Another day, Another Summit, Another Euro?

Last Friday the markets and euro rallied strongly, as hope about the news from the twentieth European summit on the financial crisis was viewed positively. Spanish bonds and European stock markets rallied while the Dow had an almost 300 point gain.

Less noticed, but more telling in my opinion was a story in Saturday’s Wall Street Journal about the 2008 acquisition of Countrywide Financial by Bank of America. According to the WSJ, the deal has cost BofA more than $40 billion in real estate losses, legal expenses and settlements with various government authorities. Countrywide was the largest mortgage lender in the US and was especially exposed in the area of subprime and adjustable rate mortgages. Quoting from the article “It is the worst deal in the history of American finance said Tony Plath, a banking and finance professor at the University of North Carolina…”

In 2008 as BofA was closing the Countrywide deal, its stock was trading in the high 20’s and low 30’s. It’s now around 8.

If you took Countrywide or BofA now, and pretended it was a sovereign nation, the country it most resembles would be ….. Spain. Half of Spain’s entire GNP over the decade of the 2000’s was real estate construction based.

Interest rates being paid by the Italian and Spanish governments in the issuance of new debt are 6-7%. Southern European governments in general are trying to rein in their borrowing costs by raising taxes and lowering spending in a move to more austerity. As a result the countries who are in the most trouble are seeing their economies shrink and in this drive to more austerity, their total government debt as a share of gross domestic product continues to increase.

As the nice, but generally vague, words from last week’s 20th summit are digested it would pay to think about these issues: (thanks to Simon Dixon, WSJ):

1. Given that France’s new president Hollande has recently decreased the retirement age for workers to 60, how likely is it that he will reverse direction and raise the retirement age for French workers to 67?
2. Coming out of the summit will Italy’s prime minister Monti be able to change Italian law so that companies who are seeing reduced business can lay off workers without a priori obtaining the approval of a judge?
3. Will Spain, whose real estate boom and bust as a share of GNP makes the American real estate bust seem small and manageable, allow bankrupt banks to shutter bank branches?

It is true that most of Europe has many more bureaucratic and sclerotic rules making it far more difficult to start and run businesses than in the US. This past week CNBC ran a special on what this financial crisis means to the person on the street in Greece. One story was about a lady who was trying to open a bookstore with an attached coffee shop. She recounted that for over 18 months she had been working with 20+ government agencies to obtain permits and had not yet gotten all the permits she needed to open a small storefront. To a very significant extent European regulatory rules favor the establishment, making new entrants jump a high hurdle. The result in the south of Europe is extremely high unemployment among the young ranging from 20% to 50%.

Too much borrowing, too much debt, and too much under water real estate for sale are characteristics of societies with inflexible labor markets and unaffordable welfare systems. THIS is the problem that has driven a wedge between the productivity of Northern Europe vs. Southern Europe. And without the political will to change and improve the productivity of the South we’ll still be talking about this at the 30th and 40th summits. Watching European politicians I’m reminded of the Mad Magazine board game we used to play with our kids. Mad’s ultimate ‘trump’ card was the “What, me Worry? You Worry!” card. With that card you could reverse any attacker’s approach right back onto the person attempting the move. Too many European politicians seem focused on convincing their foreign rivals to change, rather than attacking their internal inefficiencies.

Quoting, again, from Simon Nixon who stated it beautifully:

The alternatives are a breakup of the single currency or turning it into a giant version of Italy—a difficult-to-govern transfer union with political and financial instability hard-wired into its constitution. Both of those ultimately lead to the risk of financial catastrophe.

And us? We are marching in the same direction. Even in my beloved New Hampshire, whose state motto is “Live Free or Die”, the march toward more bureaucratic rules and regulations seems inexorable. Beware.