“What happened of world importance in 1776?”  That was the question Mike Leslie, Dean and Professor of British Studies at Rhodes College of Memphis, Tennessee, posed to my daughter and son-in-law on their visit to Oxford.  Leslie was actually referring to the creation of the garden at St. John’s College, one of the thirty-eight colleges that comprise Oxford University. 

The garden, which was actually redesigned in 1776, greets each visitor with a beautiful configuration of stately trees, rock gardens, walking paths, and perfectly manicured lawns.  What is even more breathtaking than nature itself is the serenity and presence that can only be described as authentically English.  http://www.cumber.com/content/special/oxford2.jpg

As I walk through the portals of St. John’s, I am reminded of the opening scene in Chariots of Fire.  Standing in the picturesque cloister, one cannot help but close one’s eyes and envision the students racing in The Great Court Run – the challenging feat to run a complete lap around the court before the clock completes its series of chimes at high noon.  St. John’s and the glory of its gardens are a marvelous welcome to Oxford. http://www.cumber.com/content/special/oxford1.jpg

My colleague Bill Witherell tells me he is named after an ancestor who received his BA from Corpus Christi College at Oxford in 1626 and his MA in 1627.  It was the first William Witherell who came to the United States with his family on the ship Hercules in 1635.  Towards the end of his tenure at OECD, Bill attended and spoke at the annual International Financial Crime conferences held at Oxford.  Readers may not know that Bill held the position of Director for Financial and Enterprise Affairs of the OECD before he retired.  He also reminded me that he was attending a conference at St. John’s during the 9-11 attacks and attended a memorial service there.  We have conversed on 9-11 and its implications as the inflection point for America and the rest of the world. 

The solitude of the gardens at St. John’s facilitates contemplation of the turmoil in the European financial markets.  This week has raised the profile of Italy, forced political activity in the Berlusconi regime, and brought about the repricing of sovereign debt in the five peripheral countries in question.  Nicknamed the ‘PIIGS’, they are Portugal, Ireland, Italy, Greece, and Spain. 

Europeans are aware that this is no longer about Greece.  Their original policy was to build a wall around Greece, isolate their debt problems, and find ways to defer payments well into the future.  On this trip to London and Oxford, multiple conversations have led us to the conclusion that Europe must face the reality of making serious, credible decisions about its structure, banking system, and supervision of banks.  It is imperative to address their functioning structure for bank deposits and budgets that need to be brought under control. 

Perhaps European nationals could look for direction to many of the states in the US, which are reining in budgets and imposing changes in order to address their debt loads.  However, the United States has a much different structure than the European Union and the euro zone.

The majority of our fifty sovereign states function with some form of a balanced budget requirement.  Over time, this has forced them to maintain discipline on the balance between their revenues and their expenditures.  Have they used financial and accounting gimmicks, or deferrals of pension funds to get around this discipline?  Yes, they have.  Have those tricks been discovered, measured, and estimated by the markets and rating agencies, forcing them to address the matter directly?  Again, the answer is yes. 

In Europe there is a different construction.  Unlike the US, which has a single, central bank – the Federal Reserve – and a single currency – the US dollar – the Europeans have a structure that comprises twenty-seven member states within the European Union.  Of those, seventeen are in the euro zone.  Those seventeen member countries look to the European Central Bank to fulfill the central banker’s role.  The other ten are either in the process of joining the euro zone or waiting until the euro zone gets its act together.  Some have decided they do not want to have any part of the euro zone.  Countries like the UK and Sweden have their own central banks, own currencies, own policies, and are not buying into the mess they view when they look at the euro zone.

The euro zone’s seventeen suffer from a different problem.  Rules and procedures are in place for the central bank to actively manage their currency.  Having a common currency was their attempt to establish world credibility; this is now in question.  Further, the banks through which the central bank has to do business are still national banks.  The established central bank, the ECB, has to transact with a French bank, or a German bank, or an Italian bank.  That is where the rubber hits the road, because those banks hold the sovereign debt of their countries.  The debt is denominated in euros and carried on the banks’ books.  There are no reserves for loans; they have assumed all along that the debt will pay. 

Now Greece and others are undermining the very fundamental assumption that government debt is riskless.  In fact, it is seen now as very risky, depending on the issuer.  No one worries about getting paid if they hold German bonds, denominated in euros.  Worries abound if you hold a Greek bond. 

How this plays out will determine whether the euro zone and the European Union emerge stronger, with a more solid footing and with more transparent banking, supervision, and regulation.  There must be an understanding that if losses have to be taken, they must be realized and adequately reserved.  If the European leadership can coalesce to that position, the euro will emerge stronger than ever.  The European experiment will have been tested by fire and come out victorious.

However, if European leaders cannot find a way to come together on these issues, then dismemberment is on the horizon.  Some countries may fail and some may default.  There may be departures from the euro zone; and if there are no provisions to handle this, the whole situation could become very ugly.

While in Oxford, we have been able to read and ponder thoughtfully about a wonderful collection of essays on the situation in Europe.  The title of this e-book is Life in the Eurozone: With or Without Sovereign Default?  The book was assembled by three editors and was published this year.  You can access your free copy of this e-book at http://fic.wharton.upenn.edu/fic/.  This writer congratulates the authors and editors for a terrific assembly of perspectives on sovereign debt in Europe in the euro zone, and the various ways it may or may not play out.