Breakingviews

BoE governor’s arm-twisting raises tricky issues

By Hugo Dixon

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

In the old days it used to be said the Bank of England governor could get his way by raising his eyebrows. The current governor, Mervyn King, seems to have engaged in heavy arm-twisting to get Barclays to remove its former chief executive Bob Diamond. While the bank itself should have got rid of Diamond because he could not credibly engineer a change in its brash culture, the manner of his departure raises tricky questions.

Marcus Agius, Barclays’ chairman, told MPs on July 10 that King “made very plain” to him that Diamond “no longer enjoyed the support of his regulators”. But on whose behalf exactly was King speaking? The BoE, after all, is not responsible for supervising banks – and won’t be until next year. That’s still the job of the Financial Services Authority. If King wasn’t speaking for the FSA too, he was arguably stepping beyond his authority.

On the other hand, if the BoE governor was speaking on the FSA’s behalf, why didn’t the regulator itself deliver the message that Diamond should go? And why too did the FSA apparently change its position? After all, the regulator had only just agreed a settlement with Barclays over the Libor rate-fixing scandal. If it had wanted Diamond to go, that would have been the moment to say so.

A further question is how exactly the regulators managed to twist Barclays’ arm. If the FSA doesn’t support a bank director in his role, the current mechanism for removing the executive is to deem him no longer “fit and proper”. But it seems hard to argue that Diamond didn’t meet that test. After all, the lengthy investigation into the Libor scandal did not criticise him personally.

Some people will no doubt say it is good that Diamond has gone and it doesn’t really matter how that was engineered. But methods used in difficult situations can easily become precedents.

Regulators have to tackle flawed benchmarks

By Pierre Briancon

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Regulators chase financial fraud like anti-doping inspectors pursue Tour de France riders: they play catch-up. Innovation – in the form of new products or new drugs – is always a few steps ahead. So the police only come in after the fact – and often before the fact has even been defined as a crime.

In the wake of the scandal over the rigging of the London Interbank Offered Rate (Libor), European Commissioner Michel Barnier and the British government are looking at regulating the benchmark interest rate, as well as other rates. These attempts may get bogged down, and could backfire or miss their targets. They also risk missing new fraud or misbehaviour. But with the financial crisis entering its sixth year, the era of self-regulation for widely-used market barometers must become a thing of the past.

A case can – and undoubtedly will – be made that regulating private benchmarks raises questions of regulatory overreach. Finance is awash with private indicators and those set up by market participants.

The question of when exactly they become so important that public regulation is legitimate isn’t an easy one. But in the case of Libor, which over the years has become the reference for contracts worth trillions of dollars, that threshold has long been passed. Its daily calculation on the basis of hypothetical submissions by a handful of bankers clearly does not stand up to scrutiny.

Credit ratings agencies have tried to resist regulation by arguing that doing so would encroach on their ability to utter opinions. Similarly, free-market fundamentalists argue that mere numbers should remain beyond the regulators’ reach.

Supreme Court gives shot in arm to Obamacare M&A

By Robert Cyran

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Expanding health coverage to more than 30 million Americans remains politically contentious. But the Supreme Court’s decision not to overturn the law means that it’s here to stay. The increased number of covered patients is a lucrative opportunity for insurers that helps justify juicy merger premiums. That’s the logic behind WellPoint’s pricey $4.5 billion bet on Amerigroup. More deals are likely.

Amerigroup is one of the biggest providers of managed care for Medicaid, the government program covering poor patients. Medicaid already accounts for 24 percent of the average state’s budget, according to the National Association of State Budget Officers. So getting costs under control is a necessity. Encouraging patients to emphasize preventive care rather than make trips to the emergency room can yield big savings – and Amerigroup takes a chunk of that.

With Medicaid’s budget expected to reach $587 billion in 2014, and only about a fifth of these patients currently in managed care, the opportunity is obvious. But the new law effectively supercharges growth, making at least 7 million people eligible for Medicaid in the states where Amerigroup operates.

WellPoint is paying up to grab this opportunity. At 23 times estimated 2012 earnings, the company is baking in a lot of growth. Moreover, the $125 million of estimated annual synergies over three years are only worth about $650 million currently when taxed, discounted and capitalized. That’s just half the $1.3 billion premium. Yet investors sent WellPoint’s stock up 3 some percent on the news.

Expected growth may explain that. But the synergies are probably a lowball estimate – it’s notable that WellPoint said there were “at least” $125 million. Throwing in too high a figure might encourage regulators and lawmakers to bargain harder. The combined company may also have more heft in negotiations with hospitals and the like.

Saudi Arabia pushes accelerator on reform

The author is a Reuters Breakingviews columnist. The opinions expressed are her own

By Una Galani

Saudi Arabia is moving at its fastest pace in years to overhaul the economy, and this time there isn’t even the crunch of lower oil prices. Last year’s effort to tackle unemployment, and a recent and long-expected mortgage law designed to help solve the housing problem, should help shore up stability in the absolute monarchy. These are tentative steps so far. But they go in the right direction.

Change, at least by design, is always slow in the kingdom. But his week’s surprise approval of the first mortgage law, a sharia-compliant piece of legislation debated for over a decade, seems to confirm a trend. One year ago, Saudi tightened its labour laws in a bid to address the problem of the massive unemployment of nationals. In the peculiar time zone that is Saudi Arabia, this amounts to the beginning of reform.

Home loans amount to 60 to 70 percent of GDP in developed economies but  no more than 2 percent in the kingdom. That proportion could rise to more than a third if the mortgage law, as expected, lowers borrowing costs and protects lenders better.

The Arab spring seems to have ended the old correlation between oil prices and the kingdom’s reform drive, which used to wane when money flowed in. The last significant period coincided with Saudi Arabia’s entry into the World Trade Organization in 2005, after years of rising government debt. That period ended in 2008 when Saudi granted foreigners limited access to the stock market.

Kingdom watchers gave up hope of meaningful reform early last year when King Abdullah pledged $130 billion of extra spending to limit contagion from regional revolts. The introduction of an unemployment benefit paying more than the average private sector income epitomised the kingdom’s apparent willingness to throw oil money at its problems.

China grows faster but most Cubans are better off

By Martin Hutchinson

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Raul Castro could use his visit to China to pick up a few tips. True, the Caribbean nation hasn’t done so badly despite being isolated by U.S. trade sanctions. It is still richer than China, less unequal and less corrupt. Still, a smattering of China-style reforms, particularly allowing freer movement of prices, could produce a useful boost to growth and prosperity.

China is the great growth story of the 21st century, while Cuba is often deemed a basket case. That’s not entirely fair. China is economically freer than Cuba, according to the Heritage Foundation, but Cuba is less corrupt and ranks much higher on the United Nations’ Human Development Index. Cubans have a higher life expectancy, and more years of schooling. Moreover, Cuba’s per capita GDP, measured in current U.S. dollars, is still somewhat higher even after China’s recent growth, while its incomes are significantly more equally distributed.

Economic policy under the Castros has interspersed periods of ideological crackdown with moments of liberalization. After Soviet subsidies ended in 1989 the economy shrank by 35 percent, but Raul Castro’s ascension to power in 2006 has brought further modest reform. Cuba has not opened up its agricultural sector as China did, maintains more extensive price controls than China, does not allow a free market in housing and remains relatively restrictive and arbitrary in its attitude to foreign investment.

There are some big differences. China’s relative poverty mostly reflects its vastly larger population and the level to which its economy sank under Mao Zedong. Copying some of China’s agricultural policies, its acceptance of the price mechanism in housing and elsewhere and its ability to work with foreign investors could provide a major boost to Cuba and its people.

There’s always the concern that opening up the economy could return Cuba to the ultra-unequal society of its 1950s past and some other Latin American countries. That’s something China itself is wrestling with. But Castro should take a pinch of China’s gradualism as well as its reform. Small-scale opening could help Cuba’s economy without destroying its social fabric. Castro can learn from China’s examples, both good and bad.

Spain needs to get on with its to-do list

By Fiona Maharg-Bravo

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Spain’s current government, like its predecessor, always seems behind the curve. It has made some progress in passing budget cuts and some structural reforms, but it’s not enough. Only recently did it start to mention additional measures to get the country’s finances under control. The hope is that it won’t fall short.

Spain’s 2012 budget target of 5.3 percent of GDP will be impossible to reach and is arguably too ambitious (last year’s deficit ended at 8.9 percent). The central government’s deficit already adds up to 3.4 percent at the end of May – when the target for the whole year is supposed to be 3.5 percent. Madrid argues that it’s due to up-front transfers to the liquidity-starved regions. But the regions themselves will struggle to hit their own targets. And the economy is also getting worse: the Bank of Spain has warned that the recession intensified in the second quarter of the year.

But even if this year’s target looks out of reach, Spain can’t sit on its hands – and doesn’t have to. As part of the 100 billion euro bailout for its banks, the EU said progress on deficit targets would be closely reviewed. The European Commission has already made several recommendations: broaden the VAT tax base, boost other special taxes, eliminate tax breaks on housing, and speed up plans to raise the retirement age to 67. Simultaneously, it recommends actions to fight poverty and a youth action plan.

Boosting VAT may hit consumption, but Spain must find a way to boost dwindling revenues without hurting the economy’s competitiveness. It should also focus on cutting waste in government at the regional and local level: Spain has over 8000 municipalities, 60 percent of which have a population of less than a 1000. Unemployment benefits, the most generous in Europe, should be overhauled to encourage job seeking. Then there is a long list of pending privatisations: airports, buildings, utilities and prime real estate.

Spain needs to come up with answers because the government must soon approve next year’s spending ceiling. Meanwhile, other structural reforms are on the to-do list, such as liberalising services or the energy sector. Spain still hasn’t done everything it can to get the markets off its back.

Bankia probe will help Spanish banking cleanup

By Fiona Maharg-Bravo

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Bankia will face its day of reckoning at last. Spain’s parliament had disappointingly declined to investigate the events that led to the Spanish lender’s spectacular 23.5 billion euro bailout. But after a suit launched by one of Spain’s smaller independent parties, the country’s High Court has launched a high-profile fraud probe, meaning that bank’s former board members will have to face the music. At the top of the list is ex-chairman Rodrigo Rato, former conservative finance minister and head of the International Monetary Fund. This is a welcome step towards a necessary Spanish banking cleanup.

No specific charges have been brought against these executives yet. But the 49-page document is seething about Bankia’s bailout, just months after its stock market listing. The judge says there are grounds to investigate, among other things, whether executives falsified the true state of Bankia’s accounts both before and after the IPO in July 2011. He also mentions political meddling, dubious investments and fat pay packages.

The case should clarify whether fraud or mere incompetence was at the source of Bankia’s implosion. The savings banks that formed the bank had sought to list the supposedly cleaner entity (Bankia) while leaving some of the more toxic assets in the parent (BFA). The idea was to separate the banking business from the contaminated parent. But the fall in Bankia’s value (driven by fears over dud properties) made the whole structure vulnerable, as did over-valued tax credits.

High profile characters will now be forced to explain what happened. The former governor of the Bank of Spain will be called to testify, as well as the auditors and the head of the stock market regulator. More may be implicated. Many of BFA-Bankia’s investment decisions were taken before Rato’s time. Bankia’s army of IPO advisors, including investment banks, shouldn’t escape scrutiny. The 347,000 new investors in the IPO have already lost three-quarters of their investment.

The Bankia case will hopefully lead to probes of other bailed-out banks. These weren’t publicly listed, but their gullible retail clients are still stuck with billions in illiquid preference shares. No wonder the public is baying for blood.

China can’t reproduce its way out of trouble

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

China has outgrown its one-child policy. Three prominent government scholars called this week for the government to scrap it before China’s population gets too old, too fast. Yet after 30 years, such an intrusive policy can’t be reversed overnight. China will need time to prepare for the 2.3-child world.

For all the justified criticism, the programme has served a purpose. China’s annual population growth rate was 2.8 percent in the late 1960s. Now it is around 0.5 percent, barely higher than Europe’s. Countries with rapid population growth – think Egypt or Nigeria – have an unhappy record of shortages and social unrest. With 1.3 billion people, China already struggles with crop and water scarcity. Without the one-child policy, it would be in much worse shape.

Yet socially the costs outweigh the benefits. The policy has been blamed for evils ranging from China’s alarming surplus of males – 118 boys were born last year for every 100 girls – to forced abortions. The birth quota remains a key target for local officials, and fines imposed for having extra children, often calculated as a multiple of income, cause tension.

Economically, the case is ambiguous. More babies would mean more consumption, but the fruits would be spread among more people. Local governments’ education bills would rise, as might their tax take, but they would lose income from one-child fines, which demographer He Yafu estimates at 2 trillion yuan ($314 billion) since 1980. China would also have to rethink its already ambitious goals of self-sufficiency in grains and energy.

And when it comes to labour, productivity may matter more than plenty. China’s productivity growth is still running at a remarkable 8.8 percent annually, according to the Conference Board. But output per worker is only a sixth that in the United States, and below what most of Latin America manages. Bloated state enterprises and government offices are a big factor.

Mongolia’s task: avoid Nigerian resource curse

By Martin Hutchinson

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

In much of the developing world, natural resources seem to offer a handy way out of poverty. But they also present a curse. Mongolia, where the center-right Democratic Party led last week’s elections on a wave of resource nationalism, would be wise to avoid the mistakes of Nigeria and other nations. Government and private fingers can get sticky, the bonanza wasted and non-resource activity burdened and disincentivized.

Mongolia is the world’s newest member of the commodity boom. The country wedged between Russia and China has enjoyed spectacular growth in GDP – close to 17 percent in the first quarter from a year earlier – largely on the back of exploration and construction related to its massive Oyu Tolgoi gold and copper mining project. From August, Oyu Tolgoi will begin producing revenue, and from 2013 it will turn into a massive cash generator with relatively low employment.

Nigeria’s sad example shows what can go wrong when such newfound wealth is misallocated. Current estimates are that more than $1 billion of oil per month is stolen from the Niger Delta fields and corruption remains endemic even under well-meaning President Goodluck Jonathan. Nigeria ranks 133rd on the World Bank’s Ease of Doing Business Index and 143rd on Transparency International’s Corruption Perceptions Index. True, high oil prices reversed 40 years of decline in living standards through 2000. And while GDP growth is slowing, it’s still expected to run at 6 percent to 7 percent this year. But with inflation in double digits and government expenditure budgeted to exceed revenue by 31 percent in 2012, Nigeria’s situation is unstable.

Mongolia’s election was fought on the issue of resource nationalism, with the Mongolian People’s Party wanting to renegotiate the foreign investment agreements covering Oyu Tolgoi and other mines and increase the cash handouts of around $16 per month to Mongolia’s people. The Mongolian People’s Revolutionary Party opposed foreign mining investment altogether. The Democratic Party’s slim lead is good news for foreign resource companies, but development problems remain.

Once Oyu Tolgoi comes on stream, state revenue will increase, even as the employment boom subsides. However, as in Nigeria, that will lead to greater opportunities for wasteful spending and corruption. Mongolians will only benefit if the government ensures its fiscal stabilization fund – built up from excess revenue – is inviolable for the long term and promotes a culture that rewards private thrift and legitimate business formation.

France arrives early to austerity rendezvous

By Pierre Briancon

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

François Hollande has chosen the early strike option. His government will not wait to embark on the austerity programme needed to take the budget deficit back to three percent of gross domestic product next year. French Prime Minister Jean-Marc Ayrault was expected to detail the pain in his address to parliament on July 3. Public-sectors unions will protest and threaten. But in spite of the likely uproar, fiscal discipline is the easy part. Making the economy competitive again will be much harder.

In his electoral campaign, and in his first two months of office, Hollande gave the impression that his commitment to fiscal discipline didn’t go much beyond lip service. The painful reality check was not expected before the autumn. But after a few meetings with Angela Merkel, and a couple of euro summits, it looks like wisdom has struck. Furthermore, a scathing review of France’s public finances by the country’s top audit court, earlier this week, didn’t leave any room for doubt. Due to slowing growth, France needs to find up to 10 billion euros in extra savings or tax hikes this year, and 33 billion in 2013.

Adding austerity to austerity may not look like a bright idea in France anymore than elsewhere, given the stagnant economy. But the country is a special case because public spending is the highest in the euro zone, at 56 percent of GDP. And as the audit court reports showed, it is also one the most inefficient in major areas like education. Cutting spending is in France a structural reform by itself, not just a fiscal obligation.

Tax hikes are also on the horizon for France to meet its target and reassure markets that it is not the next euro basket case. But beyond that, the country needs competitiveness and growth. Its current account deficit is as preoccupying as its fiscal one, if not more so. To address this, Hollande will need to liberalise services, lower labour costs and reform a growth-hostile tax system. He will find that more difficult than simply plugging holes in the budget, as gaping as they may be.