Business

The Jeremiah Wright affair

The trouble with uncles

Barack Obama is having the worst fortnight of his campaign

REALISTS (there are a few) within the Clinton campaign must have asked themselves, over the past dismal months, whether the war was worth the fighting. Hillary Clinton has no reasonable chance of catching up with Barack Obama's lead in elected delegates. Only this weekend Mr Obama added another nine delegates to his tally in Iowa's spring convention, putting him just under 170 clear of Mrs Clinton. Even when you add in the superdelegates, where Mr Obama has trailed Mrs Clinton, the totals are still 1,627 to 1,494: an Obama lead of 133.

But if Mrs Clinton cannot win the nomination, perhaps Mr Obama can lose it. That is the hope that has kept Mrs Clinton alive. And it is a hope that has come a bit closer to being realised in recent days.

The Obama campaign has been topsy-turvied by revelations about the eccentric views of his pastor, Jeremiah Wright. Mr Wright has been shown on video urging his congregation to sing “God damn America” rather than the usual version, and referring to America as “the US of KKKA”. This was not a momentary aberration but part of a pattern of incendiary rhetoric.

Mr Wright believes that September 11th 2001 was “chickens coming home to roost”. He accuses the American government of manifold evils, from manufacturing the AIDS virus in order to kill blacks and grinding the faces of the world's poor (“America is still the number-one killer in the world”). Mr Wright is an admirer of both Louis Farrakhan, the leader of the Nation of Islam, and Muammar Qaddafi, the president of Libya.

Mr Obama has spent the past few days on the television responding to endless replays of his pastor's greatest hits. He likened Mr Wright (who has recently retired) to “an old uncle who says things I don't always agree with,” and claimed that he had not been present when any of the incendiary sermons were delivered.

Mr Obama also used the opportunity to dump some more bad news. He told reporters that his relationship with Tony Rezko, a Chicago property developer and former Obama fund-raiser who is on trial in federal court, was closer than he has said, and that his campaign has received more money from him than it had admitted ($250,000 rather than $150,000).

None of this is very convincing. Mr Wright was not an uncle but the man who brought Mr Obama to God. Mr Obama has been a member of his Trinity United Church of Christ for 20 years. Mr Wright presided at his wedding and baptised his children. Mr Obama even borrowed the title of his bestselling autobiography, “The Audacity of Hope”, from one of Mr Wright's sermons.

Mr Obama addressed his “Wright problem” at greater length in a speech in Philadelphia on March 18th. He made no attempt to distance himself from Mr Wright (“I can no more disown him than I can disown the black community”). But he argued that there is more to the reverend than a handful of noxious remarks: his church has been doing good works in Chicago for 30 years. Then he turned his speech into a broad discussion of race—a subject that he has hitherto touched on only lightly in his campaign.

He argued that the original sin of slavery and segregation has left deep scars on black America. Mr Wright's anger is shared by many black Americans who were born in a country that denied them basic rights. But he softened this with a more ecumenical message. He argued that blacks bear some responsibility for their plight. He sympathised with white voters who feel short-changed by affirmative action. And he argued that America is making strides in addressing the racial divide. Mr Wright's mistake was not his anger at America's past sins but his failure to understand that the country is evolving beyond them. Mr Obama's message, in the end, was that his own presidential campaign is the solution to the resentments his pastor expressed.

This was extremely well done, a speech that challenged Americans' intelligence rather than insulting it. Mr Obama went some way towards addressing the criticism that his association with Mr Wright undercuts his message of racial reconciliation. He also demonstrated that he can use his formidable rhetorical powers to address difficult subjects rather than simply to rev up a sympathetic crowd.

But the Wright affair could still cause problems with white voters, particularly the white working-class voters whom Mr Obama has had trouble with in the past, most recently in Ohio. There are two things that annoy these people more than anything else—insulting America and playing the victim card. Mr Wright did not just argue that America's past is imperfect; he blamed it for mass-murder. He did not just complain about slavery; he said that whites are continuing to oppress blacks.

A recent poll suggests the affair could end up costing Mr Obama votes: 56% of all voters and 44% of Democratic voters said that Mr Wright's comments made them less likely to vote for Mr Obama (though 11% of voters said they made them more likely to vote for him). But pundits will have to wait for the Pennsylvania primary, on April 22nd, to see whether this is a blip or a longer-term problem. A new Quinnipiac University poll shows Mrs Clinton increasing her lead among white voters in Pennsylvania from 56% to 37% on February 14th to 61% to 33% on February 27th.

Mr Obama's association with the likes of Messrs Wright and Rezko also raises doubts about his judgment, a virtue that he has stressed, particularly over the Iraq war, to trump Mrs Clinton's claim to experience. There is not only the question of why he associated with Mr Wright in the first place (arguing that he represents the “black church” is rather like arguing that Al Sharpton represents the black civil-rights movement). There is also the question of why Mr Obama waited for the recent media firestorm to distance himself from the reverend. Questions about his judgment take on a particular significance at a time when the economy is in trouble, and people are looking for steady leadership.

Mr Obama is not the only candidate with rattling skeletons. Mrs Clinton has refused to release her recent tax returns (as Mr Obama has done) and given everybody the run-around on the question of her White House records. But one thing is clear: the row and the Democratic deadlock are wonderful for John McCain, who is looking like the luckiest man in American politics.

Internet communities

Break down these walls

History suggests that open standards will once again trump “walled gardens” on the internet

“THE farther back you can look, the farther forward you are likely to see.” Apply Winston Churchill's aphorism to the internet, and about the farthest back you can look is 1994, when the previously obscure computer network first became known to a wider public. Many people first ventured onto the internet from AOL, CompuServe and Prodigy, which were subscription-based online services that offered e-mail, chatrooms, discussion boards and so on. Having provided their users with access to the internet, however, these venerable digital communities were undermined by it.

Why stay within a closed community when you can roam outside its walled garden, into the wilds of the internet proper? Admittedly, it took a while for open and standardised forms of e-mail, discussion boards and file downloads—not to mention a new publishing technology called the world wide web—to match the proprietary, closed versions that preceded them. Today only AOL survives, and in a very different form: as an open web portal supported by advertising.

Now history seems to be repeating itself. Two of the biggest online phenomena of the past couple of years—social networks such as Facebook, and virtual worlds such as Second Life—look an awful lot like AOL did in 1994. They are closed worlds based on proprietary standards. You cannot easily move information in and out of them: try shifting your Facebook profile to MySpace, or moving a piece of clothing or furniture from Second Life to Entropia Universe. True, the walled-off nature of these communities is part of their charm. And their proprietary nature is also inevitable: only when a technology is established do standards emerge. But that is now starting to happen with social networks and virtual worlds.

The gate in the corner and the meadow beyond

Just as the web's open standards, embodied in the Netscape browser, displaced AOL and its ilk, so Netscapisation awaits Facebook and Second Life. As new standards make it easier to pipe data in and out of social networks, the need to visit a particular website to catch up with friends may come to seem as quaint as AOL's “You've got mail” alert (see article). Similarly, work is under way to allow links, akin to those between websites, to be set up between virtual worlds based on open standards and hosted on different machines. Why bother with an island in Second Life when you can build your own world?

Marc Andreessen, Netscape's co-founder, now runs Ning, a start-up that lets people set up their own social networks; and Multiverse, founded by several Netscape veterans, is one of several firms providing virtual-world construction tools. The question for Facebook, Second Life and the rest is how fast they can adapt. Philip Rosedale, Second Life's creator, is keenly aware of the historical precedent and scans old news reports about AOL in an effort to avoid a similar fate. Facebook, a little reluctantly, is starting to open up. Most curious of all is AOL's acquisition of Bebo, an up-and-coming social network, earlier this month. Has AOL forgotten the lessons of history—or might it just be uniquely well-placed to apply them?

Wall Street

Wall Street's crisis

What went wrong in the financial system—and the long, hard task of fixing it

THE marvellous edifice of modern finance took years to build. The world had a weekend to save it from collapsing. On March 16th America's Federal Reserve, by nature hardly impetuous, rewrote its rule-book by rescuing Bear Stearns, the country's fifth-largest investment bank, and agreeing to lend directly to other brokers. A couple of days later the Fed cut short-term interest rates—again—to 2.25%, marking the fastest loosening of monetary policy in a generation.

It was a Herculean effort, and it staved off the outright catastrophe of a bank failure that had threatened to split Wall Street asunder. Even so, this week's brush with disaster contained two unsettling messages. One is analytical: the world needs new ways of thinking about finance and the risks it entails. The other is a warning: the crisis has opened a new, dangerous chapter. For all its mistakes, modern finance is worth saving—and the job looks as if it is still only half done.

Rescuing Bear Stearns and its kind from their own folly may strike many people as overly charitable. For years Wall Street minted billions without showing much compassion. Yet the Fed put $30 billion of public money at risk for the best reason of all: the public interest. Bear is a counterparty to some $10 trillion of over-the-counter swaps. With the broker's collapse, the fear that these and other contracts would no longer be honoured would have infected the world's derivatives markets. Imagine those doubts raging in all the securities Bear traded and from there spreading across the financial system; then imagine what would happen to the economy in the financial nuclear winter that would follow. Bear Stearns may not have been too big to fail, but it was too entangled.

Gordian conduits

As the first article in our special briefing on the crisis explains, entanglement is a new doctrine in finance (see article). It began in the 1980s with an historic bull market in shares and bonds, propelled by falling interest rates, new information technology and corporate restructuring. When the boom ran out, shortly after the turn of the century, the finance houses that had grown rich on the back of it set about the search for new profits. Thanks to cheap money, they could take on more debt—which makes investments more profitable and more risky. Thanks to the information technology, they could design myriad complex derivatives, some of them linked to mortgages. By combining debt and derivatives, the banks created a new machine that could originate and distribute prodigious quantities of risk to a baffling array of counterparties.

This system worked; indeed, at its simplest, it still does, spreading risk, promoting economic efficiency and providing cheap capital. (Just like junk bonds, another once-misused financial instrument, many of the new derivatives will be back, for no better reason than that they are useful.) Yet over the past decade this entangled system also plainly fed on itself. As balance sheets grew, you could borrow more against them, buy more assets and admire your good sense as their value rose. By 2007 financial services were making 40% of America's corporate profits—while employing only 5% of its private-sector workers. Meanwhile, financial-sector debt, only a tenth of the size of non-financial-sector debt in 1980, is now half as big.

The financial system, or a big part of it, began to lose touch with its purpose: to write, manage and trade claims on future cashflows for the rest of the economy. It increasingly became a game for fees and speculation, and a favourite move was to beat the regulator. Hence the billions of dollars sheltered off balance sheets in SIVs and conduits. Thanks to what, in hindsight, has proven disastrously lax regulation, banks did not then have to lay aside capital in case something went wrong. Hence, too, the trick of packaging securities as AAA—and finding a friendly rating agency to give you the nod.

That game is now up. You can think of lots of ways to describe the pain—debt is unwinding, investors are writing down assets, liquidity is short. But the simplest is that counterparties no longer trust each other. Walter Bagehot, an authority on bank runs, once wrote: “Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone.” In our own entangled era, his axiom stretches to the whole market.

A question of priorities

This mistrust is enormously corrosive. The huge damage it could do to the world economy dictates what must now be done first. No doubt, there are many ways in which financial regulation needs to be fixed; but that is for later. The priority for policymakers is to shore up the financial system. That should certainly be done as cheaply as possible (after all, the cash comes from the public purse); and it should avoid as far as possible creating moral hazard—owners and employees should bear the costs of their mistakes. But these caveats, however galling, should not get in the way of that priority.

To its credit, the Fed has accepted that the new finance calls for new types of intervention. That is the importance of its decision on March 16th to lend money directly to cash-strapped investment banks and brokers and to accept a broader array of collateral, including mortgage-backed and other investment-grade securities. If investment banks can overcome the stigma of petitioning the central bank, this will guard them against the sort of run that saw Bear rejected by lenders in the short-term markets. Henceforth, the brokers will be able to raise cash from the Fed. The Fed is now lender-of-last-resort not just to commercial banks but to big investment banks as well (a concession that will surely in time demand tighter regulation).

Even if that solves Wall Street's immediate worries over liquidity, it still leaves the danger that recession will lead to such big losses that banks are forced into insolvency. This depends on everything from mortgages to credit-card debt. These, in turn, depend on the American economy's likely path, the depth to which house prices decline and the scale of mortgage foreclosures—and none of these things is looking good. Goldman Sachs's latest calculations, which suppose that American house prices will eventually fall by 25% from their peak, suggest that total losses will reach just over $1.1 trillion. At around 8% of GDP that is not to be sniffed at. But it includes losses held by foreigners, and “non-leveraged institutions” such as insurers. Goldman expects eventual post-tax losses for American financial firms to be around $300 billion, just over 2% of GDP, or about 20% of their equity capital.

The rebuilders' dilemma

That suggests a serious problem, but not a catastrophic banking crisis. And with the world awash with savings, banks ought to be able to raise new capital privately and continue lending. Unfortunately, things are not quite so simple. It would not take many homeowners to walk away from their debts for the losses to grow rapidly. Also, bank shareholders may prefer to cut back on lending rather than raise new equity. That would suit them, as equity is expensive and dilutes their stake. But it would not suit the economy, which would be pushed further into recession by sudden cuts in leverage.

By lending money to more banks for longer against worse collateral, the Fed hopes to stem panic and buy time. It wants Wall Street's banks to assess their losses and strengthen their balance sheets without the crippling burden of dysfunctional markets. And it hopes that cheaper money will ease that recapitalisation, inject confidence and cushion the broader economy. But that lingering risk of insolvency means that the state needs to be ready to take yet more action.

One option is to keep on intervening as events unfold. The other is to shock the markets out of their mistrust by using public money to create a floor to the market, either in housing or in asset-backed securities. For the moment, gradualism is the right path: it is cheaper and less prone to moral hazard (ask investors in Bear Stearns). Yet it is not easy to pull off—again, ask Bear Stearns's backers, who could possibly have been saved had the Fed begun lending to brokers sooner. If the crisis drags on and claims more victims, gradualism could yet become more expensive than a more ambitious approach.

Something important happened on Wall Street this week. It was not just the demise of a firm that traded through the Depression. Financiers discovered that they had created a series of risks that the market could not cope with. That is not a reason to condemn the whole system: it is far too useful. It is a sign that the rules need changing. But, first, stop the rot.

Business

Business this week

Financial markets endured another tumultuous few days, starting with a run on Bear Stearns, a venerable Wall Street bank, amid rumours of its imminent collapse. The Federal Reserve led a rescue by assuring $30 billion of the bank's assets and engineering its takeover by JPMorgan Chase. At the same time it said it would accept investment banks' collateral. The action was praised for halting Bear Stearns's complete meltdown. The deal values the investment bank at just $2 a share: in January 2007 its shares traded for over $170. See article

The Fed also made an emergency cut of one-quarter of a percentage point to its discount rate (which it charges commercial banks), to 3.25%, and extended the rate to securities firms. At its regular meeting, the Federal Open Market Committee reduced the federal funds rate by a further three-quarters of a percentage point, to 2.25%.

Small mercies

Lehman Brothers sought to reassure jittery investors after it saw 20% wiped off its market value on March 17th. Its share price stormed back after it reported a quarterly net profit of $489m, 57% less than in the same period a year ago but better than had been expected. Goldman Sachs also posted a much-reduced quarterly profit, of $1.51 billion, stemming from losses in mortgages and securities.

n a week when the markets were highly agitated, Visa managed to raise $17.9 billion from its initial public offering, the world's second-biggest (behind Industrial & Commercial Bank of China in 2006). The flotation will provide some much-needed cash to Visa's shareholders, the banks that issue credit cards.

Siemens issued a surprise profit warning because of delays to projects and contract cancellations, which will drag down its quarterly earnings by euro900m ($1.4 billion). The German engineering giant stressed that its problems had nothing to do with the present market turmoil. The news was a blow to Peter Löscher, Siemens's boss, who has begun a big clean-up at the company following a bribery scandal.

The dragon catches a cold

China's prime minister, Wen Jiabao, said his government would take “forceful” steps to dampen inflation, which is running well above official targets. Soon after Mr Wen spoke, China's reserve ratio was increased for the second time this year, with lenders ordered to place 15.5% of deposits with the central bank. See article

A federal appeals-court threw out the conviction handed down last year to Joseph Nacchio and ordered a retrial. Mr Nacchio was sentenced to a six-year prison term (though he remains free on bond) for insider-trading while chief executive of Qwest Communications. The appeals court said the conviction was unsound because testimony had been barred from an expert witness deemed crucial to Mr Nacchio's defence.

Responding to recent speculation, BNP Paribas, France's biggest bank, said it would not make a takeover bid for Société Générale, which in January unveiled a euro4.9 billion ($7.2 billion) loss that stemmed from a rogue-trading scandal.

CME Group made formal its agreement to buy the New York Mercantile Exchange for $9.4 billion. CME, created when the Chicago Mercantile Exchange and the Chicago Board of Trade combined last year, began negotiations with Nymex in January.

International Paper said it would buy Weyerhaeuser's packaging and recycling business in a deal valued at $6 billion. Because the offer is for assets and not stock, IP should reap a tax benefit worth around $1.4 billion, reducing the net purchase price accordingly. On either measure, it is one of the biggest deals in the timber-products industry in recent years.

Piping hot

Evraz, a Russian steelmaker part-owned by Roman Abramovich, agreed to buy the Canadian pipemaking business of Sweden's SSAB for $4 billion. Evraz then sold some of the division's assets to TMK, its compatriot. Demand is strong for steel piping in the North American oil and gas industry, but regulators will study the deal to see if there are any implications for energy security.

Air France-KLM cemented its offer to buy Alitalia, valuing the equity of Italy's loss-making state airline at just euro139m ($217m). The Italian government has been trying to offload the carrier for more than a year (several potential buyers pulled out of an auction last summer). It recommended Air France's offer, as did Alitalia's management. The airline's powerful unions, however, remain hostile, as are opposition politicians, one of whom invoked the battle of Caporetto—Italy's biggest defeat in the first world war. See article

Politics

Politics this week

China suppressed the worst outbreak of violence in Tibet since 1989 and perhaps since 1959 (when Tibet's spiritual leader, the Dalai Lama, was forced into exile). The violence spread from the Tibetan capital, Lhasa, to other areas of the region. China blamed the Dalai Lama for fomenting the violence even though he called for an end to it. See article

China's annual session of parliament ended with the appointment of Li Keqiang as vice-prime minister. Mr Li is tipped as a candidate for the top when the current generation of leaders retires. See article

Still smarting from an electoral rebuff, Malaysia's prime minister, Abdullah Badawi, shuffled his cabinet, removing several scandal-tainted ministers and promoting a prominent judicial reformer. See article

Something for everyone

A meeting of foreign ministers of the Organisation of American States “rejected” Colombia's recent raid on a FARC guerrilla camp just inside Ecuador. But it also committed member countries “to combat threats to security caused by...irregular groups or criminal organisations”.

Five women whose missionary husbands were abducted and killed by the FARC guerrillas in Colombia in the early 1990s filed a civil suit in a Miami court for compensation against Chiquita Brands International, an American banana company that has admitted paying protection money to the FARC and right-wing paramilitaries.

In another of a series of cautious economic reforms, Cuba's government said it would allow private farmers to buy supplies from hard-currency shops rather than directly from the state. The government is also to relax curbs on the purchase of computers and other electronic gadgets. See article

In Mexico, Alejandro Encinas, an ally of Andrés Manuel López Obrador, the narrow loser of the last presidential election, won a ballot for the leadership of the left-wing Party of the Democratic Revolution, the main opposition. His victory means that his party is likely to adopt a more intransigent stance towards the government of Felipe Calderón. See article

A British judge lifted a freeze on $12 billion of the assets of Venezuela's state oil company, quashing an order granted to Exxon Mobil in January as part of its bid for compensation for the takeover of a heavy-oil project.

Wright and wrong

AP

Barack Obama made a big speech on race that tackled head-on his relationship to Jeremiah Wright, a former pastor at the church Mr Obama attends in Chicago. Many moderates took umbrage after videos were broadcast of Mr Wright's sermons, in which he raged against “white” America. Mr Obama said Mr Wright had “expressed a profoundly distorted view” of America, but backed away from disowning his former mentor. See article

Democrats in Florida floated and quickly abandoned a plan to re-stage their primary election in June. The national party nullified the state's January primary because it jumped the election calendar, but with the nomination still up for grabs an argument is raging in the party about whether to count Florida's delegates. The state party's chairman said she had received little support for a re-vote.

David Paterson was sworn in as New York state's governor after Eliot Spitzer's recent resignation amid revelations about his sexual dalliances with a prostitute. Mr Paterson, who was Mr Spitzer's deputy, is the Empire State's first black governor (and only America's third since Reconstruction). He is also blind. See article

The Supreme Court heard arguments in the biggest gun-rights case to come before it in decades. At issue is a ban on the ownership of handguns in Washington, DC. The justices will give their verdict in June. See article

The clerics still rule

Iran's conservatives, who call themselves “principlists” for their devotion to the Islamic Republic's ideals, performed well in the first round of elections for the majlis, the country's parliament. Although many would-be reformists were barred from competing, the controversial president, Mahmoud Ahmadinejad, could yet face strong opposition if he stands for the job again next year. See article

In Baghdad, a conference to conciliate Iraq's rival political parties fell apart. Sunni and Shia groups walked out soon after Dick Cheney, America's vice-president, lauded political and security improvements in the country as “phenomenal”. Mr Cheney was on a visit to mark the fifth anniversary of the American-led invasion.

A poll by a respected Palestinian firm, PSR, found that Hamas's Ismail Haniyeh would beat Fatah's Mahmoud Abbas in a presidential election. It was PSR's first such finding since the Islamists of Hamas won a parliamentary election two years ago, and a blow to American and Israeli efforts to weaken the party and boost the more accommodating Mr Abbas.

In Kenya, Parliament debated amendments to the constitution that would entrench a new power-sharing arrangement agreed between the president, Mwai Kibaki, and his main rival, Raila Odinga. Both sides also agreed to set up a commission of international experts to examine December's disputed election.

Soldiers from the African Union prepared to invade Anjouan, one of the Comoro Islands off the coast of Mozambique. Troops loyal to the Comoros' president have already clashed with supporters of the renegade leader of Anjouan, Mohamed Bacar, who took power last July after winning an election that the president declared illegal. See article

Sour Serbs

As long feared, newly independent Kosovo saw an outbreak of violence as United Nations forces tried to take back control of a courthouse in north Mitrovica from Serbs. One UN policeman was killed. See article

The ruling centre-right UMP party did badly in France's local elections, losing several cities and lots of council seats to the Socialists. But President Nicolas Sarkozy vowed to press on with his reforms. See article

EPA

Angela Merkel became the first German chancellor to address Israel's parliament. She spoke of Germans' shame over the Holocaust and promised to be a true friend and partner of Israel. The German cabinet also held a joint session with the Israeli cabinet. See article