Angela Merkel, German Chancellor and Frank-Walter Steinmeier, German Deputy Chancellor and Minister for Foreign Affairs at the EU summit on Brussels on Thursday, June 18, 2009. Steinmeier will challenge Merkel for her job in the September elections.

Bloomberg reports European Union leaders spotted the first signs of a “sustainable economic recovery” from the worst slump since World War II and ruled out further pump- priming measures.

In a draft statement at today’s summit in Brussels, the 27 EU heads of state and government said the looming end of the recession makes additional stimulus unnecessary, adding that it is time to start hatching an “exit strategy.”

“Further budgetary stimulus would not be warranted and attention should shift toward consolidation, keeping pace with economic recovery,” the leaders said in the draft, which was obtained by Bloomberg News. “There is a clear need for a reliable and credible exit strategy.”

Professor Peter Morici of the University of Maryland, on Thursday commented on the Obama regulation proposals, in a National Public Radio  "op-ed," which examined the challenges inherent in creating a systemic regulator and a resolution authority for bank holding companies and large non-banks.

"On Wednesday, President Obama rolled out a proposal for the most sweeping changes in financial market regulation since the New Deal, reaching every corner of banking and finance.

Obama's proposed reforms come on the heels of the federal government's billion-dollar bailout of Citigroup and AIG. And Obama has included in his proposed changes more regulatory power for the federal government over financial institutions. The idea is to give the federal government the power to head off risky investing before our biggest financial institutions reach the verge of collapse. The new regulatory powers would even give the government the ability to reorganize or flat-out sell portions of large companies whose outright failure would threaten financial market stability. Right now, the government is propping up big, failing firms with loans.

Thus upping the government's regulatory powers is supposed to ensure that taxpayers never have to bail out the banks again.

A noble goal. But it isn't going to work.

Here is the problem: Just as Citigroup and AIG are too big to fail, they are proving too big for regulators to effectively restructure. Selling assets and reorienting such large businesses in trouble, instead of letting them fail, is a Herculean task. Hercules, at least, had the advantage of being half-divine. Our government is run by mortals.

The unfortunate truth is that financial crises often occur because regulators fail to see the greatest threats until after the fact. In this most recent financial crisis, regulators knew lots of subprime mortgages were being written, and that banks were parking mortgage-backed securities in structured investment vehicles. But no one realized how much of a risk those practices posed to home values and the solvency of banks until lots of homeowners defaulted.

The only way to be sure of avoiding financial crises is by bestowing perfect foresight on government regulators. That's the stuff of fairy tales. Obama's new financial regulations reforms can't make him omnipotent, and Obama can't protect us from what he can't predict."

The FT reports today that Switzerland upped the ante in a global regulatory assault on the banking industry on Thursday as its central bank warned that Zurich was examining the forced shrinkage of banking groups such as UBS and Credit Suisse to contain the risks posed by their size.

The central bank is looking at imposing constraints on the size of its biggest domestic banks unless global policymakers can come up with a new system to deal with large banks when they fail.

Philipp Hildebrand, vice-chairman of the Swiss National Bank, said: “There can be no more taboos, given our experiences of the last two years.”

“There are advantages to size . . . [but] in the case of the large international banks, the empirical evidence would seem to suggest that these institutions have long exceeded the size needed to make full use of these advantages,”Hildebrand said as the central bank unveiled its stability report.

The FT also reports: Mafia blamed for $134bn fake Treasury bills

It says One summer afternoon, two “Japanese” men in their 50s on a slow train from Italy to Switzerland said they had nothing to declare at the frontier point of Chiasso.

But in a false bottom of one of their suitcases, Italian customs officers and ministry of finance police discovered a staggering $134bn (€97bn, £82bn) in US Treasury bills.

Whether the men are really Japanese, as their passports declare, is unclear but Italian and US secret services working together soon concluded that the bills and accompanying bank documents were most probably counterfeit, the latest handiwork of the Italian Mafia.

“They are all fraudulent, it’s obvious. We don’t even have paper securities outstanding for that value,’’said Mckayla Braden, senior adviser for public affairs at the Bureau of Public Debt at the US Treasury department. “This type of scam has been going on for years.’’

Davy chief economist Rossa White comments: US Conference Board indicator confirms signal of imminent bottom - - "The Conference Board leading indicator flashed an end-of-recession signal as expected in May (see Starting Points, May 22nd, for more detail on its signalling powers). The six-month rate of change turned positive. It has never fired a false signal before and this time is unlikely to prove any different. The question now is pinpointing the exact month of the trough.

Interestingly, a couple of times before (e.g. 1991) the leading indicator has flashed an end-of-recession signal a month too late (i.e. the economy had already bottomed, albeit that was judged retrospectively by the NBER). That is unlikely this time around: the ISM surveys do not point to growth just yet. Moreover, last week's Beige Book showed that a majority of US regions were still shrinking.

We expect the US economy to bottom around September or October. By that stage, growth in new orders will translate into actual activity. The housing market may also have improved a touch. And businesses may be confident enough to increase capex a little. America will benefit too from the multiplier effect of continued fiscal expansion in China. For equity markets, the timing of that recession end is important. Recent jitters were probably associated with a triumvirate of US macro data points suggesting delay in reaching that trough. But yesterday's Philly Fed ended that run of poor numbers: it reached a ten-month high."

On Thursday, the Dow Jones Industrial Average rose 58.42 points, or 0.7%, to 8555.60, after sliding more than 300 points over the previous three trading sessions.

The S&P 500 advanced 0.8%, while the Nasdaq Composite Index fell 0.02%.

The Wall Street Journal reports financier R. Allen Stanford - - who is a British knight courtesy of the Caribbean island of Antigua - - was indicted Thursday and charged with orchestrating fraud through his eponymous Caribbean-based financial firm, and hours later surrendered to federal agents in Virginia.

The Justice Department is expected Friday to announce the charges returned by a Houston grand jury, according to people familiar with the matter. The Securities and Exchange Commission had filed a civil lawsuit alleging fraud against Mr. Stanford and two other top executives at his firm, Stanford Financial Group. Dick DeGuerin, Mr. Stanford's attorney, said Mr. Stanford surrendered to agents outside the home of his girlfriend in northern Virginia. Mr. DeGuerin said he hadn't seen the indictment but that Mr. Stanford was expected to appear in court Friday morning.

AP reports that an Alabama judge has ordered former HealthSouth CEO Richard Scrushy to pay about $2.8 billion to shareholders due to accounting fraud at the rehabilitation chain.

Circuit Judge Allwin E. Horn ruled Thursday in favour of HealthSouth shareholders who filed a lawsuit claiming Scrushy was involved in a massive accounting fraud that nearly sent the company into bankruptcy.

Scrushy was acquitted in a federal criminal case over the fraud and testified in the state civil case that he knew nothing about it.

The MSCI Asia Pacific Index rose 0.5% Friday and lost 3.8% this week. It is up 43% from a five-year low on March 9th.

The Nikkei 225 rose 0.9%.

In Europe, the Dow Jones Stoxx 600 is up 1.3% Friday..

In Dublin, the ISEQ index is up 1.9%.

CRH is up 3%; AIB 7% and BoI 10%.

The IMF’s report will likely deal with all of these issues, but the two media leaks refer to the latter two priorities. You can read about the views on the banking sector in the Financials’ piece below, while we are unsurprised to learn that the IMF believes that the budget deficit will be higher than Government estimates this year, which is a similar view to our own (we forecast a budget deficit of 13% of GDP, relative to the Government estimate of 11%). To correct this deficit, the IMF will recommend some painful, but necessary, choices on further tax increases and government expenditure cuts. It is nothing we didn’t know already, but the report should probably be used as a tool to inform the public about some of the sacrifices that are necessary over the coming years to return the Irish economy to growth."

Goodbody analyst Eamonn Hughes comments: Rising charges possible in Dublin Airport - - "Press commentary highlights that the Irish Regulator has made a draft decision that passenger charges at Dublin Airport should rise from €7.39 to €8.35 from next January, a 13.5% increment. It is also indicated that prices may have to rise further later in 2010 to help pay for the second terminal at Dublin airport (for instance, a further 50c would get the total charge up 20% yoy). As anticipated, the main airlines were out of the traps quickly to dismiss the moves as fanciful and flying in the face of basic economic theory.

A recent report by Capstats indicated that airport charges across Europe are up c.5% in the current year. However, post its recent results, Ryanair indicated that it was being “inundated” with offers to cut charges at airports across the continent, which if we take at face value implies that charges are likely to ease back next year. Also, given the weak economic environment, many airports have attempted to stimulate traffic through cutting prices and the Spanish recently offered rebates to airlines showing yoy growth (of which there was only one in H1). As such, Dublin appears to be moving in the opposite direction, though on the other hand, most airports in Europe will not have the same heavy investment programme that Dublin does. Nevertheless, a heavy investment at a time of a weakening economy is not exactly ideal.

Ryanair has pulled out of other airports for less, but its importance in the Dublin/Ireland market presumably means it kicks up a stink, especially since the airline has made it clear it disagrees with the requirement for a second terminal. Expect a lot of huffing and puffing on this one. Last year, it appears that Ireland accounted for c.15% of Ryanair’s traffic, which would pitch it at the 5-6m passengers carried level, though it has cut its capacity materially this year. So lets say c.4.5m or so passengers through Dublin, so an extra €1 will be noticed, but not material. In the case of Aer Lingus, we estimate it has something similar out of Dublin in terms of passenger figures, so presumably something similar on the cost infrastructure and we note its comment about its “disappointment” with the proposed charges hike. However, the importance of Dublin for AL means on a relative basis, it’s more important."

Goodbody analyst Anna Lalor comments: Progress on new regulatory bodies and IMF recommendations on NAMA - - "The Irish Minister for Finance yesterday announced the establishment of a new “single fully integrated regulatory institution”, the Central Bank of Ireland Commission, which will replace the current board structure of the Central Bank and the Financial Services Regulatory Authority. The Commission will be chaired by the Governor of the Central Bank and will supervise individual firms as well as being responsible for the stability of the financial system. The consumer information and education role is to be reassigned to the National Consumer Agency. The Minister indicated that the Government will “ensure Ireland is regulated to the best EU and international standards” and that the changes are in line with those proposed at an EU level.

In relation to EU proposals on financial services regulation, at the EU summit that is currently being held, it is reported by Bloomberg that the UK has got agreement that the proposed EU financial services regulator won’t impinge on national regulators. The UK’s concern was that the EU regulator could force a national government to take actions in relation to its financial institutions that could have an impact on its fiscal situation. However, it is likely that the EU regulator will still be in a position to comment on the state of member states’ banking systems and to recommend actions, while it will probably also have some oversight of banks operating in multiple jurisdictions. Member states are said to have reached agreement that there should be a European council for systemic risk.

Changes to regulatory regimes in Europe and the US will see increased monitoring and supervision of banks, while the costs of this increased intensity will presumably be sourced from the financial sector. Comments from the former Bank of England Deputy Governor, John Gieve, on Bloomberg, highlight his concern that the rescue of the financial system has created a moral hazard that “threatens the next economic cycle”. Presumably, with such concerns, increased supervision and higher capital requirements are seen as a safe-guard, which is why we expect to see bank tier 1 capital ratios likely to reach 10% in the post-crisis world, with 7.5% core tier 1 capital. This will impact bank ROEs, while higher liquidity requirements will also reduce the return banks earn on their assets over the medium term.

Separately, the Irish Times reports today that the IMF, in its annual review of Ireland which is due to be released either today or Monday, has recommended that NAMA be set-up in such a way that it retains the flexibility to include other secured lending, such as residential mortgages, should it become necessary to deal with such assets as the credit cycle unfolds. The article also indicates that the IMF supports measures taken by the Government to deal with the banking sector, including NAMA, while it has encouraged the Government to set-up and run the agency as transparently as possible, as was the case for asset management companies that have previously been successful."