa, a chocolate manufacturer that has lost 20 percent of its credit line, says she juggles her business among nearly a dozen banks. These days she says the banks are more likely to give the company a loan against a specific unpaid invoice, for instance, than for day-to-day expenses.

Mr. Moreno and his partner, Chus Castejón, hope they can find a private investor. But they fear that their brand will lose hard-to-reclaim momentum in the fashion-conscious world of skateboarding. “Sometimes you have your moment, and then you can’t get it back,” Mr. Castejón said. “And that makes me so angry.”

Recently Mr. Moreno and his wife invited some friends for dinner. The gathering was hard for Sergio Eltoro, 34, who grew up with Mr. Moreno and worked for him for nearly 10 years before being laid off recently. He loved his job and now finds himself facing questions he thought were settled, like, “What am I going to do with myself tomorrow?”

The Phony Regulation Debate

American business has always chafed at regulation, but rarely have the cries of outrage been as shrill as during the Obama administration. The United States Chamber of Commerce has moaned of a “regulatory tsunami of unprecedented force” issuing from Washington. Every Republican candidate this year has run on an antiregulatory platform, and one of the loudest has been Mitt Romney, who has promised to immediately tear down President Obama’s “vast edifice of regulations.”

That is not surprising, since Mr. Romney’s campaign is being bankrolled by big-business interests. The industries making unlimited donations to pro-Romney “super PACs” would prefer that Americans not be reminded that government regulations keep the air and water clean, improve the safety of consumer products, reduce workplace hazards, and prevent destructive financial practices.

It is absurd, however, for Republicans to attack Mr. Obama for carrying out an unprecedented “regulatory jihad” when, in fact, the administration has a mediocre record when it comes to curbing dangerous practices by industry. As much as any Republican administration, Mr. Obama’s has focused narrowly on the costs of a rule compared to its benefits, and has for political reasons rejected rules opposed by business. The results have often disappointed environmentalists and consumer advocates.

The administration has adopted sensible and important rules to ensure health, safety and economic security. Increased automobile fuel efficiency standards, imposed in 2010, will reduce dependence on foreign oil, improve the environment, and save money for consumers. Requiring power plants to reduce emissions of mercury and other toxic pollutants, and cutting smokestack emissions over 27 Eastern states, will improve public health. Other rules have raised truck safety standards. The president fought hard for the Dodd-Frank financial bill, which, if properly carried out, could protect consumers and help reduce the banking abuses that led to the Great Recession.

Nonetheless, the administration has issued slightly fewer rules than George W. Bush did at the same point in his tenure. A draft of its most recent report to Congress says that the $19.8 billion cost to the economy associated with all of its major rules through 2011 was slightly less than the cost of regulations issued in the last years of the Bush administration. But the administration says the $91 billion in health and other social benefits of those rules was about 30 times greater than those from the Bush regulations.

The White House’s restraint means that two-thirds of the rules required to carry out Dodd-Frank have yet to be finalized, to cite one example. And there are numerous other examples of capitulation to political or industry pressure:

¶Last month, the Labor Department withdrew a proposed rule that would have reduced the deaths of children working on farms by prohibiting them from using power equipment and working in silos and stockyards. Farm lobbyists had loudly protested the rule, but human rights advocates rightly pointed out that the rule was needed to protect migrant teenage workers.

¶Workplace regulation has ground to a halt, largely because of the kind of cost-benefit analysis imposed by Congress and championed by the administration’s regulatory czar, Cass Sunstein. A rule limiting exposure to silica dust, which can cause cancer and other illnesses in the road-building and sandblasting industries, has been in the works for 14 years. Hundreds of doctors and safety experts have urged the administration to issue the rule, but it is stalled while the White House weighs the benefits.

¶The single biggest disappointment has been the president’s refusal to tighten the national standards on smog, clearly giving way to re-election concerns in the face of industry pressure. In August, when a pulmonologist explained the terrible effects of ozone on the lungs of children, William Daley, the White House chief of staff at the time, responded, “What are the health impacts of unemployment?” That is precisely the kind of false choice that big business and Republicans constantly demand, as if jobs and the economy cannot survive if public health is protected.

Mr. Daley’s telling remark shows how ridiculous it is for Mr. Romney to claim that agencies can now impose any rule they like with little or no presidential oversight. In the end, no amount of capitulation by the Obama administration will end the attacks from the right. In fact, Republicans are running against the rejected ozone rule anyway, insisting that Mr. Obama will eventually adopt it.

Let Facebook's fumbled stock offering be a warning to anyone thinking about trading Facebook's soon-to-be listed options.

Because the stock (ticker: FB) has behaved so atrociously since the initial public offering, the options are initially expected to be too expensive to buy and too cheap to sell when they begin trading Tuesday.

"On Day One you will be able to drive a truck through the spreads." predicts a senior executive at a major Wall Street firm. "Don't buy options until she settles in."

In other words, the prices at which dealers will be willing to buy and sell—the bid and ask—are expected to be wide in reflection of the uncertainty about Facebook's stock price. Wide spreads create more profits for dealers. Wide spreads mean bad prices for investors.

But if only it were that simple. Options prices are more nuanced than just quoted market prices.

Implied volatility, which is the most critical and most subjective part of options pricing models, is expected to initially be unusually high and elastic when Facebook's options begin trading. Dealers will likely set implied volatility at 50% to 55%, keying off the volatility of other social-media stocks, including LinkedIn (LNKD), Zynga (ZNGA) and Google (GOOG), which some dealers reference because it is, like Facebook, a large-capitalization stock.

A 55% implied volatility implies Facebook's stock will move about 3.4% each day, a level that could prove too conservative, or not conservative enough. The talk in the options market is that Facebook's volatilities will initially be, according to one senior exchange executive, "super-high, and that's a recipe for volatile volatility."

So even if Facebook's options are priced at 55% implied volatility, the volatility could drop to 45% or surge to 85% depending on options demand and stock action.

"No one knows how to set Facebook's volatility," says a senior trader at a top options market-making firm. "If no one's pricing models agree, volatility will move around as the models bump into each other."

And then there is the issue of all the investors who think Facebook's stock is poised for a nasty fall. Not a Pets.com dirt nap, but a strong correction reserved for any stock that trades over 75 times earnings. Initial options strike prices will be as low as $16, or about 40% below Facebook's stock price.

BECAUSE SO MANY INVESTORS want to short Facebook's stock but can't borrow shares, a lot of them are expected to buy Facebook's puts since puts rise in value when stock prices decline. In anticipation, options dealers will likely raise volatility to offset the risk of effectively being short Facebook stock. If they have to sell puts—and they do—they are effectively letting other investors short stock, and that creates problems for dealers who must offset the risk.

Despite those difficulties, the uncertainty around Facebook will prove extremely attractive to many aggressive investors. They will want to sell Facebook's high-priced puts to bet that implied volatility will ultimately settle at a lower price as dealers better understand options and stock trading patterns. We even recommended this strategy, but that was before Facebook's IPO proved so problematic.

If you decide to trade Facebook's options on Tuesday, use limit orders. If you use market orders, you will get steamrolled. In fact, some banks are limiting market orders on Facebook to 500 contracts, down from 10,000, on the first day Facebook's options trade to prevent the kind of fiasco that occurred in the stock market.

Limit orders let you pick the price you want to buy or sell. Market orders let dealers decide your price. In a normal market, market orders are not terrible, but right now nothing is normal about Facebook. 

If Financed, Projects Could Create More than 28,000 Jobs in Design and Construction

Contact: John Schneidawind
202-626-7457
johnschneidawind@aia.org
twitter.com/AIA_Media

For immediate release:
Washington, D.C.  – January 19, 2012 – Barely more than two and a half months after its launch, the American Institute of Architects’ stalled projects database now contains 36 projects worth a total of almost $1.2 billion, and 50 (both anonymous and public) investors looking for projects to finance, the AIA announced today.

Launched on November 7, the AIA’s stalled projects database, housed at www.aia.org/stalledprojects, is designed to let developers and architects network with investors interested in lending to projects that have been stalled primarily due to lack of financing. The database seeks to addresses the persistent lack of financing facing the construction sector, which has an unemployment rate of 16 percent, almost twice the national average.

According to a study by George Mason University economist Stephen J. Fuller, each $1 million in new construction spending supports 28.5 full-time, year-round-equivalent jobs. If each of the projects listed in the database obtained financing, according to this equation, 28,500 jobs could be created nationwide.

“This effort by the AIA to match projects with investors has no precedent we know of, and so we have to be pleased with the development of the database so far,” said AIA President Jeff Potter, FAIA. “We won’t be satisfied, however, until we see deals being consummated at a rapid pace as a result of our efforts.”

“In large part the fortunes of the entire U.S. economy rest on whether the design and construction industry can create jobs,” said Potter.

The credit crunch crisis in design and construction shows no signs of abating. A report issued by the AIA’s economics and market research group finds that the share of projects stalled due to financing problems through August 2011 has almost doubled since 2008 and that one-in-five stalled projects directly result from financing problems. Indeed, almost two-thirds of architects responding to a May AIA survey reported at least one project stalled due to lack of financing.

About The American Institute of Architects
For over 150 years, members of the American Institute of Architects have worked with each other and their communities to create more valuable, healthy, secure, and sustainable buildings and cityscapes. Members adhere to a code of ethics and professional conduct to ensure the highest standards in professional practice. Embracing their responsibility to serve society, AIA members engage civic and government leaders and the public in helping find needed solutions to pressing issues facing our communities, institutions, nation and world. Visit www.aia.org.

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The Party Animals at the Secret Circus

WASHINGTON

THE Secret Circus, as the traveling Secret Service extravaganza is known, had come to town. And the pack of macho Secret Service agents were hitting the clubs, drinking and hanging out with comely young women in alluring outfits.

That was half a century ago in Fort Worth at the Press Club and a joint called the Cellar, where the waitresses wore only underwear. The carousing started after midnight on Nov. 22, 1963, the day the agents were charged with keeping President Kennedy and Jackie safe in Dallas.

Boys will be boys. And no one doubts that being an agent is a tough job. John Malkovich, playing an aspiring presidential assassin in “In the Line of Fire,” muses to Clint Eastwood’s Secret Service agent: “Watching the president, I couldn’t help wondering why a man like you would risk his life to save a man like that. You have such a strange job. I can’t decide if it’s heroic or absurd.”

The heroism is captured in Robert Caro’s latest book on Lyndon Johnson, “The Passage of Power,” which vividly retells the story of the day J.F.K. was assassinated.

Rufus Youngblood, the Secret Service agent in the vice president’s car, grabbed “Johnson’s right shoulder, yanked him roughly down toward the floor in the center of the car, as he almost leaped over the front seat, and threw his body over the vice president, shouting again, ‘Get down! Get down,’ ” Caro writes, adding that L.B.J. said he would never forget Youngblood’s “knees in my back and his elbows in my back.”

The absurd was captured on Wednesday in a Senate hearing into Secret Service shenanigans, focused on the drinking and prostitution scandal in Cartagena last month, but also touching on an incident in 2008 when an on-duty uniformed agent was arrested for soliciting a D.C. police officer posing as a hooker, and an episode in 2002 when three to five agents were ordered home from the Salt Lake City Olympics for misconduct involving alcohol and under-age girls in their hotel rooms.

As The Washington Post reported, noting that some Secret Service employees call the road show “the Secret Circus,” one 29-year-old agent who was forced to resign after the Cartagena meshugas is protesting that he did not know the two women he brought to his room were prostitutes. Like Dudley Moore in “Arthur,” he just thought he was doing great with them.

Mark Sullivan, the Secret Service director, came across like a credulous Boy Scout under rigorous questioning from Senator Susan Collins of Maine, the ranking Republican on the homeland security panel.

He said he was sure, given that the Secret Service had 200 people in Colombia and only 12 bad apples, that someone on his team would have reported the misconduct — even if Arthur Huntington, the cheapskate cheating agent, hadn’t started a ruckus by handing his hooker $28 for a night worth $800.

Collins reminded Sullivan that he had told the panel about a survey of personnel in the Secret Service — a muscular fraternity that indulges a wheels-up, rings-off swagger — showing that only about 58 percent would report ethical misconduct.

“I came away with a sense of disbelief that Mr. Sullivan is still maintaining that this was an isolated event,” she told me. “I think he’s an extraordinarily honorable person who is so blindly devoted to the Secret Service that he just cannot conceive of agents’ acting in a way that he would personally never act.

“It’s going to make it difficult for him to truly solve the problem if he can’t admit that there was a problem.”

Collins professed a special fondness for law enforcement officers. “But most of the ones I know who have had 29 years of service have a less sanguine view of human nature,” she said. “That’s what Mark Sullivan totally lacks.”

Dryly, she noted: “Thank goodness it was just prostitutes. They could have been spies planting equipment. They could have blackmailed or drugged agents. This is Colombia, for heaven’s sake.”

Collins talked about the actions that led her to believe that the culture of the agency was warped.

“The 12 agents didn’t go out on the town together in one group, where arguably some could have gotten swept away with what was going on,” she said. “They went in small groups but with the same end results.

“And they made no effort whatsoever to conceal what they were doing. They were registered under their own names. The women registered under their own names. They didn’t go to an alternative place or to the women’s homes. They went back to the hotel where the other agents were staying, with no fear of ramifications if they were caught.”

Pronouncing herself “astonished,” Collins said she would keep after Sullivan to treat the matter more seriously.

The EU’s implementation of Basel III: A deeply flawed compromise

By all accounts, EU member countries have for months been debating how to implement the minimum bank capital standards agreed under Basel III. Their arguments have unfolded as the EU works to complete its fourth Capital Requirements Directive and its Capital Requirements Regulation (see Veron 2012).

Three issues have been contentious:

• Whether member countries should be permitted to enact minimum capital ratios considerably tougher (higher) than those specified under Basel III without approval of the EU;
• Whether the restrictions on what can be counted as high-quality capital under Basel III should be scrupulously adhered to in EU legislation; and
• Whether the Basel III deadlines for introducing an unweighted leverage requirement for bank capital and two new quantitative liquidity standards (the liquidity coverage ratio and the net stable funding ratio) should be mirrored in EU legislation.

Unfortunately, the decision of the finance ministers announced on 15 May 2012 reflected a compromise that set back the cause of reform, risking further instability for the banking system in Europe and the global economy generally. The European Parliament should demand significant changes before approving this very flawed measure.

It has been reported that in the debates, the UK, Sweden, and Spain, with the support of the ECB, favoured a “yes” on all three questions. For convenience, I call this position the Osborne View – named after perhaps its most ardent proponent, George Osborne (UK Chancellor of the Exchequer). Another group of EU countries, reportedly led by Germany and France, with the support of the European Commission, opposed that position. I call this position the Schäuble View in honour of Germany’s Minister of Finance, Wolfgang Schäuble.

The 15 May compromise at a meeting of EU finance ministers was endorsed unanimously by the Council. Not all the details have been published, but the main features can be summarised as follows.

• Measured against banks’ total exposure, EU members will need EU approval to implement in their national banking legislation minimum (risk-weighted) bank capital ratios that exceed the Basel III minimum by more than 300 basis points.
• For domestic and non-EU exposure, the threshold for EU approval will be higher, at 500 basis points.

These thresholds would allow the UK to implement the recommendations of the Independent Commission on Banking (the Vickers Report) – including the ringfencing retail banking operations and a minimum equity capital ratio of 10%, without EU approval.

• The 15 May accord also permits EU banks to count as equity capital several financial instruments with dubious loss-absorbency, including the so-called “silent participations” of German banks and the minority stakes of French banks in insurance companies.

Such a step weakens the Basel III guidelines on the quality of bank capital. In one of the few concessions to the Osborne View, the agreement adheres to the Basel III time schedules for the leverage ratio and the two liquidity standards. Finally, to provide additional macro-prudential tools against asset-price bubbles in real estate, member countries will be allowed to modify (increase) the bank capital risk-weights against exposures to residential and commercial property.

Over the next few weeks, the European Parliament will discuss these steps and negotiate a final version with EU finance ministers. There are reports that the European Parliament may demand restrictions on bonus payments (in bank compensation policies) before approving the package, however.

Evaluation of the 15 May decisions

From a narrow procedural perspective, the 15 May ECOFIN decision is a step forward on financial sector reform. After all, the Basel III bank capital standards cannot go into effect until they are embedded in national banking legislation and the 15 May ECOFIN decision advances their implementation.

But fundamentally the 15 May decision is a setback for reform.

Basel III’s main purpose was to enhance financial stability and to limit the liability of taxpayers for bank losses by putting much more high-quality bank capital into banking systems around the world. The 15 May decision makes that harder in two ways.

• Requiring EU countries to win approval of the EU for minimum capital ratios much in excess of the modest standards in Basel III will discourage urgently needed strong capitalisation (and recapitalisation) of banks in the Eurozone.
• Watering down the Basel III standards for the quality of bank capital may encourage a race to the bottom on the loss-absorbency of bank capital. Such a development would weaken limits on taxpayer liability for bank losses.

I base my conclusion on five main points that I address in turn.

EU banks are undercapitalised

First, EU banks remain undercapitalised when evaluated by the appropriate metrics. The most reliable metric of capital adequacy – warts and all – is the simple unweighted leverage ratio (the ratio of equity to total assets). All the risk-weighted measures of bank capital have been distorted by political pressures, conflicts of interests, and gaming of the regulations by banks (Helwig, 2010, Admati et al, 2011).

Exhibit A: with all the questions about debt sustainability in some EU periphery countries, the sovereign debt of EU countries still receives a zero risk weight for the purpose of calculating risk-weighted assets, the denominator in all risk-weighted capital ratios. Experience in the run-up to the global economic and financial crisis of 2007-2009 also demonstrated the poor quality of risk-weight calculations for banks’ trading assets, securitised instruments, credit ratings of complex financial instruments, and the estimation of risk-weighted assets in banks’ internal models (Goldstein, 2012).

For this reason alone, the stress tests conducted by the European Banking Authority (EBA), which focus on risk-weighted capital ratios, ought to be viewed skeptically. Indeed, concern over deficiencies of risk-weighted capital metrics led the authors of Basel III to include a minimum (unweighted) leverage ratio over the objection of the banking industry.

The April 2012 Global Financial Stability Review reports that the leverage ratio (the ratio of Tier 1 common capital to adjusted tangible assets) for EZ banks in 2011 was a little more than 4% – versus about 5% for UK banks and roughly 6.5% for US banks (IMF, 2012a).[1]

Other measures of bank fragility point to the weakness of EU banks.

• The IMF (2011) estimated that between end-2009 and August 2011, EZ banks had a €200 billion increase in credit risk associated with holdings of the stressed sovereign debt of Greece, Ireland, Portugal, Belgium, Italy, and Spain.
• Inter-bank exposures to these countries brought the increase in credit risk to €300 billion.

No wonder that IMF Chief Christine Lagarde, speaking in August 2011, emphasised the urgent need for recapitalisation of EU banks (Lagarde 2011).[2]

EZ banks also rely more heavily on wholesale financing than US or UK banks, with loan-to-deposit ratios hovering at 125 – versus 105 for UK banks and less than 80 for US banks. The vulnerability of relying on wholesale funding was of course dramatically underlined in the second half of 2011, when wholesale funding strains for European banks compelled the ECB to launch its three-year Long-Term Refinancing Operation (LTRO) – a two-stage rescue effort that has risen to more than a trillion euros.

While necessary to prevent large-scale liquidity problems from generating massive deleveraging and exacerbating solvency concerns, the LTRO has produced undesirable side effects.

• It has facilitated a carry trade on peripheral sovereign debt that has led banks in those countries to load up even more sovereign debt, aggravating the adverse feedback loop between bank debt and sovereign debt.
• In addition, by tying up large amounts of collateral, the LTRO has further imperiled the position of unsecured bank creditors in the medium term. Spanish banks alone have enormous exposures to real estate.
• Despite a Spanish housing bubble bigger than the recent one in the US, property prices in Spain have fallen from their peak by less than in the US.

On top of all this, the IMF (2012a, b) has estimated that Eurozone banks are likely to face pressures to deleverage more than $2 trillion of bank assets by the end of 2013. The fund has also warned that such deleveraging would slow EU economic activity and reduce the health of its banks.

In the face of such obvious banking fragility in the EU, the 15 May ECOFIN decision on bank capital seems divorced from realities.

With potentially large future EU bank losses on the horizon, constraining the ability of regulators in some EU countries to set minimum bank capital standards in excess of the Basel III minimums is imprudent. Doing so would prevent banks in some EU countries from having enough “self-insurance” to handle potential losses. Consequently, the burden of financing those losses would again fall unfairly on taxpayers and lead to greater dependence on the ECB for liquidity.

Cross-country differences in the size of too-big-to-fail banks call for cross-country differences in minimum capital standards

The 15 May decision also does not adequately address differences among EU countries in the extent of the too-big-to-fail problem and the implications for minimum bank capital ratios. The combined assets of the five largest banks relative to GDP are three times as high in the UK and the Netherlands (at about 450% of GDP) as in Spain and Italy (Goldstein and Veron, 2011).

The greater the size of too-big-to-fail banks in an individual country, the more pressing the need to provide adequate self-insurance against losses in those institutions. Such self-insurance must come from higher bank capital. It is thus no accident that two countries where the combined assets of the few largest banks are particularly large relative to home-country GDP – Switzerland and the UK – have already moved to enact national minimum bank capital standards tougher than those in Basel III (Goldstein, 2011).

The May 15 agreement constrains the ability of EU countries to set such rational self-insurance requirements for their banks. Those EU countries with large banks (relative to home-country GDP) will henceforth face two unpalatable choices. Either they will have to break-up their largest banks to minimise the government’s prospective liability – something that they have so far (unfortunately) refused to consider seriously – or they will have to accept (implicitly) the reality that if these very large banks do come under acute distress, the cost of saving or liquidating them will fall predominantly on taxpayers.

European leaders have pledged repeatedly to spare taxpayers from that burden. More generally, it makes no sense to constrain differences in minimum bank capital ratios across EU countries when there is no pan-EU deposit insurance and bank resolution regime in place and when there are sizeable differences in banking risk across these economies. Such differences reflect troubled legacy assets, sovereign debt burdens, cyclical positions, and longer-term structural factors (like the size of too-big-to-fail banks).

The minimum capital ratios in Basel III are way too low

Third, the minimum capital standards agreed under Basel III itself, while better than those in Basel II, are still way too low. Thus, individual countries – whether or not they are members of the EU – need the latitude to exceed those Basel III minimums in their own national legislation.

Such freedom supports the spirit of successive Basel bank capital agreements, which have always aimed to set minimum standards to prevent a race to the bottom and to avoid maximum standards that would discourage a race to the top. Costly banking crises occur when banks have too little capital – not when they have ample capital.

The literature suggests several approaches for estimating the minimum or optimal ratio of bank capital.

• One derives from the fact that banks typically hold bank capital in excess of the Basel minimums even at the bottom of the business cycle.

Banks arguably behave that way because the markets – nervous about the near-death experience of some banks in the previous crisis – pressure them to do so. The following question is then posed: if we want banks to remain solvent after suffering credit and trading losses in severe crises and still have enough capital to meet the market imposed minimum at the bottom of the cycle, how high would the minimum capital ratio have to be at the top of the cycle?

A recent study by Hanson, Stein, and Kashyap (2010) noted that U.S. banks lost roughly 7% of assets during the 2007-2010 period and that very large U.S. banks had a common tier one capital ratio (relative to risk-weighted assets) of about 8% in the first quarter of 2010 (near the bottom of the cycle). From that, they concluded that the minimum capital ratio needed to be about 15% at the top of the cycle – far above Basel III’s minimum 7% ratio (for common core tier 1 capital) or its 9.5% ratio for the globally most systemically-important banks. Applying this approach to other countries’ bank-loss experience and to banks’ capital holdings at different times generates estimates of minimum (common equity) capital ratios in the 12-25% range. Again, these levels are far higher than the Basel III minimums.

• A second approach is to employ a cost-benefit framework to the estimation of optimal bank capital ratios.

On the benefit side, higher capital reduces the probability of a systemic bank crisis that would depress economic growth and undermine government fiscal positions. On the cost side, higher capital is assumed to increase bank funding costs, lower loan volumes, and impede economic growth. A recent study done at the Bank of England (Miles, 2011) applied such a cost-benefit approach and concluded that the optimal bank capital ratio (as a percentage of risk-weighted assets) was about 20% – more than double the Basel III minimum for even the most systemically-important banks.

Also employing a cost-benefit approach, a group of twenty distinguished professors of finance (Admati et al, 2010a) concluded that the minimum unweighted leverage ratio for banks ought to be at least 15% – five times the minimum leverage ratio (3 percent) included in Basel III. The main reason why the cost-benefit approach leads to (optimal) minimum capital ratios higher than those in Basel III is that while the social benefits of higher bank capital are substantial, the social costs of higher bank capital turn out to be modest.

The yawning gap between the minimum standards in Basel III and the minimum standards derived from the best empirical evidence makes it counterproductive to prevent countries from imposing standards higher than those in Basel III.

The quality, not just quantity, of bank capital matters

Basel III was not just about increasing the quantity of bank capital. It was also about improving the quality of that capital so that it would be truly loss-absorbing.

In this regard, the Basel Committee on Banking Supervision (BCBS) was responding to one of the main lessons of the global economic and financial crisis: when banks are permitted to count financial instruments as regulatory capital that either are not fully loss-absorbing or are loss-absorbing only if and when the bank is being liquidated, de facto bank capital can be much less than regulatory capital and the government winds-up having to inject funds as common equity into the rescue.

To avoid repeating that mistake and to limit the future public-sector liability, Basel III emphasised the highest quality bank capital – namely, equity capital. It also restricted (to 15% of the common equity component) the combined weight of lower-quality financial instruments that had been previously allowed. These components included deferred tax assets, mortgage servicing rights, and significant investments in common shares of unconsolidated financial institutions (including insurance companies).

The parts of Basel III dealing with the quality of bank capital represent a compromise in which the US, Japan, and the EU each agreed to restrict a low-quality component of bank capital that was viewed as attractive by their own banks. For example, Japanese banks were reluctant to disqualify tax deferred assets, U.S. banks wanted to hold on to their mortgage servicing rights, and EU banks – particularly those with large insurance subsidiaries – wanted to retain their minority stakes in unconsolidated subsidiaries.

The 15 May EU agreement threatens to unravel the Basel III compromise on the quality of bank capital – largely to appease some German and some French banks, which do not want to go to the market to raise high-quality bank capital in order meet higher capital requirements under both Basel III and the EBA stress tests. Instead, these banks pressured their governments to convince other EU members that various low-quality capital components should satisfy such capital requirements. In that way, these EU banks can continue to pay dividends and dole out excessive compensation packages to employees.

If the 15 May concessions had not been forthcoming, these banks would likely be judged as under-capitalised.[3] The Schäuble View on the quality of bank capital should be seen for what it is: an effort to use smoke and mirrors to weaken the Basel III restrictions on the definition of high-quality bank capital. Some EU ministries of finance may also see short-term advantage in carrying the banks water on this issue. Recapitalizing the banks via government injections of capital, after all, would increase already high sovereign debt levels and would anger voters fed up with government bailouts of the financial sector.

The EU retreat on the quality of bank capital is likely to have two costly consequences.

• First, French and German banks will have less real, high-quality bank capital than advertised, putting French and German taxpayers on the hook for bank losses in excess of available, truly loss-absorbing capital.

Markets will see through this tactic, so there will be little if any advantage in funding costs.

• Second, giving French and German banks a pass from an important part of Basel III will almost surely encourage U.S. and Japanese banks, among others, to press for similar concessions from their national regulators, invoking other low-quality components of bank capital relevant to their balance sheets.

If successful, such efforts will weaken the effectiveness of the overall Basel III agreement and thwart one of its main objectives – forcing banks to become responsible for financing their own losses, without inflicting costs on innocent bystanders.

Unpersuasive arguments about the effect of higher capital requirements on economic growth and the single market

In campaigning against higher bank capital standards, the banking industry argues that a higher capital ratio will be a calamity in terms of increased bank funding costs, lower loan volumes, and slower economic growth. Unfortunately, most EU finance ministers seem to have bought into that fallacy. In addition, the Schäuble camp trotted out the equally weak argument that permitting EU countries to implement much higher minimum capital ratios than the Basel III minimums would jeopardise Europe’s Single Market.

Perhaps the best rebuttal of this contention has been made by Anat Admati and her colleagues at Stanford Business School and at the Max Planck Institute (Admati et al, 2010a, 2010b, 2011). A summary of their reasoning, which I strongly support, goes as follows.

• The cost of capital depends on the risk to which the capital is put.
• Relying more heavily on equity unambiguously reduces the volatility of the return on equity and lowers the risk premium on equity.
• The required return on equity must therefore decline with an increase in equity.
• The end result is that the bank’s overall cost of capital is likely to be little affected by increasing its capital ratio.

Nor does a higher capital requirement necessarily imply a reduction in loan growth unless banks are allowed to meet that requirement by shedding assets.

Unlike liquidity requirements over bank assets, capital requirements deal with the liability side of bank balance sheets and with funding choices. Banks do not hold the securities they issue; investors do. Capital is therefore not put in a strongbox. Many successful non-financial corporations fund themselves more heavily from equity than banks; yet these companies are not constrained by that funding choice in expanding their investments. Historically, the most severe credit crunches – like the 2007-2009 global crisis – occur when bank capital is very low, not when it is high. When leverage is low, such as the bursting of the internet bubble, the consequences for the macro-economy are much more benign that when leverage is high.

The empirical evidence on the effect of bank capital on bank funding costs and economic growth also supports the Admati View. For the US and UK economies it is possible to get time-series data on bank capital than go back to the 1840s. Over this long history, leverage ratios for bank capital varied widely. At times the ratio was more than four times higher than they are today. Yet statistical tests show no link between higher bank capital ratios and higher bank funding costs or weaker macroeconomic performance (Hanson, Kashyap, and Stein, 2010, and Miles, 2011). The cross-section evidence goes in the same direction. Small banks in the US routinely have much higher capital ratios than large banks, yet this difference has hardly led to their demise. The average capital ratio for non-financial companies in the US is 70 percent. Yet there no reason to believe that such a funding mix has hurt their performance.

The Schäuble View on the impact of bank capital requirements on bank lending also appears to run counter to that of the sitting Chairman of the European Banking Authority (EBA), Andrea Enria. In a recent (April 2012) speech, Enria (2012b, p. 10) said:

“On this, I want to be blunt. I do not believe that high levels of capital are a deterrent to new lending. On the contrary, banks with low capital levels—or perceived by the market as being so – are those that have had problems in increased lending. They either face major funding difficulties – which in turn do not allow them to grant loans – or focus primarily on preserving their meager capital. Banks with large capital positions, by contrast, are less sensitive to cyclical shocks and more likely to pursue lending growth strategies.”

The way in which higher capital requirements are implemented also matters. As argued in Goldstein (2012), when revealing the results of its stress tests and designing bank recapitalisation guidelines, the EBA should have included a firm policy on bank dividends and executive compensation. Any bank that did not meet the minimum capital ratio should have been directed to suspend dividend payments until it reached the target and was no longer in danger of falling below the target over the next year. The EBA should also have included an adverse macroeconomic scenario for the Eurozone to strengthen confidence in the stress test results. Last but not least, the target capital ratio should have been translated into a target for increases in bank capital alone. That step would have avoided giving banks an incentive to meet the target by decreasing the denominator (asset shedding) rather increasing the numerator (raising new capital).

The way forward

To sum up, denying EU countries the scope to raise minimum capital levels above the Basel III minimums, ostensibly to sustain lending and economic growth in the region, flies in the face of both economic theory and the evidence. Here too, the Schäuble View is merely another sop to the banks.

The argument that large differences in minimum bank capital ratios among EU countries would risk splintering the Single Market likewise has little foundation. As maintained by Veron (2012), the largest distortion to the EU market for financial services is that the framework for supervision and resolution of financial institutions remains predominantly national. For this reason, the financial health of banks is tied to the health of their home-country sovereigns. If EU finance ministers want to strengthen the single market for financial services, they should implement an EU-wide framework for deposit insurance and bank resolution, going if necessary beyond the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM) (Roubini, 2012), along the lines of the Federal Deposit Insurance Corporation (FDIC) in the US. Tinkering with cross-country differences in minimum bank capital ratios will do little to advance the Single Market. And if the concern is that individual EU countries with high minimal bank capital ratios would use those minimums to shed assets outside their home market, this should be addressed by negotiating an EU-wide coordination agreement on cross-border bank lending, like the Vienna Initiative of 2009. A “convoy approach” to bank capital – in which EU countries seeking safer banking systems are barred from doing so out of fear of pressure on other EU countries with weaker regimes – will not promote the Single Market. As in the case of Japan’s banking crisis (Posen, 2000), such a convoy approach will delay addressing the problem of under-capitalised banks and weaken economic recovery in the euro zone.

The decision by European finance ministers on EU implementation of Basel III on 15 May is a setback for financial regulatory reform not only in Europe but globally. The priority ought to have been focused on increasing the quantity and quality of bank capital to deal with the under-capitalisation of EU banks and reducing the potential for an adverse feedback loop between bank debt and sovereign debt. Instead, EU finance ministers went in the opposite direction by constraining the ability of EU countries to do more than Basel III on the quantity of bank capital and by weakening Basel III on the quality of that capital. Their action will further undermine confidence in the solvency of EU banks and make resolution of the EU debt crisis more difficult. In addition, it will impede efforts to implement capital reforms of Basel III in the US and Japan, as banks in those countries try to engage in a regulatory race to the bottom.

Fortunately, EU Finance Ministers still must negotiate and agree on a final text of the EU bank capital rules with the European Parliament. The Parliament should take seriously its responsibilities in this area. It should demand significant changes to the 15 May ECOFIN draft agreement. Specifically, the Parliament should press ECOFIN: (i) to raise the (no-EU approval-required) threshold on national bank capital minimum above the Basel III minimum to at least 700 basis points (for total exposure); (ii) to reinstate the Basel III restrictions on what can be counted as equity capital; and (iii) to introduce the amendment that any EU bank failing an EBA stress test with regard either to the common Tier 1 capital ratio or to the leverage ratio should be prohibited from either paying dividends or employee bonuses until it reaches the bank capital target and is (in the EBA’s judgment ) not in danger of falling below the capital target over the next year. If these negotiations between the Parliament and EU Finance Ministers take a month or two, so be it: better to take the time to hammer out an agreement that promotes reform on bank capital than to rush into a compromise that undermines it.

By LIAM DENNING

Friday afternoon is fast becoming prime-time for Chesapeake Energy . For the third week in a row, shareholders were treated to a late announcement. This time, it confirmed the news that had already boosted the flagging stock 10% this past week: Activist Carl Icahn is back.

As a 2010 academic study of Mr. Icahn's investment impact concluded, he is attracted to highly leveraged companies. Chesapeake, carrying over $30 billion in debt and other obligations on $3.5 billion of annual cash flow, according to ISI Group estimates, fits the bill.

But as he wrote in his letter to the board, this isn't Mr. Icahn's first tilt at Chesapeake. Its stock soared after he disclosed a 5.8% stake back in December 2010 and Chesapeake said it would rein in its spending. But he started cutting that position as soon as March 2011, with the stock trading around $38. Fast forward, and the stock now trades around $16, and Chesapeake has just taken on an expensive loan of $4 billion to ease liquidity concerns.

Mr. Icahn has 7.6% this time and alleges the board let the company renege on promises made in 2010. To prevent this from happening again, he wants representation—although it is unclear why he didn't pursue this last time despite "recognizing this fundamental problem with the board" back then.

Having Mr. Icahn on board is useful, not least because it might stiffen the spines of Chesapeake's other shareholders. But as that 2010 study concluded, his best results have usually come when the company he targets ends up selling itself. Chesapeake, with its complicated capital structure, wouldn't be an easy sell. Certainly, despite the stock-price slump and Chesapeake's consistent refrain that it is hugely undervalued, no bidder has emerged publicly to date.

Write to Liam Denning at liam.denning@wsj.com

In Egypt’s Likely Runoff, Islam Vies With the Past

CAIRO — The runoff to become Egypt’s first freely elected president is shaping up as a contest between two of the most powerful and polarizing forces in Egyptian society: political Islam or the leadership of the past.

After a wild and fluid two-month campaign by more than a dozen candidates, Mohamed Morsi of the Muslim Brotherhood and Ahmed Shafik, a former air force general who served as President Hosni Mubarak’s final prime minister, emerged with the most votes on Friday, according to independent tallies and the official state news media.

Mr. Morsi won about a quarter of the vote and Mr. Shafik slightly less, effectively reprising the power struggle decades old between a military-backed, secular strongman and Islamists from the Muslim Brotherhood. At least for the moment, the results appeared to dim the hope that last year’s popular uprising would open a middle path, transcending divisions that kept Egypt paralyzed between fear of religious radicalism and fear of the secular police state.

The outcome provoked frantic warnings on Friday of either a counterrevolution should Mr. Shafik win, or an Islamist takeover, should Mr. Morsi emerge as the next president. The candidates who tried to offer a more unifying vision — and were critical of both the Mubarak era and the Brotherhood — failed to overcome the deep divisions in Egyptian society.

The result will be a runoff that offers a wrenching choice for the majority of voters who cast their ballots for one of the other candidates.

“It is a shock,” said Ahmed Kabany, 38, an engineer, after the voting. “I don’t want either one, so I am not going to vote.”

Although Mr. Shafik never explicitly promised to resurrect the old order, he campaigned as a strongman who would crack down on street protests, restore law and order and check the power of the Islamists. He surged in popularity toward the end of the campaign, by playing to voters’ fears of crime and lawlessness, and to the worries of Egypt’s Christian minority about the growing power of the Islamists, who already control Parliament.

And he never backed away from comments he made during the uprising against Mr. Mubarak comparing the insurrection to a disrespectful child who slaps his father.

Mr. Morsi, facing a serious challenge from an Islamist rival during the campaign, reverted to a conservative and expressly religious appeal, portraying his platform as a distillation of Islam itself while promising to carry out Islamic law.

Although both candidates have pledged to support the peace treaty with Israel, the runoff set up a stark choice between the Brotherhood’s vows to unite Palestinian factions in order to increase pressure on Israel to recognize a Palestinian state and Mr. Shafik’s pledges of continuity with positions of the former government.

Though official final results are to be released in a few days, early returns show that about 20 percent voted for Abdel Moneim Aboul Fotouh, a former Brotherhood leader campaigning as both an Islamist and as a liberal in an effort to break out of Egypt’s culture war. And another roughly 20 percent voted for Hamdeen Sabahi, a secular populist with a record of fighting the Mubarak government on behalf of the poor. (Fifth place went to Amr Moussa, a former foreign minister who presented a softer and more conciliatory version of Mr. Shafik’s secular law-and-order appeal.)

Handicapping the runoff was all but impossible. Although candidates from the Muslim Brotherhood or more conservative Islamist parties won about three-quarters of the seats in Parliament, Islamists and more secular candidates split the vote in the first stage of the presidential election. It was unclear whether voters who picked Mr. Sabahi, the secular populist, would lean toward Mr. Morsi to avoid returning a Mubarak minister to power, or to Mr. Shafik in order to avoid giving so much power to the Brotherhood. But at the end of the day, the possibility of low turnout favors the Brotherhood because its vast political machine can drive its voters to the polls.

As soon as the results became clear, each of the two leading candidates began to try to shift to the center, by rallying against the other. In a Friday night news conference, officials of the Muslim Brotherhood announced that they were inviting the other “revolutionary candidates” — effectively, all but Mr. Shafik — to a meeting to talk about a coalition to oppose the former prime minister and about sharing power in a Brotherhood-led government.

“Rescuing the homeland includes securing victory for a candidate who belongs to the revolutionary camp, and the camp that struggles against the old regime,” Essam el-Erian, a Brotherhood lawmaker, said, trying to portray Mr. Morsi as the champion of the whole popular uprising and not just the Islamist forces.

Supporters of Mr. Shafik, meanwhile, circulated a cellphone message urging unity against the Brotherhood. “I beg you to please put your differences aside and go vote for Shafik not because you believe in him but because it will be a catastrophe if we consolidate all power to one party (presidency and Parliament)!” the message read. “History has proved, so please spread!”

The race is further complicated by the uncertainty about the powers of the next president. A committee picked by Parliament that was supposed to draft a new charter has become deadlocked in a dispute between Islamists and liberals. The military council that has governed Egypt since Mr. Mubarak’s ouster says it will issue an interim constitution to define the president’s powers, but it has not yet done so.

Mr. Shafik has close ties to the members of the military council, and his opponents often accuse the generals of actively supporting his campaign, but no conclusive evidence has emerged. Indeed, the Brotherhood has also indicated that it intends to take a conciliatory approach toward the generals, allowing them to preserve the commercial empire they control, protecting their budget from public scrutiny and keeping them out of civilian courts.

Mr. Morsi, the least charismatic of the leading candidates in the race, relied mainly on the Brotherhood’s political machine to turn out his voters. He sat out the one televised debate, and his face barely appeared in his television commercials.

Mr. Shafik, a gruff former fighter pilot, earned the nickname “the Pullover” for the sweaters he wore in television interviews and on campaign posters, apparently to make him seem more approachable. It was all but unheard-of for a Mubarak minister to appear in public without a jacket and tie.

Both Mr. Morsi and Mr. Shafik were derided for their awkward speaking styles. During his brief tenure as prime minister, Mr. Shafik was forced to resign after a humiliating public debate on a television talk show with a liberal critic and author, Alaa al-Aswany. “I fought in wars,” Mr. Shafik said in exasperation at one point. “I killed and was killed.”

His signature campaign commercial plays to the public anxieties about the crime and lawlessness that have swept Egypt since Mr. Mubarak’s ouster, when police and security forces scattered or stopped working. The commercial begins with jarring television images of protests and riots, and the clipped voice of a television newscaster in the background.

Bank Regulators Under Scrutiny in JPMorgan Loss

Scores of federal regulators are stationed inside JPMorgan Chase’s Manhattan headquarters, but none of them were assigned to the powerful unit that recently disclosed a multibillion trading loss.

Roughly 40 examiners from the Federal Reserve Bank of New York and 70 staff members from the Office of the Comptroller of the Currency are embedded in the nation’s largest bank. They are typically assigned to the departments undertaking the greatest risks, like the structured products trading desk. Even as the chief investment office swelled in size and made increasingly large bets, regulators did not put any examiners in the unit’s offices in London or New York, according to current and former regulators who spoke only on condition of anonymity.

Senior JPMorgan executives assured the bank’s watchdogs after the financial crisis that the chief investment office, with hundreds of billions in investments, was not taking risks that would be a cause for concern, people briefed on the matter said. Just weeks before the trading losses became public, bank officials also dismissed the worry of a senior New York Fed examiner about the mounting size of the bets, according to current Fed officials.

The lapses have raised questions about who, if anyone, was policing the chief investment office and whether regulators were sufficiently independent. Instead of putting the JPMorgan unit under regular watch, the comptroller’s office and the Fed chose to examine it periodically.

The bank pushback also suggests that JPMorgan had sway over its regulators, an influence that several said was enhanced by the bank’s charismatic chief executive, Jamie Dimon, long considered Washington’s favorite banker.

Now, as regulators scramble to determine whether the chief investment office took inappropriate risks, some former Fed officials are asking whether the investigation should be spearheaded by the New York Fed, where Mr. Dimon has a seat on the board. Some lawmakers and former regulators also have reservations about the comptroller’s office, which is investigating the trade and was the primary regulator for JPMorgan’s chief investment unit.

“The central question is why Jamie Dimon was able to so successfully convince both its regulators that there was nothing to see at the chief investment office,” said Mark Williams, a professor of finance at Boston University, who also served as a Federal Reserve Bank examiner in Boston and San Francisco. “To me, it suggests that he is too close to his regulators.”

Regulators, for their part, say they cannot micromanage a bank or outlaw its risk taking and did not bow to bank pressure when assigning examiners. William C. Dudley, president of the New York Fed, has said that JPMorgan’s losses did not pose a threat to the bank’s viability. In a statement on Friday, the comptroller of the currency, Thomas J. Curry, said, “I am committed to ensuring this agency provides strong supervision for all of the institutions we oversee.”

Regulators are not typically stationed at divisions like JPMorgan’s chief investment office, which are known as Treasury units. The units hedge risk and invest extra money on hand, and tend to make short-term investments. But JPMorgan’s office, with a portfolio of nearly $400 billion, had become a profit center that made large bets and recorded $5 billion in profit over the three years through 2011.

Officials of JPMorgan declined to comment on its relationships with regulators.

Long before the recent trading blunder, JPMorgan had a pattern of pushing back on regulators, according to more than a dozen current and former regulators interviewed for this article. That resistance increased after Mr. Dimon steered JPMorgan through the financial crisis in better shape than virtually all its rivals.

“JPMorgan has been screaming bloody murder about not needing regulators hovering, especially in their London office,” said a former examiner embedded at the bank, adding, in reference to Mr. Dimon, “But he was trusted because he had done so well through the turmoil.”

Even now, executives at JPMorgan disagree with some regulators over how quickly the bank should unwind the soured trade, according to people briefed on the negotiations. JPMorgan would like to be done with the bad bet that has resulted in at least $3 billion in losses already, but senior executives argue it is a delicate process, especially as traders and hedge funds on the opposite side of the trade seize on the fact that JPMorgan is under pressure to exit the position.

Senior staff members at the Federal Reserve want the bank out of the position “yesterday,” according to a regulator privy to the discussions who insisted on anonymity because the talks are private.

Some politicians — including Senator Bernard Sanders, independent of Vermont, and Elizabeth Warren, a Democrat running for Senate in Massachusetts — argue that Mr. Dimon’s position at the New York Fed further compromises regulatory oversight. “Mr. Dimon should not be in a position to have such influence on a major regulator,” Ms. Warren said. When asked on PBS’s “NewsHour” last week about JPMorgan, Treasury Secretary Timothy F. Geithner said that regulators needed to “be above any political influence.” He did not say Mr. Dimon should resign from the Fed, but he acknowledged that the perception of a conflict was “a problem.”

At the bank’s annual shareholder meeting last week in Tampa, Fla., Mr. Dimon pointed out that he served as an economic adviser at the New York Fed. Bankers who sit on the New York Fed do not have a say about the supervision of banks or the writing of rules, but provide guidance on the state of the economy, according to Fed officials. Mr. Dimon, however, has been a vocal critic of some bank regulatory reforms being drafted in Washington.

Current and former regulators said that lower-level officials at JPMorgan had at times tried to undermine their supervision of the bank. JPMorgan has a reputation for challenging regulators more forcefully than rival banks like Citigroup and Goldman Sachs, former New York Fed officials said. Long before the recent trade, an embedded examiner said he had asked for JPMorgan’s three- to five-year capital plan, and after waiting a couple of days was told that the bank’s management had gone over his head and “already sent it to my bosses.” By cutting out lower-level regulators, the bank officials telegraphed a message that those concerns were irrelevant, the former examiner said.

JPMorgan also kept its regulators somewhat in the dark about the troublesome trades. Senior executives, for example, did not tell the Fed that they had changed their value-at-risk measure in the first quarter to evaluate potential losses at the chief investment office. Though reporting such a change was not required, the size of the office alone merited more oversight, said Mr. Williams, the former Fed examiner.

“From a regulatory standpoint, it needs to be scrutinized because it was a hedge fund,” Mr. Williams said.

Bank officials played down the trade after it began to sour, according to a senior supervisor at the Federal Reserve. The supervisor said he was assured in the first week of April that the bank’s senior management was not concerned about Bruno Iksil, the trader who earned the nickname the London Whale for his outsize bets in the credit markets.

The Office of the Comptroller of the Currency is also facing scrutiny about whether it is too cozy with the banks it oversees.

At JPMorgan, when media reports surfaced that the bank was making aggressive bets on credit derivatives, comptroller officials began taking a closer look, people briefed on the matter said. After thumbing through the bank’s own projections for the related risks in early April, the people said, the examiners pushed for more answers but saw no immediate need to change course. The agency notes that it does not bless specific trades.

In a briefing on Capitol Hill last week, two comptroller officials told a room of Congressional staff members that it was “common” and “appropriate” for banks in general to hedge their exposure to various risks, according to people who attended.

Drug for Adults Is Popular as Children’s Remedy

Since it was first introduced 13 years ago, a drug called Miralax — an odorless, tasteless laxative that can be easily diluted in orange juice or water — has become a staple in many American households.

But the way many families use Miralax and its many generic equivalents has strayed far from its original intent. The Food and Drug Administration approved the drug for use only by adults, and for only seven days at a time.

Instead, Miralax has become a long-term solution for childhood constipation — a problem that can be troubling not just physically, but also emotionally — rather than a short-term fix so that parents can change their children’s diets to include more fruits and vegetables.

“I’ve had kids on it daily for years,” said Dr. Scott W. Cohen, a pediatrician in Beverly Hills, Calif., adding that he will generally refer them to a specialist in prolonged cases. For children with chronic constipation who are not being helped by dietary changes, “We literally give it like water.”

No studies have shown that the drug’s active ingredient — polyethylene glycol 3350, or PEG — has severe side effects. But there is a growing chorus of questions about why it has been used and prescribed for children for so many years.

Last week, for example, the Empire State Consumer Project, a New York consumer group, sent a citizen petition to the F.D.A. on behalf of parents concerned about the increase in so-called adverse events related to PEG that health professionals and consumers have reported to the F.D.A. over the past decade.

The warning label on Miralax does not reflect a known risk to children. It means only that no long-term studies that meet the F.D.A.’s standards have been conducted on children using Miralax and its generic counterparts, which work by drawing water into the colon. However, discussion groups on many Web sites suggest that thousands of parents have questions and concerns about it, including the effects of long-term use.

In interviews, more than a dozen doctors nationwide, including pediatricians and gastroenterologists, said that they routinely see young patients who have been on Miralax for months and years. Many doctors acknowledged that they have recommended the use of PEG to treat childhood constipation over long periods.

Dr. Dean Focht, a pediatric gastroenterologist at Geisinger Medical Center in Danville, Pa., has known about Miralax’s popularity for years. He was the lead author of a peer-reviewed study in 2006, the year it became an over-the-counter drug, that found 75 percent of about 350 pediatricians nationwide had suggested parents use Miralax or similar generics to treat childhood constipation.

Dr. Focht said he is seeing more children who having been taking it for long stretches, even though the label warns that it should be used only for seven days and that parents should consult a doctor before treating children younger than 17. “It’s definitely not unheard-of that kids are on it for years,” Dr. Focht said.

Despite the drug’s popularity, it has never been approved by the F.D.A. for pediatric use. In 1999, when the F.D.A. first approved Miralax, the patient materials included the warning: “Miralax should not be used by children.” In 2009, an F.D.A. drug safety oversight board raised a number of concerns about PEG’s use in children, including the uncertainty of the long-term effects of large doses, but concluded that current evidence does not suggest that PEG causes severe side effects.

Even so, some doctors said they are concerned about the lack of information about its long-term effects. “We don’t know 30 years from now what will happen,” said, Dr. Carlo Di Lorenzo, the chief of the gastroenterology department at Nationwide Children’s Hospital in Columbus, Ohio.

Still, Dr. Di Lorenzo, who once did a study financed by a company that produced Miralax before Merck, is not alarmed. “As far as we know, polyethylene glycol is safe,” he said.

In a statement, Merck said it recommends the use of Miralax only for patients 17 and older and only for a week, and added that it “regularly analyzes and reports all adverse event information as part of our ongoing post-marketing surveillance.” Asked whether it plans to conduct studies to get F.D.A. approval for pediatric use, the company declined to say.

After its 2009 drug oversight meeting, the F.D.A. decided that no action was necessary “based on available information.” This week, the agency declined to comment about the citizen petition.

Pediatricians, some of whom acknowledged in interviews that they were unaware of the drug-safety concerns raised by F.D.A. in 2009, said PEG had grown in use because it provides a no-fuss solution to constipation. Often a contributing factor is diet, like too much dairy and too few vegetables and fruits. Other factors include not sitting on the toilet routinely, stress, lack of hydration, being sedentary and school rules that discourage children from using the bathroom as needed.

Rather than tackling those factors, Miralax “can be a Band-Aid,” said Dr. Tricia Jean Gold, a pediatrician at TriBeCa Pediatrics in Park Slope, Brooklyn. When parents try to wean their children off Miralax, “the underlying work isn’t done, so they become constipated again,” she added.

Following a pediatrician’s advice, Mary, a Manhattan mother who asked to be identified only by her first name, started giving her daughter Miralax at 3 years old, when she defecated only every three to seven days, with many tearful hours in between.

“You’re begging her, promising her anything,” Mary said, adding that her child did eat broccoli and pears. Then came “the magic powder,” as she called it. A capful diluted in juice made her regular, but the problem returned when she tried to wean her off it.

After two years of sporadic use of Miralax, another pediatrician told her, “That’s not healthy.” She now gives her daughter, 5, half a capful every other day, and wants to stop using it.

Lillu Tesfa said she never felt comfortable giving her 18-month-old Miralax but did after her pediatrician suggested it. “I did read the label,” which says for adults and children 17 and over, said Ms. Tesfa, who is a contracts administrator for a government contractor in Arlington, Va. “When I brought this up with her, she said, ‘Oh no, don’t worry about it. It’s  completely safe. I’ve had patients on it for years.’ ”

She found a Yahoo group of more than 1,600 people who trade tales of what they believe are troubling side effects from PEG. Not taking any chances, Ms. Tesfa stopped giving Miralax to her daughter, and increased fiber and used lactose-free milk.

Studies of Miralax or PEG cite adverse effects no more severe than diarrhea and bloating. But there have also been no large long-term studies of the effects of PEG on children.

“It’s a drug we use long-term; it’s very effective, has a good safety profile,” said Dr. Samuel Nurko, the director of a center for gastrointestinal disorders at Children’s Hospital Boston. “I’m comfortable prescribing it even though it’s not F.D.A.-approved for children.” (Dr. Nurko has done research partially supported by the former maker of Miralax.)

The F.D.A., however, held the drug safety oversight meeting in 2009, with a neurologist as a guest expert, that raised questions about the perception that PEG is “safe because it is minimally absorbed from the stomach and intestines.” Instead, the board concluded, “little is known about whether absorption in children differs from adults, especially in children who are constipated, have underlying intestinal disease, or are very young.”

Dr. Leo Heitlinger, a pediatric gastroenterologist at St. Luke’s Hospital in Bethlehem, Pa., said doctors can often be complacent about drugs that were never approved by the F.D.A. for children.

Billionaire Finds New Role in Effort to Defeat Obama

When news broke last week that the billionaire investor Joe Ricketts had considered financing a $10 million advertising effort linking President Obama with the fiery race-based rhetoric of his former spiritual adviser, the Rev. Jeremiah A. Wright Jr., Mr. Ricketts quickly distanced himself from the proposal and Mitt Romney’s campaign denounced it.

But Mr. Ricketts is continuing to play a provocative role in the effort to defeat Mr. Obama.

He is involved in another effort slated for this summer, a documentary film based on a widely criticized book, “The Roots of Obama’s Rage” by Dinesh D’Souza, which asserts that Mr. Obama is carrying out the “anticolonial” agenda of his Kenyan father.

Mr. Ricketts’s aides said he was one of roughly two dozen investors, providing only 5 percent of the film’s budget. But his involvement shows how the more strident attacks against Mr. Obama, which Mr. Romney’s aides view as counterproductive, continue to find backing even as the Republican Party and the Romney campaign seek to keep the focus on the economy.

The episode involving the proposed Wright advertisement put new attention on the ability of wealthy donors, working with groups independent of the candidates, to shape the presidential race, and stoked further debate about whether outside groups were driving politics to become increasingly negative.

It also made Mr. Ricketts, who founded TD Ameritrade and is the patriarch of the family that owns the Chicago Cubs, the subject of intensive scrutiny and left his family’s business empire exposed to political backlash. He has refused several interview requests since The New York Times obtained a copy of the proposed Wright campaign. He is not affiliated with the Romney campaign, although he shares a legal adviser with Mr. Romney in Ben Ginsberg, the prominent Republican lawyer in Washington.

But interviews with friends and associates over the past week, along with a review of Mr. Ricketts’s own publicly expressed views, show why he is willing to put millions of dollars behind an effort to defeat the president.

An early glimpse of his views on Mr. Obama can be found in a June 2010 graduation speech he gave at Bellevue University in Nebraska, for which he is a leading benefactor. Lamenting the banking and auto bailouts, he declared, “Our Republic is under assault from our government,” adding the historical note that “most of the past threats have come from outside our borders.”

He called this “a most dangerous time,” when “people begin to second-guess the American experiment” and “flirt with dead-ends like socialism.” It was in that climate, he said, that he had decided to become more personally involved in politics.

Mr. Ricketts’s aides said he was primarily motivated by his concern for the budget deficit and government spending. And he has developed a reputation for supporting Democrats as well as Republicans when he believes they will act on his calls to rein in the deficit.

His political action group Ending Spending is financing a book by the husband and wife economists Ayse and Selahattin Imrohoroglu that in effect argues for an embrace of the bipartisan Bowles-Simpson debt reduction plan. (Called “The Fiscal Cliff: How America Can Avoid a Fall and Stay On Top” and due out late next month, it has a clinical, academic approach.)

In explaining the rejection of the Wright proposal questioning Mr. Obama’s character, which was drafted after Mr. Ricketts held two meetings with the strategists behind it, a top aide said that it reflected “an approach to politics that Mr. Ricketts rejects” and that his role this year would “be focused entirely on questions of fiscal policy, not attacks that seek to divide us socially or culturally.”

Yet the film Mr. Ricketts is helping to finance, called “2016: Obama’s America,” is built on the premise that “Obama has a dream, a dream from his father, that the sins of colonialism be set right and America be downsized,” according to a trailer.

Mr. Ricketts’s aides also said that he had helped pay for newspaper and Internet advertisements promoting Mr. D’Souza’s book in late 2010, one of which called it “the book the White House doesn’t want you to read,” and warned, “The real Barack Obama is even worse than you think.”

Some of Mr. D’Souza’s theories have been widely criticized by prominent conservative and Republican Party leaders. The columnist George F. Will urged Republicans to “recoil” from such views, and wrote last year: “To the notion that Obama has a Kenyan, anticolonial worldview, the sensible response is: If only.”

A review of “The Roots of Obama’s Rage” in The Weekly Standard criticized it for “misstatements of fact, leaps in logic, and pointlessly elaborate argumentation.”

A spokesman for Mr. Ricketts said that he had supported the book and the movie only because of his friendship with Mr. D’Souza, whom he has known for several years. The two men became acquainted through the American Enterprise Institute, a spokesman said, when Mr. D’Souza, now president of the King’s College in New York, was a scholar there and Mr. Ricketts was on its board of trustees.

In response to questions about Mr. D’Souza, Mr. Ricketts said in a statement that he had long been a “proud supporter of his scholarship” and shared his fiscal conservatism, and that he was deeply inspired by his personal story. “As an immigrant from India who built a life for himself in the United States, becoming a respected scholar, a best-selling author, and the president of the King’s College in New York, he embodies to me what American opportunity is all about,” he said.

He also said Mr. D’Souza and he had spent hours together “exploring ideas for my Opportunity Education foundation,” which provides textbooks, televisions, curriculums and advice to schools in developing nations including Ghana, India and what its Web site calls “Palestine.”

Mr. D’Souza did not return calls seeking comment about the film, which he describes on his Web site as “one of my biggest projects ever.” It is produced by Gerald R. Molen, the producer of the Academy Award-winning “Schindler’s List.”

The Web site promoting the film says it is “opening in theaters this June” and warns, “Love him, hate him, you don’t know him.”

Hope and Frustration in New U.S. Effort to Help Homeowners

As mortgage rates have hit one record low after another, millions of homeowners have been forced to watch, longingly, from the sidelines. They haven’t had the option of refinancing because sliding home values pushed their mortgages underwater, meaning they owe more than their homes are worth. The banks would just not work with them.

Yet many of these borrowers are gainfully employed, have solid credit histories and have never missed a mortgage payment. And they want to stay in their homes — even if those homes are worth substantially less than they paid. These are the families that President Obama and other political leaders like to call “responsible” homeowners.

The government’s initial effort, back in 2009, to ease refinancing rules to include them was underwhelming. Now, though, there may be reason for some guarded optimism, as the machinery for a new and improved government refinancing program is finally up and running. And this glimmer of hope for underwater homeowners — as well as borrowers with only a small sliver of home equity — has resulted in a rush of loan applications (even if they are unlikely to secure the lowest, rock-bottom interest rates).

“The updated program is still far from perfect, but most people, both consumers and those in the mortgage industry, would say it’s a huge improvement from what we had in the past,” said Guy D. Cecala, publisher of the newsletter Inside Mortgage Finance. “But the bar was very, very low with the old program.”

The rules for the initial program were restrictive. Partly as a result, only a little more than a million borrowers were helped, far short of the four million to five million initially predicted. So the government tried again, announcing the second iteration of the Home Affordable Refinance Program last fall — called HARP 2.0. It’s too soon to tell whether this latest version will be more successful or whether it, too, will end up in the dust bin of homeowner programs that overpromise and underdeliver.

From the perspective of big banks, borrowers have reason to be hopeful, though they need to be patient. The banks have been inundated with HARP applications — accounting for about 60 percent of all current refinancing applications at Bank of America and 40 percent at Wells Fargo — because of pent-up demand. Many institutions have added staff to handle the volume, and they have a big incentive to keep them motivated: analysts say they stand to make a tidy profit on the business.

But some homeowners and mortgage brokers are telling another story: one of frustration and still more obstacles. They say they’ve found that the program’s rules on paper don’t necessarily translate to the real world.

One of them is Terrence Janas, a 31-year-old software engineer, who bought a two-bedroom condominium in Oak Park, Ill., in 2008 for $280,000. Two virtually identical units recently sold for $150,000; one was a short sale. That has pushed his $237,000 mortgage far underwater; it’s now 158 percent of what his home is worth. He has a healthy income, a credit score of about 760, and simply wanted to reduce his 6 percent mortgage rate.

“HARP was designed to help people in my situation,” said Mr. Janas, who has been trying to refinance for more than a year. “So why was I unable to take advantage of it?”

He said his application was denied by his current lender, GMAC, and about five others. Their reasons ran the gamut. GMAC told him it was because he had lender-paid mortgage insurance. Another told him that his “loan-to-value ratio” was too high — that is, the loan amount, divided by the home’s value — even though HARP 2.0 eliminated the cap. (Previously, only borrowers with ratios of 125 percent or less, meaning they owed 25 percent more than their homes were worth, could refinance.) Another told him he was not eligible for an appraisal waiver, and would need to get one showing that the property was worth at least $206,000, which Mr. Janas knew was unlikely.

But he is still trying, and is now working with a smaller lender who is more optimistic about his prospects. “I haven’t given up,” said Mr. Janas, who is getting married next month and would like to pocket the $400 a month he expects to save with a lower rate.

Still, the number of success stories is edging higher. In the first quarter, HARP loans accounted for about 14 percent of all refinancing activity on loans backed or owned by Fannie Mae or Freddie Mac, according to Inside Mortgage Finance. That’s up from about 12 percent of refinancing activity for each of the last two years.

According to the Federal Housing Finance Agency, Fannie and Freddie’s regulator, HARP 2.0 has only been fully available since mid-March, “and the early results are dramatic,” said Meg Burns, a senior associate director at the agency. About 180,000 loans were refinanced through the program in the first quarter, nearly double the 93,000 loans in the fourth quarter of 2011. Refinancing among borrowers with loans that are more than 105 percent of their home’s value has increased to 41,000 during the first quarter, up from 13,000 in the fourth quarter.

So how can you gauge your chances of refinancing your mortgage through the HARP 2.0 program?

First, you need to meet some basic requirements: Your mortgage must have been owned or guaranteed by Fannie or Freddie, and it must have been sold to either one before May 31, 2009. You must also have less than 20 percent equity in your home (that is, a loan-to-value ratio above 80 percent). And you cannot have had any late payments in the last six months, and no more than one late payment in the last year. HARP is also generally a one-shot deal: this has to be your first HARP refinancing.

Shopping around for a HARP refinancing may be frustrating, however, particularly if you’re trying to compare prices among the big banks. That’s because many of them, including Bank of America, Chase and Citigroup, are providing HARP refinancing only for their own customers. Why? Experts say it is still riskier for the banks to take on new customers, particularly those who are far underwater. It also makes sense for the banks to start with their existing clients, and several are expected to begin marketing campaigns aimed at them next month. But the regulator of Fannie and Freddie said that it should not make a difference whether a new or existing customer was seeking to refinance because it relaxed the rules that leave the banks responsible should a loan sour. Still, experts said, the lack of competition among banks has led to higher prices. It varies by lender, but HARP borrowers could pay more on their interest rate than with conventional refinancing, according to Laurie S. Goodman, a senior managing director at Amherst Securities Group. “The economics of origination would suggest lower rates are in order,” Ms. Goodman said, because mortgage servicers that are refinancing existing customers are relieved of certain risks. Nor, she said, do they have to do much to document the new loans since they already have the customers’ information. “And borrowers have little choice but to pay the higher rates.”

Wells Fargo is working with both new and old customers — though it isn’t accepting new customers with mortgage insurance since it can be difficult to transfer the insurance to the new loan. (Experts said there had been problems reported with some mortgage insurers refusing to reassign its insurance to the new HARP loan.) And if Wells buys a loan from a smaller bank or broker, it must have a loan-to-value ratio of 105 percent or less, meaning the borrower cannot be more than 5 percent underwater. Those limits do not apply to Wells’s own customers.

Besides mortgage insurance, experts said, some borrowers have run into trouble or long delays if they have second mortgages. To complete the refinancing, the second lender needs to agree to remain second in line should the new loan default. Other experts said this hasn’t been a problem, particularly if the same bank holds both loans.

All the nuances that exist from lender to lender make it hard to figure out the best course to take. Rick Cason, a branch manager at Integrity Mortgage, a mortgage firm in Orlando, Fla., said he had been working with about 30 customers since March, and many of them were being denied by Fannie’s and Freddie’s automated underwriting systems, even though they meet the program’s new guidelines on paper. In some cases, he said he has found that reducing credit card debt has helped, even though the customers were within the allowed debt-to-income ratio limits.

Legislation was recently introduced by Senators Robert Menendez of New Jersey and Barbara Boxer of California, both Democrats, that would extend the program’s rules to homeowners with more than 20 percent equity, in part because the HARP program has fewer refinancing fees.

For now, it’s clear that borrowers, particularly those with more complicated financial situations or homes that are far underwater, may need to be persistent. In fact, starting on June 1, lenders will be able to securitize, or sell loans that are valued at more than 125 percent of the underlying home’s worth, which may provide more opportunities for homeowners significantly underwater.

What a Return to the Drachma Really Looks Like

From a distance, returning to the drachma seems like a great solution for Greece. Economists such as New York University’s Nouriel Roubini say that by quitting the euro, Greece would seize control of its fate. It could pay off its euro debts with less valuable drachmas—stiffing creditors. Having a cheap currency would make Greece’s goods and services more affordable, drachma advocates say, shrinking a current-account deficit that’s about 9 percent of the entire economy. It actually poses a huge risk.

There’s no question that quitting the euro would be an easy way for Greece to shrink its unsupportable debt. Yet if Greece does leave or is kicked out of the single currency, it will most probably suffer inflation, layoffs, capital flight, shortages of essential commodities, and civil unrest, judging from what happened in Argentina when that country quit its dollar peg a decade ago. “Leaving is difficult and messy, so anyone who thinks it’s easy is just wrong,” says Lorenzo Bini Smaghi, a University of Chicago-trained economist who left the European Central Bank’s executive board last year.

What’s more, Greece is likely to find that a devalued currency doesn’t buy competitiveness. Outside of agriculture, many Greek exporters rely on imported components and raw materials that would soar in price in drachma terms, erasing the hope that exports could quickly lead the nation back to a trade balance.

Take Hellenic Aluminum Industry, known as Elval (ELBA), which is one of the nation’s biggest exporters and has 10 plants in Greece. Although it collects used cans at a large center in the Athens suburb of Marousi, its website says “a relatively small percentage” of the aluminum it needs comes from inside Greece. “Raw material costs can represent over 60 percent of sales” for big metals processors such as Elval, Victor Labate, a stock analyst at Athens-based National Securities, writes in an e-mail.

Many smaller businesses are likewise dependent on importers. “If we left the euro, we’d definitely have a problem,” says Demetri Politopoulos, a Greek American who is chief executive officer of Macedonian Thrace Brewery. He can’t even source beer bottles and cans locally. Complains Politopoulos: “Greece is a country that doesn’t produce anything.”

berlich@gmail.comThe View From Spain - 'El Pais' (May 13, 2012) By Erlich

Beauty is one thing Greece doesn’t need to import, and it will be more attractive on sale as a result of a currency devaluation. Tourism would be the largest beneficiary of a devaluation because it would make Greece a cheaper travel destination than Turkey, Croatia, and other vacation spots. “A German guest complained the other day that ‘You don’t have an economy, government, or money, but you’re charging me €4 for a coffee,’ ” says Costis Mouzakis, who works in a downtown Athens hotel.

Still, tourists might not come for bargain holidays if Greece is in chaos and xenophobia is running high. Air Berlin, a discount carrier, says its Greek business has declined about 30 percent from a year ago—not a huge surprise, considering that some Greek politicians’ speeches have demanded reparations for the Nazi occupation of Greece.

Greece’s export profile looks like something out of the 1950s. Aside from tourism and shipping, there are petroleum and aluminum products, medicines, fish, iron, piping, vegetables, fruits, cotton, cheese, fur and, of course, olive oil. Income from those exports is not enough to pay for everything Greece imports, from crude oil and vehicles to computers and consumer electronics.

Quitting the euro is only one way to solve what everyone agrees is Greece’s underlying problem: The nation lost cost competitiveness and became dependent on foreign capital after joining the euro in 2001. Germany reduced its inflation-adjusted labor costs four times as fast as Greece did over that period, according to an analysis of data from Eurostat, the European Union statistical agency. Greeks lived beyond their means, paying for imports with IOUs instead of exports.

Whether in or out of the euro region, Greece has to lower its costs (mostly via wage cuts) and increase efficiency by weeding out corruption, streamlining government, and reducing the power of entrenched interest groups.

The advantage of staying with the euro is that the other 16 euro area nations are giving Greece the time it needs to make those painful adjustments. They’re providing fiscal transfers from the EU and easy lending terms from the European Central Bank. The deal is harsh: Liberal economists such as Nobel prizewinners Paul Krugman and Joseph Stiglitz argue that austerity is driving Greece deeper into recession, making it even harder to balance the budget.

Still, the terms are better than Greece will get if it’s suddenly on its own. It would lose the backing of the European Central Bank and may also be forced out of the EU. The International Monetary Fund would probably continue limited lending to prevent complete chaos, but Greece will be cut off from private borrowing and run out of money, at least until lender amnesia sets in. That’s why economists fear a shortage not only of luxuries but of such essentials as food and medicine.

Economists such as Roubini—call them the drachmatists—say Argentina’s rapid return to growth after its chaotic devaluation in 2002 shows that Greece should drop the euro immediately. “A breakup is painful and costly, but a rotten marriage is worse,” Roubini wrote last year. “In short order, Greece could restore its competitiveness, turn its current-account deficit into a surplus, and start growing rapidly again.”

Argentina’s experience does show that devaluation and default don’t have to be disastrous in the long term. The short-term costs are sky-high, however. And if Greece goes off on its own, the useful external pressure for reform (aka meddling) will diminish.

The best outcome would be for Europe to form a fiscal union and switch decisively from austerity to growth—rescuing not only Greece but Ireland, Portugal, Spain, and Italy as well. That, however, doesn’t seem to be in the cards. Greece faces a choice between a bad situation and one that looks even worse.

The bottom line: Greece’s main problem is its lack of competitiveness, and switching to the drachma would do little to remedy it.

Plantations, Prisons and Profits

“Louisiana is the world’s prison capital. The state imprisons more of its people, per head, than any of its U.S. counterparts. First among Americans means first in the world. Louisiana’s incarceration rate is nearly triple Iran’s, seven times China’s and 10 times Germany’s.”

That paragraph opens a devastating eight-part series published this month by The Times-Picayune of New Orleans about how the state’s largely private prison system profits from high incarceration rates and tough sentencing, and how many with the power to curtail the system actually have a financial incentive to perpetuate it.

The picture that emerges is one of convicts as chattel and a legal system essentially based on human commodification.

First, some facts from the series:

• One in 86 Louisiana adults is in the prison system, which is nearly double the national average.

• More than 50 percent of Louisiana’s inmates are in local prisons, which is more than any other state. The next highest state is Kentucky at 33 percent. The national average is 5 percent.

• Louisiana leads the nation in the percentage of its prisoners serving life without parole.

• Louisiana spends less on local inmates than any other state.

• Nearly two-thirds of Louisiana’s prisoners are nonviolent offenders. The national average is less than half.

In the early 1990s, the state was under a federal court order to reduce overcrowding, but instead of releasing prisoners or loosening sentencing guidelines, the state incentivized the building of private prisons. But, in what the newspaper called “a uniquely Louisiana twist,” most of the prison entrepreneurs were actually rural sheriffs. They saw a way to make a profit and did.

It also was a chance to employ local people, especially failed farmers forced into bankruptcy court by a severe drop in the crop prices.

But in order for the local prisons to remain profitable, the beds, which one prison operator in the series distastefully refers to as “honey holes,” must remain full. That means that on almost a daily basis, local prison officials are on the phones bartering for prisoners with overcrowded jails in the big cities.

It also means that criminal sentences must remain stiff, which the sheriff’s association has supported. This has meant that Louisiana has some of the stiffest sentencing guidelines in the country. Writing bad checks in Louisiana can earn you up to 10 years in prison. In California, by comparison, jail time would be no more than a year.

There is another problem with this unsavory system: prisoners who wind up in these local for-profit jails, where many of the inmates are short-timers, get fewer rehabilitative services than those in state institutions, where many of the prisoners are lifers. That is because the per-diem per prisoner in local prisons is half that of state prisons.

In short, the system is completely backward.

Lifers at state prisons can learn to be welders, plumbers or auto mechanics — trades many will never practice as free men — while prisoners housed in local prisons, and are certain to be released, gain no skills and leave jail with nothing more than “$10 and a bus ticket.”

These ex-convicts, with almost no rehabilitation and little prospect for supporting themselves, return to the already-struggling communities that were rendered that way in part because so many men are being extracted on such a massive scale. There the cycle of crime often begins again, with innocent people caught in the middle and impressionable young eyes looking on.

According to The Times-Picayune: “In five years, about half of the state’s ex-convicts end up behind bars again.”

This suits the prison operators just fine. They need them to come back to the “honey holes.”

Furthermore, the more money the state spends on incarceration, the less it can spend on preventive measures like education. (According to Education Week’s State Report Cards, Louisiana was one of three states and the District of Columbia to receive an F for K-12 achievement in 2012, and, this year, the state, over all, is facing a $220 million deficit in its $25 billion budget.)

Louisiana is the starkest, most glaring example of how our prison policies have failed. It showcases how private prisons do not serve the public interest and how the mass incarceration as a form of job creation is an abomination of justice and civility and creates a long-term crisis by trying to create a short-term solution.

As the paper put it: “A prison system that leased its convicts as plantation labor in the 1800s has come full circle and is again a nexus for profit.”