FRIDAY, DECEMBER 3, 2010


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‘SENIOR’ BOND HOLDERS SAFE


Move aims to stave off global contagion


BY HOWARD SCHNEIDER Fear of a broad economic


meltdown prompted officials in Europe and at the International Monetary Fund to protect key investors in Ireland’s troubled banks from losses, despite in- tense debate about the use of public funds to bail out private companies. As officials scrambled last


week to rescue Ireland from a banking crisis that threatened to make the government itself in- solvent, officials drew a firmline when it came to investors who had purchased the most secure form of bank bonds, known as “senior” debt. Senior bonds are a staple source of funding for Eu- ropean banks and are considered such a safe investment that they are widely held by other banks, pension funds and similar insti- tutions. In Ireland’s case, many of those investors are in Germa- ny and the United Kingdom. Forcing losses on senior bond-


holders, it was feared, would hit Europe with the same force as the collapse of Lehman Brothers in the United States — casting doubt on an entire system and with potentially global ramifica- tions if it threwEurope back into recession or undermined an im- portant economy, such as Ger- many’s. Even with taxpayers’ money involved fromaround the globe, in the form of $30 billion lent to Ireland fromthe IMF and $60 billion fromEuropean coun- tries, the holders of an estimated $50 billion to $60 billion in Irish senior bank bonds were assured theirmoney would be repaid. “The driving force behind the


decision to not involve the senior unsecured debtholders was the fear of contagion to other Euro- pean banks — Spanish banks, Portuguese banks, maybe even Italian. You just wanted to avoid another sort of freeze on the capital markets,” said Frank En- gels, senior European economist at Barclays Capital. The structure of the Irish res-


cue deal shows the uncertainties that still surround efforts to shore up the finances of the


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Irish bailout protects key investors


companies were fully wiped out when the businesses were na- tionalized, and owners of less secure debt have, in some cases, suffered losses. Holders of less- secure debt at the Anglo Irish bank, for example, were paid 20 cents on the dollar, and many analysts expect similar write- downs at other Irish banks as the country restructures its financial industry. But the secure senior debt


represents part of amore intense entanglement that Europe needs to resolve if its financial system is to be put back on sound enough footing to support stron- ger economic growth. Over the years, European banks and fi- nancial institutions have invest- ed widely in the bonds of other European countries, and in the bonds of banks in other nations — often with little regard to the underlying risks and on the as- sumption that each country would ultimately repay its own debts and stand behind its finan- cial institutions. In a booming economy, no one


second-guessed whether Greece was as sound a credit risk as Germany or raised questions when Irish banks fed a local property boom with aggressive lending. As the downturn began to expose the flaws, it remained uncertain how a default in one country or companymight affect others. “You don’t necessarily know


PETER MACDIARMID/GETTY IMAGES


The Irish economy has faltered after years of growth, and the country recently received a $90 billion emergency bailout package.


16-nation euro zone, a currency region that includes economic giants such as Germany and weak links such as Portugal. Although vast public resources have been pledged to the effort, investors remain doubtful that countries can do what’s needed to right public finances and re- store growth. The European Central Bank


moved to calm the situation Thursday, saying it would con- tinue buying bonds of troubled European countries and lending money to banks as needed. But the Irish bailout has fo-


cused attention on some of the central issues yet to be resolved from the financial crisis: how to protect taxpayers fromshoulder- ing future bailouts, and how to prevent a crisis in one corner of


theworld frominflicting damage on the global economy because of the financial links between companies and countries. The bank and corporate bail-


outs in the United States also protected many investors — by some reckoning, even a broader group than in Europe. Both se- nior and “subordinate” creditors were largely made whole in the U.S. rescues of companies such as Citibank and AIG. Although many stockholders lost out, oth- ers gained as the bailouts helped some companies recover and the value of their shares rose. In Europe, by contrast, the


drive to punish bank owners and investors has been more forceful as governments there stepped in with trillions of dollars in state support. Stockholders in some


where the next domino will fall, but you know there will be a chain effect set in motion,” said Jacob Kirkegaard, a Europe spe- cialist at the Peterson Institute for International Economics. It has made for complex poli-


tics — German officials strug- gling to balance an underlying distaste for public bailouts with the fact that their banks are deeply entangled in weaker Eu- ropean countries; and the IMF undertaking one of its most di- rect-ever rescues of a specific industry — but little clarity. Ultimately, European officials


say they want to make clear to investors that those who buy European government or bank bonds may well suffer losses. That is likely to lead to higher interest rates for weaker coun- tries or companies but also a more careful assessment of how banks and nations are run. At Germany’s urging, such a provi- sion may become part of Eu- rope’s debtmarkets in 2013. schneiderh@washpost.com


We need a grand compromise on the deficit, not hyperbole


ideology and values as economic necessity. You see that now in the


A


pitched battle over whether to extend the Bush tax cuts to wealthy households. Judging fromthe dire warnings coming fromRepublicans, you’d think that raising themarginal rate by four percentage points would snuff out the recovery and sentencemillions of Americans to permanent unemployment. In fact, all the economic evidence shows that the short-run impact of such amodest tax increase would be negligible. Or take the liberal fixation


about fiscal stimulus. It’s probably true that injecting $100 billion into the economy to extend unemployment benefits and business tax breaksmight create asmany as 1million new jobs. But with 20million Americans now unemployed or underemployed, that falls rather short of the economic fix you’d expect given all the Keynesian hype. The same dynamic is at work


in the overheated criticismof the deficit-reduction plan put forward by Alan Simpson and Erskine Bowles, the chairmen of the soon-to-expire deficit commission. To hear it from liberal groups, you’d think the proposed spending limits would cut the federal government down to that of a small state, even as it “decimates” the middle class and forces seniors to eat dog food. Fromthe right come similar hysterics about the “hollowing out” of the American military and the economic catastrophe that will befall us froma 15-cent-a-gallon hike in the gas tax. Logically, there are two


possible explanations for this hyperbole. One is that these critics are


STEVEN PEARLSTEIN


pushing as hard as they can so that the inevitable compromise better reflects their preferred positions. In that case, we should consider their critiques for what they really are— political posturing. The other possibility is that


these zealots genuinely believe that it’s better to kill this centrist compromise so they can then push through a plan that reflects their own values and ideology. This, of course, is political fantasy, as anyone who has been awake over the past 20 years will tell you.Many have tried; none has succeeded. Unfortunately, this isn’t just a


political fantasy—it’s an economically dangerous one. The longer we wait, themore painful it will be to get our fiscal house in order, whether we do it voluntarily or it is imposed upon us by global creditors. Happily, at least half of the


deficit commission’smembers now realize that you’re not supposed to like the Simpson- Bowles plan. You’re not supposed to agree with all of it. If it is successful, the only thing you’re supposed to say about it is that it’s credible and, froma political standpoint, represents the least bad plan for the greatest number of Americans. Whilemost of us would prefer


to alter it a bit one way or another, any plan that is both fiscally and politically credible is going to involvemost of the same compromises. As Harvard economist Ben Friedman put it this week, the differences in economic impact among the


credible options would be “small potatoes,” particularly when compared with the large economic benefits of adopting any of them. “Fromamacroeconomic


standpoint, the details don’t make thatmuch of a difference,” agrees DavidWyss, chief economist at Standard & Poor’s. “Whatmatters—and itmatters a lot—is to get things back into balance. In the scheme of things, we’re arguing aboutminutia.” In fact, I’d argue that pushing


through a grand budget compromise would be themost effective thing we could do for the economy, even in the short run. Lifting that black cloud and demonstrating to ourselves and the world that our political systemcan function would provide a big boost to the confidence of consumers, investors and business executives whose “animal spirits” have been in hibernation. How large a boost? Here’s a


wild guess: 1,500 points on the Dow Jones industrial average, half a percentage point off the yield on 30-year Treasury bonds, 750,000 jobs created and an extra percentage point of gross domestic product growth in 2011. Longer run, the impact would


be even greater. Besides the boost to confidence and lower interest rates, there would be significant gains in efficiency fromthe proposal to simplify individual and business income tax rates and eliminatemany business and agricultural


favorite tactic for zealots on the right and the left is to try to disguise their


subsidies. Lowermarginal rates would spur investment and make U.S. companiesmore competitive, while reducing tax credits and subsidies would curtail themisallocation of capital that has led to overpriced housing and farmland, inefficient health care and an oversized financial sector. Perhapsmost important, a


grand budget compromise would represent the first thaw in a political stalemate in Washington that has stood in the way ofmuch-needed compromises on trade, energy and immigration, all of which could significantly improve American competitiveness. While the rejectionist


response to the deficit reduction plan is predictable, it need not be fatal, even if it denies Simpson and Bowles the 14 votes they need for an up-or- down vote on their plan in Congress. The plan now offers President Obama exactly the kind of defining issue he needs to rebound fromhis recent political drubbing. If he were clever, he would immediately embrace the commission’s plan —or an improved version offered by former union leader Andy Stern—incorporating it into his own budget, selling it to voters at every opportunity and using it to distinguish himself fromfaux leaders who put ideology and special interests ahead of the national interest. Beneath their well-polled


cynicismand disenchantment, Americans are hungry for such leadership and open to shared sacrifice that can restore the pre-eminence of the American economy. The deficit commission has offered the outlines of just such a program. The question is whether Obama will have the audacity to seize it and run with it. pearlstein@washpost.com


V INTERNET


Amazon invests $175 million in LivingSocial Online retail giant Ama-


zon.com is investing $175 mil- lion in LivingSocial, a District- based Web site that offers daily discounts with local merchants, LivingSocial announced Thurs- day. The minority investment by


Amazon values LivingSocial at about $1 billion. “To be the biggest player in the


local commerce space there is no onebetter toworkwiththanAma- zon,” LivingSocial co-founder and chief executive Tim O’Shaugh- nessy said in a statement. LivingSocial said in a news re-


lease that itwould use the invest- ment, including $8 million more from Lightspeed Venture Part- ners, to fuel growth.


INTERNET


Google vows tougher action on piracy Google promised Thursday to


do a better job of weeding out copyright violations on the Inter- net, vowing to respond to com- plaints about pirated material posted on its YouTube video site and other services within 24 hours. Thesearchgiantdidnot specify


what its average response time is now, but many copyright holders have griped in the past about the company taking too long to re- move videos or other content that had been posted illegally. YouTube was swamped with


pirated video in its early days, outraging television broadcasters


MERGERS&ACQUISITIONS


PepsiCo plansmajor expansion in Russia PepsiCo is buying a majority


stake in Wimm-Bill-Dann Foods for $3.8 billion, a deal that will make it the biggest food and bev- erage company inRussia. The deal is Pepsi’s largest inter-


national acquisition. It gives the company dominant position in the fast-growing Russian market and furthers its plan to build its global nutrition business. Combined, the companies will


holdsix ofRussia’s 20largest food and beverage brands and will be about twice the size of its nearest competitor in the country. Pepsi- Co said the deal willmake Russia its second-largest market behind theUnited States. Wimm-Bill-Dann, whose


shares are traded inMoscow and on theNewYork Stock Exchange, produces dairy products, juices, mineral water and baby food. Founded in 1992 shortly after the breakup of the Soviet Union, it has grown from handful of em- ployees working in one room to launch its first juice brand, J7, to


and movie studios. The rampant violations prompted Viacom to sue Google and YouTube, but a federal judge concluded in a rul- ing earlier this year that Google and YouTube had followed the law. Google has tried to prevent pi-


rated video and music from ap- pearing on YouTube by introduc- ing technology that automatically detects unauthorized content. Without providing specifics, Google said it would introduce more tools nextmonth tomake it easier and quicker to flag copy- right violations.


—Associated Press


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DIGEST


LivingSocial is grossing $1mil-


lion a day and expects to reach $500millioninrevenuenext year. The company has 10million sub- scribers and operates in more than 120 markets across five countries. Amazon’s investment in social


commerce comes amid reports that Google will buy Chicago- based Groupon — a LivingSocial rival—for billions of dollars. LivingSocial’sWashingtonarea


investors include former AOL chairman SteveCase andGrotech Ventures, a Tysons Corner ven- ture capital firm. O’Shaughnessy is the son-in-law of Washington PostCo.ChairmanDonaldE.Gra- ham.


—ThomasHeath


SERGEY PONOMAREV/ASSOCIATED PRESS


PepsiCo Europe chief executive Zein Abdalla, left, shakes hands with David Iakobachvili, a director of Wimm-Bill-Dann Foods, inMoscow.


more than 16,000 people and 38 plants in Russia, theUkraine and Central Asia. The company had revenue of about $2.4 billion for the year ended in June 2010. —Associated Press


Post Tech CECILIA KANG Excerpt from voices.washingtonpost.com/posttech


Lawmakeroutlinesdo-not-trackfor children Rep.EdMarkey (D-Mass.) saidThursday thatheplans to introduce


anInternetprivacy billnext year aimedatprotecting childrenfrom being trackedonline. The billwouldinclude ado-not-track feature thatwouldblock


marketers andshieldyouths fromhaving theirpersonal identification collectedor beingprofiledontheWeb.Hisproposal focuses onchildren andwouldnot cover all Internetusers. “Formany kids today, the Internet is like online oxygen—they can’t


livewithout it,”Markey saidduring aHousehearing toweighado-not- track systemrecommendedbyprivacy groups. “But kids growingupin this online environment alsoneedprotectionfromdangers that can lurk incyberspace.” Thisweek, theFederalTradeCommissionrecommendedado-not-


trackmechanism—most likely throughaWeb browser—as oneway to betterprotect Internetusers’privacy. Advertisershave criticizedthe idea, saying they are implementing


online tools thathelpusers toprotectdata fromthird-partymarketers andWeb sites.Those options include aWeb-page thatusers canclick to opt out ofdata collection. MikeZaneis, senior vicepresident of the InteractiveAdvertising


Bureau, saidinaninterviewthat sites suchasYahoohave begun implementing the icon.Forcing companies to adopt browser technology thatwarnsWeb sites againstdata collection,he said,would be technologically andfinancially burdensome. “The conceptwouldmeanpivotingmidstreamwhenwe are


launching aprogramwhichis successful,”Zaneis said. He also saidthe idea of stopping the tracking of individuals is a “false


promise.”Companies that count traffic forWeb sites suchas washingtonpost.com, couldbe blockedfromaccess touser activity,he said.That couldhurt the advertising andmedia industry,which depends onsuchpartners,he said. FTCChairmanJonLeibowitz saidWednesday that aplanfor a


browser-baseddo-not-trackmechanismcouldbemandatedthrough legislationordevelopedvoluntarily by companies andenforcedby the FTC.He saidGoogle,Mozilla andMicrosofthave already experimented withsuchtechnology,whichwouldlikely involve “persistent cookies” that areusedto informsites ofuser’sprivacypreferences. So far, self-regulation—whichIABmembersGoogle, IAC,NBC Universal andothers support—has fallenshort,he said.


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