Christine Lagarde, the new managing director of the International Monetary Fund, didn’t make any friends Friday when, at the US Fed’s conclave for the world’s central banks, she said that European banks have an urgent need to raise capital.
European bank regulators and finance ministers have spent the weekend shooting back. About the kindest things they’ve had to say is that Lagarde, the former French finance minister, is “confused,” “misguided,” and doesn’t understand the nature of the euro crisis.
Which means, of course, that you can be pretty sure that she precisely understands this crisis, that European banking officials know it, and that they really angry at her for daring to suggest that there’s still a debt crisis. Their strategy, you see, is to stop mentioning the problem, and hope that the financial markets will simply forget about it.
All of this means you can cross any hope of an early end to the euro debt crisis off your wish list. (I think you’re even likely to be disappointed if you put it on your list for Christmas.)
What Lagarde said was equivalent to announcing that the emperor has no clothes. Her "urgent" call for European banks to raise more capital was tantamount to saying that the recent European bank stress test—the tougher, Round Two test, which only about 10% of the 91 tested banks failed—was not an accurate measure of the shakiness of the European banking system.
Banks have to get serious about raising capital, and bank regulators have to get serious about forcing them along, she intimated, because nothing else would break the “chains of contagion” sweeping European markets.
Lagarde’s critics have replied by arguing that the problem isn’t any lack of capital, but liquidity. Because comments like Lagarde’s have scared investors, some banks are finding it impossible to access the markets that let them roll over expiring short-term debt and that provide funding for bank operations.
That’s where the problem is—and the only fix that's needed, these critics maintain, is a restoration of confidence in these banks. In other words, if we all just believe hard enough, then the problem will go away.
Unfortunately, as silly as that may be as financial policy—if we all clap hands, Tinkerbell will get better—if may be the only solution available under current political conditions.
The Germans remain adamantly opposed to any kind of joint Eurobond that would collectively underwrite the euro and national debts. They have also voiced their opposition to the European Central Bank buying the bonds of stressed countries, and to the European Financial Stability Facility buying bonds of stressed banks.
Lagarde may be right about the need for many European banks to raise capital. But that doesn’t mean the governments that run the Eurozone are ready to do anything about it.
The euro debt crisis is by no means over, even if global—and European—stock markets are rallying.
ull disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.
