September 23, 2021

Google Offers Changes in Europe to Settle Complaints

The decision by the European Commission is intended to address complaints from competitors concerned that Google favors its own results over theirs. By announcing the start of market testing, the commission allows others in the industry to weigh in.

The commission said it needed to intervene because “Google has had a strong position in Web search in most European countries for a number of years now” and because it “does not seem likely that another Web search service will replace it as European users’ Web search service of choice.”

The market testing would last for one month and a final settlement could be agreed upon after the summer, said Antoine Colombani, a spokesman for the E.U. competition commissioner, Joaquín Almunia.

The agreement would be legally binding for five years, and a third party would ensure compliance. If the deal is accepted, Google would avoid a fine and a finding of wrongdoing. But it could face a fine of as much as 10 percent of its global annual sales if it failed to keep its promises. Google did not issue any immediate comment.

The deal would allow Google to escape the type of lengthy and expensive antitrust battles that Microsoft faced in Europe over its media player and server software.

The European Commission has taken a tougher line with Google on the issue of how it runs its search rankings than has the U.S. Federal Trade Commission. In January, the U.S. commission decided, after a 19-month inquiry, that Google had not broken antitrust laws.

About 86 percent of all online searches in Europe are conducted using Google, according to the Web analyst comScore. In the United States, it has about two-thirds of the market.

One of the centerpieces of Google’s offer is to show links from competitors who offer specialized search services. In cases where Google sells advertising next to results for particular vertical markets like restaurants and hotels, Google would provide a menu of at least three options for non-Google search services.

That plan is analogous to a system Microsoft agreed to in 2009, offering users of newly purchased computers in Europe a ballot screen enabling them to download other Web-browser software from the Internet and to turn off Microsoft’s browser, Internet Explorer. Last month, the commission fined Microsoft $732 million for lapses in adhering to that settlement.

Google would also label results pointing to its own services — like YouTube — as Google properties and separate them from general search results with a box. The boxes would be mandatory, and probably heavily outlined, in cases where Google makes money from advertising that appears with the search results.

Google also would mark results from its own services like weather or news where it does not collect money from advertising. Those frames could be boxes with a lighter outline.

In areas in which all search results are paid ads, like shopping, Google will auction links to rivals.

Google is pledging to restrict the way it integrates content from other sites and media into its own products. It would need “to offer all specialized search web sites that focus on product search or local search the option to mark certain categories of information in such a way that such information is not indexed or used by Google,” the commission said in its statement.

Google would need to provide “newspaper publishers with a mechanism allowing them to control on a Web page per Web page basis the display of their content in Google News,” the commission said.

Web sites and some print publications have complained in recent years of virtually disappearing from Google’s search engine if they posed a competitive threat or did not comply with Google’s terms.

Google would also need to end exclusive arrangements that prevent advertisers from using competing platforms.

Major technology rivals demanded a long period of market testing before the commission closes the search case.

“Google has taken a year to develop the proposal released today,” said Thomas Vinje, chief lawyer for FairSearch Europe, a group of Google’s competitors including Microsoft, Nokia and Oracle.

“We think it’s only fair that outside experts have more than a month to help the commission market-test the long-lasting effects of Google’s proposal on consumers and innovation,” Mr. Vinje said.

Other rivals took a tougher line.

“Instead of promising to end its abusive practices, Google’s proposal seems to offer a half-hearted attempt to dilute their anti-competitive effects by labeling Google’s own services and throwing in some token links to competitors’ services alongside them,” said Shivaun Raff, a co-founder of Foundem, a British comparison-shopping site that was one of the original complainants in the case.

“Neither measure will make a dent in Google’s ability to hijack the traffic and revenues of its rivals,” Ms. Raff said.

Microsoft and its allies like Foundem could appeal against the settlement, but it is unclear whether some of them want do so at a time when they are seeking to push the commission to start a new case against Google for the way it runs its smartphone operating system, Android.

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Italian Bond Rates Rise to New Levels

Is the endgame near for Italy?

Interest rates on Italian bonds rose to euro-era records on Monday, close to the level that have forced Greece, Ireland and Portugal to seek financial rescues.

Most economists do not expect Italy to plead for a bailout yet. Instead, they say they think the higher rates will force the European Central Bank or other European neighbors to intervene more forcefully with measures to push down rates.

The yields on Italy’s 10-year bonds, a measure of investor anxiety about lending money to the country, rose to 6.63 percent at one point during trading on Monday. Five-year yields were even higher, at 6.65 percent, up half a percentage point on the day. The two-year yield also rose, to 5.9 percent.

Economists and investors say the dynamic is worrying. They fear the higher rates may incite bond clearing houses — the middlemen between buyers and sellers of the bonds — to demand higher collateral payments from traders of Italian debt. That, in turn, could lead to a further damaging spike in interest rates. Higher rates also threaten to sap Italy’s long-term ability to support its debt load, nearly 120 percent of its annual economic output at the end of last year, which is among the highest for countries that use the euro currency.

“This is feeding on itself,” said Eric Green, an economist at TD Securities. “It continues to put pressure on Italy.”

Bond rates are being driven by investors’ doubts that Prime Minister Silvio Berlusconi of Italy can push through sweeping changes to improve economic growth, including making pensions less generous and selling off some of the country’s assets. The measures are widely considered necessary to tackle Italy’s heavy debt load and revive its stagnating economy.

Investors are also selling Italian bonds because they fear that other European countries will not provide billions of euros to support Italy if conditions deteriorate even more.

They worry that European leaders have not come up with sufficient details about an expanded bailout fund, which is meant to provide ample firepower for Italy and other countries, like Spain, should the markets turn against them.

“Euro zone policy makers have yet to announce a policy bazooka,” Jens Nordvig, an economist at Nomura Holdings in New York, said in a research note. He said the structure of a purported $1.4 trillion bailout fund, announced at a meeting of European leaders in Brussels last month, “is insufficient to provide a credible backstop.”

Italy’s interest rates rose early Monday, then fell back slightly as rumors spread through the markets that Mr. Berlusconi was intending to step down, although they rose again later in New York trading.

Mr. Berlusconi denied the speculation that he was leaving office. Yet the markets seemed to say that investors would be happier about Italy’s future if he yielded power.

“The government needs to do a lot more to gain the full confidence of the Italian people, external creditors and the markets,” said Mohamed El-Erian, chief executive of the bond giant Pimco.

Andrea Schlaepfer, a spokeswoman for LCH.Clearnet, the big European clearing house that trades in bonds, said the spread between the yield on Italian bonds and the yield on a basket of AAA-rated bonds is one factor the company would consider before deciding to raise collateral requirements. Other factors include rates on credit default swaps.

The credit default swap rates that measure the cost of insuring Italian debt against default rose to near-record highs on Monday. It now costs $511,000 a year to insure $10 million in Italian debt for five years, according to the data provider Markit, compared with $145,000 in June.

The higher interest rates present hurdles for issuing new debt. Italy’s next auction of debt is on Nov. 14. It must raise 30.5 billion euros in November, and another 22.5 billion euros in December, according to Daiwa Securities.

When its interest rates were just above 6 percent, Daiwa estimated, the extra bond yields were already adding as much as 3 billion euros a year in additional interest payments compared with around 4.5 percent, the rate as recently as the summer.

Now those debt costs are rising with every basis point increase in bond yields.

The climbing yields could present a worrying spiral that, before Italy, affected Greece, Ireland and Portugal. When rates for those countries’ bonds reached around 7 percent, they suddenly jumped even higher and have still not come down to more sustainable levels.

Italy, the euro zone’s third-largest economy after Germany and France, is on a different scale than those much-smaller nations.

Italy is also, in a way, in a healthier situation. Although its debt mountain is large, it is actually running a primary budget surplus, which means that its budget is running a surplus before debt service costs.

According to Mr. Green of TD Securities, this means Italy could survive paying rates close to 7 percent for some time — but not forever. Eventually, the higher rates would worsen economic growth, and as the economy contracted, a wider and wider deficit would begin to open up.

Before Italy is forced to seek assistance from the European Union or the International Monetary Fund, economists say, the rising rates will force the European Central Bank to increase its purchases of Italian debt in secondary markets, which began in August.

Because the central bank bond purchases have failed to keep Italian interest rates down, economists expect that the bank will soon have to act much more aggressively.

Mr. Green said the design of the bailout package announced last month might, in fact, have encouraged investors to sell Italian bonds. The new fund may only protect holders of newly issued Italian bonds, which reduces investors’ incentives to hold existing securities.

The deal to allow Greece to write off 50 percent of its debts to private investors without setting off credit default insurance protection has also left many investors feeling vulnerable, encouraging them to sell now.

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Fair Game: In MF Global, Sad Proof of Europe’s Fallout

That old line from the Marx Brothers came to mind last week as MF Global, the brokerage firm run by Jon S. Corzine, was felled by over-the-top leverage and bad derivative bets on debt-weakened European countries.

Suddenly, all of those claims that American financial institutions have little to no exposure to Europe rang hollow.

You can understand why Wall Street wants to play down the threats from Europe. Its profits depend on the market’s confidence in the products it sells — and on the belief that the firms that sell those products will be around tomorrow.

But MF Global provides two lessons. The first is that our financial institutions are not impervious to Euro-shocks. The second is that when those problems reach our shores, they usually ride in on a wave of derivatives.

“The problems that we’ve had since the inception of the credit derivatives market have never been solved in any meaningful way,” said Janet Tavakoli, president of Tavakoli Structured Finance and an authority on these instruments. “How many times do we want to live through this?”

MF Global’s debacle was a result of complex swaps deals it had struck with trading partners. While those partners owned the underlying assets — in this case, government debt — MF Global held the risk relating to both market price and default.

These arrangements at MF Global underscore two big problems in the credit derivatives market: risks that can be hidden from view, and risks that are not backed by adequate postings of collateral.

These are the same market flaws that helped hide the problems at the American International Group — problems that arose from insurance that A.I.G. had foolishly written on crummy mortgage securities.

The International Swaps Derivatives Association, an industry lobbying group, contends that the market in credit default swaps is far more transparent than it was in 2008. For example, the Depository Trust and Clearing Corporation compiles figures on the number and dollar amount of swaps outstanding on its trade information warehouse.

The numbers are pretty mind-boggling. As of Oct. 28, for example, the warehouse reported $24 billion in net credit default swaps outstanding on debt issued by France, up from $14.4 billion one year ago. Some $17 billion in net credit default swaps were outstanding on Spain, up from $15.5 billion in 2010. Net swaps on Italy were $21.2 billion at last count, down from $28.5 billion last year.

The amount of net credit default swap exposure on the imperiled nation of Greece was much smaller: $3.7 billion late last month. It was $7 billion a year earlier. Officials at the I.S.D.A. say these bets are manageable because they are probably backed by substantial collateral.

MOREOVER, because of the “voluntary” nature of the Greek restructuring deal, which would require private holders of the nation’s debt to write off half its value, the I.S.D.A. predicts that the arrangement should not qualify as a default.

Therefore, the insurance that has been written on all this Greek debt will not cover investor losses generated by the 50 percent write-down — a disturbing consequence to those who thought they were buying insurance against that very risk. Given this turn of events, it’s hard to imagine why anyone would continue to buy credit default swaps.

In any case, the figures compiled by the D.T.C. don’t show the entire amount of credit insurance that has been written on Greece and other nations. D.T.C. says it believes its figures capture 98 percent of the market, but credit default swaps are often struck privately; not all of them are reported to regulators.

Consider an investment vehicle known as a credit-linked note. In these deals, investors buy a note issued by a special-purpose vehicle that contains a credit default swap referencing a debt issuer, like a government. That swap provides credit insurance to the party buying the protection, meaning that the holder of the note is responsible for losses in a so-called credit event, like a default.

Credit-linked notes are very popular and have been issued extensively by European banks. Many are governed by I.S.D.A. contracts, which define the terms of a credit event and require a ruling by the association on whether such an event has occurred.

But some deals have different definitions or contractual language overriding the I.S.D.A. agreement. “The people writing these contracts may say, ‘I would like to be paid if there is a voluntary restructuring of debt, or if Greece goes back to the drachma, or if Greece goes to war with Cyprus,’ ” Ms. Tavakoli said. “I can declare a credit event where I am entitled to get paid if any of those events happen.”

Cash calls can also be generated by declines in the market price of the notes or increases in the cost of insuring the underlying sovereign debt issue, according to credit-linked note prospectuses.

The other party has to agree to these terms up front. But, given the nature of these so-called bespoke deals, we don’t know the full extent of the insurance that investors have written on troubled nations or the circumstances under which the insurance must be paid. Neither do we know who may be facing severe collateral calls or demands for termination payments on the contracts.

When those collateral calls start coming, market values assigned to the securities that have been provided as backup can decline significantly. And when a company’s credit rating is downgraded, as MF Global’s was in late October, cash demands from skittish trading partners become even greater.

“At this late date we still don’t know the risks that are out there,” Ms. Tavakoli said. “This market is opaque, bespoke, and the regulators don’t know what they’re doing.”

At least regulators didn’t deem MF Global too big to fail. That’s a plus. But given the billions at stake in these markets, more transparency is needed about market participants, their financial soundness and their ability to withstand liquidity crises like the one that wiped out MF Global.

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Euro Zone Looks Abroad to Get Support for Bailout

BRUSSELS — Struggling to assemble a credible backstop for their troubled single currency, European Union leaders on Sunday reached out for wider international support for their bailout fund by seeking investment from non-European countries or the International Monetary Fund.

Officials of the 27 nations in the European Union chalked up one victory from lengthy weekend meetings in Brussels, striking a deal to recapitalize the sickly European banking sector. Despite some resistance, agreement seemed close on a plan worth around 100 billion euros, or $138 billion, to recapitalize banks.

But as of Sunday night, officials still had no definitive answer on how they would expand the euro rescue fund, the European Financial Stability Facility — though one official said they were aiming for €750 billion to €1.25 trillion, or $1 trillion to $1.7 trillion. It is currently $600 billion or €440 billion.

The leaders were also struggling with the amount of the loss that holders of Greek bonds would  be required to take in the rescue of that country — by some estimates as much as 60 percent — a crucial element that is essential to making the rest of the E.U package of measures add up.

Final decisions on the two issues will have to wait until a second  summit meeting on Wednesday. And longer-term solutions to the problems revealed by the financial crisis are likely  to lead to a change in the European Union’s governing treaty, the leaders said — an option that many had dismissed previously.

Mindful that markets on Monday would be watching the announcements from Brussels, the president of the European Council, Herman Van Rompuy, sought to reassure investors that the European countries were on track to reach a comprehensive deal at a meeting on Wednesday to stop the crisis from spreading.

“We are confident that we will get an agreement on Wednesday,” said Mr. Van Rompuy, whose group represents European Union governments. “The union must regain safe ground.”

With the Group of 20 meeting in Cannes in less than two weeks, European leaders clearly were making an effort to internationalize Europe’s crisis, with calls for more resources from the I.M.F., which has already participated extensively in the bailout of Greece.

“We’ve seen the debt crisis is really global. We want to reinforce the I.M.F.,” said José Manuel Barroso, president of the European Commission, the group’s executive agency.

“The I.M.F. is the most important global institution for financial matters,” Mr. Barroso said, “so it’s natural that countries that have a large external surplus can contribute to the common good and to global stability in financial terms.”

In the meantime, one of the roadblocks to agreement over the bailout fund — a rift between France and Germany — seemed to have eroded, with France retreating from its position that the European Central Bank should be used to backstop the euro bailout fund and Chancellor Angela Merkel of Germany asserting that there were now “two different models” under consideration.

Under one plan, a new body would be set up, financed by the current bailout fund but also seeking to attract outside investment. This body would buy bonds of troubled countries, providing that their governments agreed to make significant changes to improve their economic condition.

The alternative would involve using the current euro rescue fund to offer insurance against a proportion of losses on sovereign bonds.

A European official said the new entity could be created under the auspices of the I.M.F, while another minister said the head of the I.M.F., Christine Lagarde, supported the idea.

Prime Minister Fredrik Reinfeldt of Sweden, when asked about a fund involving non-European investors, said “That’s obviously on the table now.”

“If you are crossing that track, it is because you think you could get additional resources,” he said, while underlining that the leaders were “not ready” to commit to a solution after Sunday’s meeting. “That’s why we are meeting on Wednesday,” he said.

The meeting Sunday proved tense and difficult on several occasions, with consistent pressure on the Italian prime minister, Silvio Berlusconi, to push through tough changes as a condition of any further European support.

Mr. Berlusconi met with Mr. Barroso and Mr. Van Rompuy, over breakfast Sunday before going on to a meeting with Mr. Sarkozy and Mrs. Merkel.

German officials are angry at the behavior of Mr. Berlusconi, who promised to enact changes in August before the European Central Bank bought Italian bonds, but then tried to water down the program once the E.C.B intervened.

Europeans leaders, fearful that Italy could be the next applicant for aid, want the country to cut its €1.9 trillion debt load, which amounts to 120 percent of gross domestic product.

“Trust will not happen from a new package for Greece,” Mrs. Merkel said, aiming her comments at Italy. “Trust will only happen when everyone does their homework.”

Mr. Sarkozy also took a clear swipe at Italy, saying that he and Mrs. Merkel were not responsible for admitting nations into the euro that did not meet the original membership criteria.

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Off the Charts: Europe’s Consumers Are Pointing the Way Down

Germany is the dominant member of the group of countries doing well, although a few smaller countries, including Austria and Estonia, are also posting good results.

In the middle group are countries that are less competitive and showing signs of stress, but still growing. In the bottom group are countries with major problems. Some are showing more signs of growth than others — Ireland this week reported surprisingly good industrial production figures — but consumers are suffering in all of them.

Statistics on imports help show which countries are in which group.

In all European countries — and virtually all other countries around the world as well — trade levels plunged after the credit crisis intensified with the collapse of Lehman Brothers in September 2008. Trade financing became hard to get for many exporters, and customers slashed orders out of fears that the recession would get much worse or that they would be unable to finance the purchases.

Trade volumes recovered after credit conditions eased, and many economies began growing again. That trend is continuing for countries whose economies are in decent shape, but in others, the recovery in trade appears to be over. This time, the issue is often a simple one: the buyers cannot afford what they used to buy.

The accompanying charts show changes in imports at eight members of the euro zone — the largest ones and the ones that have been forced to seek bailouts.

The charts are based on three-month averages of seasonally adjusted imports, and show the change in levels from the average of June through August 2008, just before the Lehman collapse.

Germany stands out because its imports are now well above the precrisis levels, and are continuing to rise. In most of the other countries, the trend line has turned down over the last few months. This week, even Germany reported a very small decline in imports from July to August, although the three-month average did continue to rise.

Greece also stands out, but for the opposite reason. There, austerity is taking its toll and imports are plunging. They totaled just 2.9 billion euros in August, on a seasonally adjusted basis. That was nearly half a billion less than the July figure and the lowest figure for any month since 2002. Before the credit crisis hit, Greece was averaging imports of more than 5 billion euros a month.

The good news for Greece is that its exports are rising rapidly, but that increase is off a very low base and the country continues to run large trade deficits.

In both France and Italy, imports have returned to precrisis levels, and the Netherlands has done a little better. But in Ireland, Portugal and Spain, imports are well below the levels of 2008 and are again falling.

Floyd Norris comments on finance and the economy at

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New Zealand Suffers Double Ratings Downgrade

The downgrade came hot on the heels of a similar move by Fitch Ratings, which cut its rating for New Zealand on Thursday, also singling out the country’s high foreign debt levels as a cause for concern.

Despite the downgrades, New Zealand’s local and foreign currency ratings remain near the top end of both agencies’ scales. The country’s financial system is sound, the agencies said, and New Zealand continues to enjoy plenty of monetary and fiscal flexibility: public debt, unlike in many other developed economies, remains modest.

Debt levels in the household and agriculture sectors, by contrast, are high, while the country’s dependence on commodity income and an aging population poses challenges for the future.

Still, the downgrade highlighted that the turmoil sweeping the globe — prompted by worries over the slow pace of growth in the United States and doubts about the ability of several European countries to meet their debt obligations — is affecting economies even as far afield as New Zealand.

Stock markets in the Asia-Pacific region have been dragged down along with those in the rest of the world, as investors have largely ignored developing Asia’s robust economic fundamentals, and pulled funds out of stocks.

Economic data from across the region also has shown that economies are growing at a more subdued pace. The latest such evidence came Friday in the shape of an index measuring manufacturing activity in China, which showed a reading of 49.9 for September — the third successive month that the reading was below 50, signaling contraction.

In a report on Sept. 21, Standard Poor’s noted that the weaker global backdrop, combined with generally high inflation, could slow the pace of upgrades for some Asia-Pacific sovereigns, and could bring negative rating actions for those countries whose balance sheets are weak.

Asia-Pacific sovereign ratings have bucked the global trend so far in 2011 with two upgrades (Indonesia and Fiji) to one downgrade (Japan). But several countries in the region now have higher debt burdens and weaker budget positions than they had in 2008, S. P. said. It singled out the Cook Islands, Japan, Malaysia, New Zealand, and Vietnam, as countries whose net general government debt levels have risen “significantly” in the past few years.

In Japan and New Zealand, reconstruction efforts following devastating earthquakes earlier this year have added to government spending needs.

That was a factor in S. P.’s decision Friday to downgrade New Zealand’s long-term local-currency rating to AA+ from AAA, and its foreign-currency rating to AA from AA+. The day before, Fitch cut the country’s credit rating to AA from AA+.

Analysts broadly agree, however, that most emerging economies in Asia are relatively well positioned to weather the turmoil in the United States and Europe. Banks across the region have little direct exposure to the debt of Greece and other beleaguered European economies, while firm domestic demand is likely to help to insulate the region’s economies from any downturn in demand for Asian-made goods from overseas.

Exports to the West are less important now than they were in the run-up to the collapse of Lehman Brothers, said Frederic Neumann, a regional economist for HSBC in Hong Kong, in a research note on Friday. “Overall economic growth should hold up better even if shipments to the US and the EU decline more sharply.”

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Spain Examines Long Hidden Swiss Account

Yet, there is one not-so-small matter that Mr. Botín (pronounced bo-TEEN) has failed to keep tabs on: a Swiss bank account secretly opened long ago by his father that grew to such a size that when Spanish authorities discovered its existence last year, Mr. Botín and other family members paid 200 million euros (about $273 million currently) in taxes to avoid tax evasion charges.

At the request of tax fraud inspectors, a Spanish national court is investigating whether the payment is enough, given the amount that was stashed abroad; tax experts in Spain say that the account could reach two billion euros. The court has also said that officials need more time to sift through the blizzard of documents that the family submitted and will consider whether a criminal charge of document fraud should be brought.

A lawyer for the Botíns, Jesús Remón, said the family was cooperating with the investigation and was “fully in compliance with its tax obligations following their voluntary filing” last year. He added that no family member had been charged with wrongdoing.

Mr. Botín’s tax problems come as debate intensifies over whether struggling governments should demand more tax revenue from the rich. On Monday, President Obama called to end some tax breaks for the wealthiest taxpayers in the United States.

Last Friday, the Spanish government reintroduced a wealth tax that it had abolished three years earlier, hoping to collect an estimated 1.08 billion euros from taxpayers with more than 700,000 euros in declared assets. Spain’s wealthiest have so far not publicly endorsed calls for higher taxes, and Mr. Botín on Friday told reporters that “it seems to me very bad to reintroduce” the wealth tax.

More so than in other European countries, where bankers are largely anonymous figures, Mr. Botín holds sway in Spain. Although he avoids social events and his public utterances are few, his influence is seen as wide-ranging. And he has been able to retain control of Santander despite his family’s controlling just 2 percent of its shares.

Neither the judiciary nor the family has provided details about how much money the Swiss bank account contained or how the amount grew over time. Nor would Mr. Remón, the lawyer, comment on whether Mr. Botín had been aware of the account.

What is known is that Mr. Botín’s father, also called Emilio, left Spain with part of his wealth in late 1936, after the start of the Spanish Civil War, fearing, like many other Spaniards, what might come.

The elder Mr. Botín spent a few months in London before moving to Basel, Switzerland, and eventually returning to Spain to resume leadership of the bank that he had run since 1933. But while he returned to Spain, the money he salted away in Switzerland did not. The senior Botín died in 1993. Last year, the French government passed on to Spain data that it had obtained from Hervé Falciani, a former employee in HSBC’s Swiss subsidiary, naming almost 600 Spanish holders of secret bank accounts. Among those was one belonging to the estate of Mr. Botín’s father.

In his opening summary, the judge in charge of the case, Fernando Andreu, highlighted “the complexity of the hereditary structures” of trusts, foundations and other companies set up to oversee the account. The closest he came to explaining what was in the account was to say that it also included a 12 percent stake in Bankinter, a midsize bank in which Jaime Botín, Emilio’s brother, is a leading shareholder. That holding, at current stock market value, would be worth about $310 million.

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High & Low Finance: Who Is to Blame if Shares Continue Steep Declines?

William Shakespeare,

Macbeth, Act V, Scene 5

At the end of last week’s wild stock market gyrations, share prices were down only a moderate amount for the week, leaving investors to wonder whether there was any meaning at all to the volatility.

As is often the case when market gyrations become excessive, governments have good reasons to hope that the significance, if any, lies in market imperfections rather than in fundamental economic problems.

If it is the latter, attention is likely to be focused on issues of sovereign debt in Europe and on whether governments on both sides of the Atlantic have the ability and the will to prevent a new global credit crisis and recession.

If it is the former, then it is the behavior of market participants, or problems of market structure, that is to blame. In the past, that explanation has been much more palatable to politicians. Sometimes it has even been correct.

If it is not real economic problems that are responsible for sharp falls in stock prices, then the blame is likely to fall, as it has in the past, on people who seek to profit from declines and on market innovations, such as stock index futures and computerized trading strategies.

Short-sellers, who bet that prices will go down and thus perhaps help to push them down, are almost always among the first targets of political criticism, and this year is no exception. At the end of last week four European countries banned short-selling of financial stocks, and Germany renewed its push to get Europe to prohibit what it calls “naked short-selling” of credit-default swaps.

It is particularly angry about swaps that allow people to place bets that governments will default on their debts. Germany’s proposal would mean no one could obtain such protection against, say, an Italian default unless he owned Italian government bonds and needed protection.

Until 2008, Wall Street almost always opposed restrictions on short-selling. But that year investment banks became strong supporters of banning such sales and investigating people spreading negative rumors.

It was not, of course, a coincidence that the rumors then were about banks. After Lehman Brothers collapsed, short-selling of financial stocks was banned. It bolstered stock prices for a while, but did nothing to halt the rot that really was spreading within bank balance sheets.

So far this year, the United States has not joined in taking action against short-selling, although regulations on it have been strengthened since the 2008 plunge.

In the 1920s, the targets of scorn were Wall Street pools, thought to be pockets of capital that would manipulate a stock up and then profit by dumping overpriced shares on speculators lured into thinking the rising price was a result of more than manipulation. After the 1929 crash, the pools were widely blamed for bear raids, which were more or less the opposite and used short-selling to drive down prices. Attacking the speculators did not, in the end, do much to help the prices.

In the 1987 crash, portfolio trading, made possible by the relatively new stock index futures market, became a target of criticism. That strategy involved taking offsetting positions in the futures market and the stock market, such as by buying a futures contract and selling short the underlying stocks

Traditional money managers loved being able to sell a futures contract quickly to protect against losses in a declining market, but were outraged that the buyer of the contract immediately sold shares short, seemingly without regard to price.

Related to that was a product called “portfolio insurance,” which convinced money managers they could buy stocks without much regard to price, secure in the knowledge they could use futures — or options on futures — to exit quickly in a down market.

Since the sale of futures by portfolio insurers was based on a computer program that assumed continuous markets, it had no way to stop selling when prices became ridiculously low. Humans who understood what was happening had no desire to buy until they were sure the portfolio insurance traders were through.

The Dow Jones industrial average fell 22 percent on one day, on Oct. 19, 1987.

In a way, the flash crash of May 6, 2010, was similar. It brought high-frequency trading firms to the fore. As markets became more and more electronic, and computers enabled trades to be completed in milliseconds, those firms had come to supply most of the liquidity needed to allow markets to function.

That is, when normal investors wanted to buy or sell stocks, the high-frequency firms were often on the other side of the trade, making small amounts on many trades. They had taken over a profitable function once restricted to stock exchange specialists and Nasdaq market makers, which were required to post bid and asked prices and to step in to buy when others did not wish to do so.

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Economix: Nurturing Start-Ups and Small Businesses Around the World, Part 1

In almost every developed country, small companies dominate the business landscape. But in many ways America, the great land of entrepreneurship and opportunity, actually has a weaker small-business presence than most.

A new report on entrepreneurship from the Organization for Economic Cooperation and Development finds that the smallest businesses — those with fewer than 10 employees — account for almost all of the businesses in most developed countries. The United States is on the low end of the distribution, though, with only about three-quarters of its businesses being so tiny.

DESCRIPTIONOrganization for Economic Cooperation and Development

The United States also finds that its biggest companies contribute a much larger share of the country’s exports than is the case in other developed nations. In the United States, companies with more than 250 employees account for 75 percent of the country’s exports; in many European countries, big businesses contribute less than half of national exports.

DESCRIPTIONOrganization for Economic Cooperation and Development

A more direct measure of entrepreneurship might be the share of workers who are self-employed. Compared to other developed countries, the United States figures are poor to middling, for both native-born and the huddled masses coming from abroad. Greece has the highest rate of self-employment for native-born citizens, and Poland has far and away the highest self-employment rate for foreigners.

DESCRIPTIONOrganization for Economic Cooperation and Development

In a separate post I’ll look at how countries fare on creating a climate that is amenable to start-up businesses, looking at the regulatory environment, availability of venture capital and other factors.

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Rescue Measures for Greece Advance as French Offer to Ease Debt

With investor pressure mounting ahead of the vote by the Greek Parliament this week, President Nicolas Sarkozy outlined a proposal under which French banks would give Athens more time to pay back loans as they come due over the next three years.

The banks would share part of the cost of the bailout by extending new loans to Athens as old loans mature, but the banks would not have to forgive the debt itself, a concern of many investors.

“We’ve been working on this with the banks and insurance companies,” Mr. Sarkozy said at a news conference in Paris. “We’re committed to going from a principle — the voluntary participation of the private sector — to concrete reality.” Mr. Sarkozy said he hoped that other European countries would adopt a similar plan.

It comes at a critical moment in the long-running drama over how to prevent a default on Greece’s $467 billion debt.

A vote on Greece’s latest $40 billion austerity package is scheduled for Wednesday, with another vote scheduled for Thursday on separate legislation to carry out the reforms. If the measures pass, the European Union is expected to announce the size and details of a new, second bailout package at a meeting of ministers on Sunday.

If the Greek Parliament were to vote the package down, a chain reaction could engulf global financial institutions.

Investor confidence in the debt of countries on the periphery of Europe like Greece, as well as Portugal and Ireland, has been rapidly eroding. European financial institutions hold more than half a trillion dollars worth of their sovereign debt. Private borrowers in these countries, who would also be hammered by a public default, owe Europe’s banks another trillion, according to the Bank for International Settlements.

The French banks’ willingness to chip in underscores just how vulnerable giants like Société Générale and BNP Paribas would be in a full-scale default, a danger also confronting large institutions in Germany, Belgium and elsewhere. It is also why European leaders have the leverage to extract concessions from banks as part of a broader rescue package for Greece.

With European leaders unable to come up with a concrete plan until now and Greek politicians balking at calls for austerity, the picture for Europe’s banks has been growing dimmer by the week. “Investors think policy makers are kicking the can down the road,” said Philip Finch, a bank analyst with UBS in London.

As a result European bank shares have fallen nearly 25 percent over the last four months, helping bring down the shares of their counterparts in the United States, which have lost 13 percent over the same period.

But unlike American banks, which raised capital and wrote off tens of billions of dollars in bad loans after the financial crisis, European institutions have been much slower to acknowledge the problems they face, analysts and investors said. Even without a sovereign debt default, Mr. Finch said, European banks need to raise $150 billion in capital to bolster balance sheets.

French officials said the proposal announced Monday was the fruit of recent meetings between the Élysée Palace, the French Treasury, the Bank of France and the French banking federation.

The initiative is likely to be supported by Jean-Claude Trichet, the departing president of the European Central Bank, who had stood against plans to automatically impose losses on the face value of Greek debt.

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