Four banks were on Wednesday charged with fraud linked to the sale of derivatives to the city of Milan in a case that could set off a string of lawsuits by Italian local governments facing potentially billions of dollars of losses on their borrowings.

A trial of the banks, Deutsche Bank, JPMorgan Chase, UBS and Hypo Real Estate Holding's Depfa Bank, has been scheduled for May 6

The banks have been accused of misleading the city on swaps that adjusted interest payments on €1.7bn of borrowings. They are also accused of earning hidden fees of €101m on the deal - a €1.7bn bond issue in 2005. In April last year police seized assets worth €476m from the four banks in connection with the case, which is being led by Alfredo Robledo, Milan's public prosecutor.

Italian prosecutors are probing banks as local and national government agencies face potential losses of €2.5bn on derivatives, lawyers say.

TOKYO -- In a bid to shore up a deflation-plagued economy, Japan's central bank eased monetary policy further Wednesday by enlarging a loan program for banks, setting the country, the world's second-largest economy, on a path divergent from those of other industrialized nations.

Central banks around the world have in recent weeks contemplated rolling back stimulus steps put in place during the global economic crisis, gradually shrinking excess liquidity in their banking systems. The U.S. Federal Reserve said Tuesday that it would let a mortgage-security purchase program expire at the end of March in the United States, the largest economy.

But in Japan, where prices have remained sluggish in a lackluster recovery from the country's worst recession since World War II, the government has urged the monetary authorities to stimulate the economy further by flooding the banking sector with cash.

Japan is also leaning on monetary policy because its public debt load, the highest among industrialized countries, makes it reluctant to spend more money on public works projects and other government stimulus programs.

In a 5-to-2 vote at a policy meeting Wednesday, the Bank of Japan's board decided to double a loan program for banks aimed at increasing liquidity in the Japanese economy, to ¥20 trillion, or $222 billion. The fixed-rate loans are available for three months.

The World Bank on Wednesday raised its growth forecast for China this year to 9.5 per cent, although it warned that tighter monetary policy and a stronger currency were needed to prevent bubbles and rising inflationary expectations.

In a generally upbeat assessment of the Chinese economy which played down some of the concerns prevalent among investors, the bank raised its forecast for 2010 from the 8.7 per cent it predicted in its last quarterly report in November.

"China's economy held up well in the global crisis and the growth prospects for this year and next year are quite good,'' said Louis Kuijs, senior economist in the bank's Beijing office.

Mr Kuijs said that China needed to adopt a tighter monetary policy this year given the strong rebound in the economy, however he played down the risk that inflation - which has risen strongly in recent months - would surge this year. The bank expects inflation to be 3.5-4 per cent in 2010.

Moreover, he said China could tolerate a rate of inflation a little bit above the 3 per cent target the government has set. The bank said in its report that in many other developing countries an inflation rate of 4-5 per cent is not a problem.

WASHINGTON -- The Senate approved and sent to President Obama on Wednesday what Congressional Democrats hope will be the first in a series of bills spurring employment by providing tax breaks and other hiring incentives to businesses.

The measure, approved on a bipartisan vote of 68 to 29, would give employers an exemption from payroll taxes through the end of 2010 on workers they hire who have been unemployed for at least 60 days. It also extends the federal highway construction program and takes other steps to bolster public building projects.

After the vote Senator Charles E. Schumer of New York praised the Republicans who voted for the bill, calling it "a legislative dream."

"Today is really a turning point," said Mr. Schumer. "And there are two words that symbolize it -- jobs and bipartisan. The American people sent us a message in Massachusetts and elsewhere. It was focus on jobs, the economy, helping the middle class stretch its paycheck. Our answer today: We heard you."

While 11 Republicans voted for the measure, others in the party were skeptical that it would help create new jobs, or said they were distressed at its cost.

The European Commission on Wednesday warned the eurozone's four largest countries - Germany, France, Italy and Spain - that their economic growth forecasts for the next three years were too optimistic, putting at risk their ability to cut their budget deficits in accordance with the European Union's fiscal rules.

The Commission asked these four countries, and others including Austria, Belgium, Ireland and the Netherlands, to spell out exactly how they intended to meet their medium-term deficit reduction targets of 3 per cent or less of gross domestic product - the EU's ceiling in normal economic times.

Britain has been warned that its plans to cut its deficit, which is estimated to be £178bn this financial year, were too timid. The Commission wants headline borrowing - currently more than 12 per cent of national output - to fall within the rules of the EU's stability and growth pact to a level of 3 per cent by 2014-15.

The Valukas report also exposes the dysfunctional relationship between the country's main regulatory bodies and the systemically dangerous institutions (SDIs) they are supposed to be policing. The NY Fed, the regulatory agency led by then FRBNY President Geithner, has a clear statutory mission to promote the safety and soundness of the banking system and compliance with the law. Yet it stood by while Lehman deceived the public through a scheme that FRBNY officials likened to a "three card monte routine" (p. 1470). The report states:

   "The FRBNY discounted the value of Lehman's pool to account for these collateral transfers. However, the FRBNY did not request that Lehman exclude this collateral from its reported liquidity pool. In the words of one of the FRBNY's on-site monitors: 'how Lehman reports its liquidity is between Lehman, the SEC, and the world'" (p. 1472).

Translation: The FRBNY knew that Lehman was engaged in smoke and mirrors designed to overstate its liquidity and, therefore, was unwilling to lend as much money to Lehman. The FRBNY did not, however, inform the SEC, the public, or the OTS (which regulated an S&L that Lehman owned) of what should have been viewed by all as ongoing misrepresentations.

The Fed's behavior made it clear that officials didn't believe they needed to do more with this information. The FRBNY remained willing to lend to an institution with misleading accounting and neither remedied the accounting nor notified other regulators who may have had the opportunity to do so.

The Fed wanted to maintain a fiction that toxic mortgage products were simply misunderstood assets, so it allowed Lehman to maintain the false pretense of its accounting. We now know from Valukas and from former Treasury Secretary Paulson that the Treasury and the Fed knew that Lehman was massively overstating its on-book asset values: "According to Paulson, Lehman had liquidity problems and no hard assets against which to lend" (p. 1530). We know from Valukas' interview of Geithner (p. 1502):

   The challenge for the government, and for troubled firms like Lehman, was to reduce risk exposure, and the act of reducing risk by selling assets could result in "collateral damage" by demonstrating weakness and exposing "air" in the marks.

Or, in plain English, the Fed didn't want Lehman and other SDIs to sell their toxic assets because the sales prices would reveal that the values Lehman (and all the other SDIs) placed on their toxic assets (the "marks") were inflated with worthless hot air. Lehman claimed its toxic assets were worth "par" (no losses) (p. 1159), but Citicorp called them "bottom of the barrel" and "junk" (p. 1218). JPMorgan concluded: "the emperor had no clothes" (p. 1140). The FRBNY acted shamefully in covering up Lehman's inflated asset values and liquidity. It constructed three, progressively weaker, stress tests -- Lehman failed even the weakest test. The FRBNY then allowed Lehman to administer its own stress test. Need we tell you the results?

'how Lehman reports its liquidity is between Lehman, the SEC, and the world'

The data are not good.

First of all, what this chart shows you is that the consumer is not deleveraging significantly (see Consumer credit down, but does it show deleveraging? and Why is everyone saying consumer credit is falling? It's not). Sure revolving debt (read: credit card debt) has fallen. But mortgage debt is still sky high. And on a debt to GDP basis, there really isn't a huge come down. Sorry, but that's what the data are saying. For an indebted household sector, this is bad news.

But, then you look at the other sectors and you see that the financial sector is deleveraging in a massive way. When I last looked the data, I concluded that the U.S. economy was wholly dependent on leverage in the financial sector to continue growing. So, the decreased financial sector leverage spells a lower growth future.

Finally, the government sector debt load continues to surge upward. Keynesians will tell you that the deficit spending that is the source of this increasing debt load is needed to increase savings in the private sector. However, it appears that most of the savings is being done in the financial sector and not in the household sector where it should be.

I see the data as an indication the private-sector deleveraging is only in its beginning stages and has much farther to go.

Regulators need new powers to control lending practices in targeted financial sectors and products to allow them to prick dangerous asset bubbles before they build up, according to the UK's top financial regulator.

Calling for a "radical reassessment" of global banking rules, Lord Turner, chairman of the Financial Services Authority, argued in a speech that politicians and regulators had to rethink the view that more lending and bigger markets are always better. They also needed to consider whether to impose transaction taxes and higher capital charges on banks to curb risky trading and financial activity that does not stimulate growth in the real economy.
...
Instead, governments could raise capital requirements for loans to overheated sectors, such as commercial real estate, or ban particular products, such as high-loan-to-value mortgages. Regulators may want to consider limits on borrowing by hedge funds to curb speculation.

"We need a new philosophical approach . . . which recognises that market liquidity is beneficial up to a point but not beyond that point, and dethrones the idea that more liquidity, supported by more trading, is axiomatically beneficial," said Lord Turner.

China and Germany are, of course, very different from each other. Yet, for all their differences, these countries share some characteristics: they are the largest exporters of manufactures, with China now ahead of Germany; they have massive surpluses of saving over investment; and they have huge trade surpluses. (See charts.)

Both also believe that their customers should keep buying, but stop irresponsible borrowing. Since their surpluses entail others' deficits, this position is incoherent. Surplus countries have to finance those in deficit. If the stock of debt becomes too big, the debtors will default. If so, the vaunted "savings" of surplus countries will prove to have been illusory: vendor finance becomes, after the fact, open export subsidies.

I am beginning to wonder whether the open global economy is going to survive this crisis.