Euro squabbling assures that euro debt crisis isn't over

08/29/2011 6:42 pm EST


Jim Jubak

Founder and Editor,

Christine Lagarde, the new managing director of the International Monetary Fund, didn’t make any friends Friday when, at the U.S. 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 to hope that the financial markets will simply forget about it.

All of which 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 the equivalent to announcing that the emperor has no clothes. Her call for European banks to raise more capital—the need is urgent, she said—was tantamount to saying that the recent European bank stress test—the tougher round two test—in which only about 10% of the 91 banks tested failed the exam 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 to raise capital, 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 all that fixing that requires, 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, Tinkerbelle 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.

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