Lagarde leads from the front on Europe

By Felix Salmon
August 30, 2011
Ben Bernanke, which turned out to be incredibly boring. The most important speech of the meeting, by far, came on Saturday, and came from the new head of the IMF, Christine Lagarde.

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Going into the Jackson Hole conference, everybody was breathlessly awaiting Friday’s speech from Ben Bernanke, which turned out to be incredibly boring. The most important speech of the meeting, by far, came on Saturday, and came from the new head of the IMF, Christine Lagarde. In decidedly undiplomatic prose she came right out and said what needed to be done:

Two years ago, it became clear that resolving the crisis would require two key rebalancing acts—a domestic demand switch from the public to the private sector, and a global demand switch from external deficit to external surplus counties… the actual progress on rebalancing has been timid at best, while the downside risks to the global economy are increasing…

I would like to delve deeper into the different problems of Europe and the United States.

I’ll start with Europe…

Banks need urgent recapitalization. They must be strong enough to withstand the risks of sovereigns and weak growth. This is key to cutting the chains of contagion. If it is not addressed, we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis. The most efficient solution would be mandatory substantial recapitalization—seeking private resources first, but using public funds if necessary. One option would be to mobilize EFSF or other European-wide funding to recapitalize banks directly, which would avoid placing even greater burdens on vulnerable sovereigns…

The United States needs to move on two specific fronts.

First—the nexus of fiscal consolidation and growth. At first blush, these challenges seem contradictory. But they are actually mutually reinforcing. Credible decisions on future consolidation—involving both revenue and expenditure—create space for policies that support growth and jobs today. At the same time, growth is necessary for fiscal credibility—after all, who will believe that commitments to cut spending can survive a lengthy stagnation with prolonged high unemployment and social dissatisfaction?

Second—halting the downward spiral of foreclosures, falling house prices and deteriorating household spending. This could involve more aggressive principal reduction programs for homeowners, stronger intervention by the government housing finance agencies, or steps to help homeowners take advantage of the low interest rate environment.

The diagnosis of what needs to be done in the U.S. is spot-on. Revenues have to be raised — in the future, not yet. Mortgage principal needs to be reduced. And the government needs to help the private sector translate low interest rates into growth, because right now it’s looking like a deer in the headlights and refusing to take advantage of them.

But it’s Lagarde’s diagnosis of her native Europe which is proving highly controversial. Anonymous “officials”, quoted in the FT, rapidly said that she had it all wrong:

Officials said Ms Lagarde’s comments missed the point of banks’ current difficulties. “The key issue is funding,” said one experienced central banker. “Banks in some countries have had trouble securing liquidity in recent weeks and that pressure is going to mount. To talk about capital is a confused message.

This is simply delusional: anybody who knows anything about banking knows that the distinction between a liquidity problem and a solvency problem is not nearly as clear-cut as this makes out. Indeed, if there weren’t any worries about European banks’ solvency, then they wouldn’t have any kind of liquidity problems. If a bank has “trouble securing liquidity,” any responsible regulator must take that as a message that the markets are worried about that bank’s solvency — especially if the problems are happening, as these ones are, in a broader global context where liquidity remains abundant.

And if the markets are worried about a bank’s solvency, then that bank’s solvency is what must be addressed — perception is reality in such matters.

Elsewhere in the FT, other anonymous officials said that the European stress tests were already doing what Lagarde was calling for. This despite the fact that only nine European banks failed those stress tests. Where Lagarde sees a huge systemic problem, European officials, it seems, still thinks it can patch things up by triaging the worst banks and applying band-aids.

All of which, in and of itself, makes Lagarde’s concluding words ring rather hollow:

We have reached a point where actions by all countries, doing what they can, will add up to much more than actions by a few.

There is a clear implication: we must act now, act boldly, and act together.

Obviously, that’s not going to happen. It’s not going to happen in Europe, where officials immediately rejected her proposals. And it’s certainly not going to happen in the US, where she’s significantly to the left of the Obama administration and where her policies could never, ever pass either the House or the Senate.

This is depressing — but the FT does manage to find a sliver of a silver lining: Lagarde, they write, “has said publicly what most policymakers have avoided addressing since the crisis began”. Maybe she’s just leading from the front, here: even if policymakers don’t embrace her position immediately, they might come round to her way of thinking as the world’s developed economies continue to stagnate and financial markets continue to fret over a possible sovereign crisis. If such a crisis starts looking imminent, then at least Lagarde has already laid out a plan for how the banks — a crucial vector of contagion — might be turned instead into a kind of firebreak.

Certainly one can’t ever imagine Lagarde’s predecessor, Dominique Strauss-Kahn, giving a speech like this. He was the consummate behind-the-scenes diplomat; he wasn’t given to big set-piece public speeches. Lagarde, in that sense, is a breath of fresh air at the IMF, and quite un-French in how she’s operating. I do suspect, though, that it’s going to take little a while before Europe’s leaders to come around to her point of view.


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Well just now the bankers and officials who went before the European parliament’s economic committee have ruled out any capital increase for banks, saying it is not needed. Hmmm……..maybe a few banks going belly up might change things.

Posted by Chris08 | Report as abusive

On the front of the United States issue, it’s good to see that she has an eye for detail and some common sense on housing. Except that she’s about two years too late with a diagnosis and in that stretch of time new problems have arisen that make her answer a moot point. Those things could certainly help, and could very well have fixed many problems some time ago.

Now, however, there is a sense of economic contagion at work, that the troubled homeowner of years past has become the frightened consumer afraid to spend at retail, who is afraid of Washington, also afraid of Wall Street, afraid that they’ll lose their job,–or– that they’ve lost a job and are afraid that they’ll never work again. Short and neat: generally afraid the sky is falling.

Even now that would probably just stabilize the consumer, but do nothing for confidence, and doesn’t fully address the greater problems plaguing the business world which isn’t hiring.

And when does she propose is a good time to increase revenue? The bulk of which, I assume to mean, are tax increases. Politically that would only be viable when the economy stabilizes somewhat, but that can’t happen without increased revenue now to fix it. And what does consolidation on expenditure mean? Spending cuts?

If she is suggesting that the underlying problem is a growing deficit that needs to be paid back with said revenue, than how can decent revenue be raised on an American populace making less (giving back modest amounts on taxes due to reduced wealth and income) to pay back on a deficit that stands to grow on increasing interest rates? And that’s only after considering the deficit to be of a central concern in the first place, which maybe it isn’t.

And then Europe!

That her perfectly rational arguments are being deemed as controversial shows just how dysfunctional things have become in the Euro zone. Far less than mere political fall out due to things being stuck in translation, it stands to be a stress test on outright brinksmanship.

All that and I have an unnerving fear that her comments are borne out of the school of thought that we beat out one recession and are precariously close to lapsing into another one, that a jobless recovery can really lead to green shoots and that inflation and bond vigilantes are the frightful specters to fear.

Until someone has the urgency to suggest that the United States is in an economic depression –and that a global economic depression is imminent– than it’s just more of the same from the higher ups spouting good common sense worth too little, too late.

And that any dummy with an internet connection could have found it on so many blogs, so many months ago.

Posted by DanPorter | Report as abusive

” Revenues have to be raised — in the future, not yet.”

It will never be “yet”. That time will never come. Of necessity because of classic Keynes ‘don’t raise taxes in a slow period’ and then too because of ordinary power politics.

“Yet” is a cartoon. Bernake said the same thing, in terms of spending. Don’t cut now he said, faintly. So faintly the NY Times in it’s first story about the speech mentioned it but later took the reference out. So did Congress with the debt limit deal, which was Boehner’s plan, Cutting spending by some number to the right of a percentage decimal point in FY12. It’s always later. There is actually no tension among any person in a position of policy power in the world. Cuts and or more revenue, later. The riff raff think they want now but they mean nothing.

This article like all pretends to say something but doesn’t. What should be said is that hute deficit is a systematic existential necessity. Stop pretending it’s a choice. Then when that is acknowledged a discussion of why can commence.

Posted by rapier | Report as abusive

@Christine Lagarde “Banks need urgent recapitalization.”

Speaking about “recapitalization of the banks” gives the false message that banks had capital to begin with.

The sad truth is that most of the capital being called for now, is capital that should have been there in the first place, had not the regulators waived almost completely the capital requirements for banks when lending or investing in something perceived as “not risky”.

The other sad truth is that it would be great to see all that capital going into new fresh and clean bank balances, capable of new lending, instead of just mending or covering of what has rotten and turned risky.

Reasonable bank capital needs to be in place when the loans are made, because that is when the banks assume the risks, and not, like know, as ordered by regulators, when the banks and the regulators discover the risk.

Per Kurowski
A former Executive Director at the World Bank (2002-2004)

Posted by PerKurowski | Report as abusive

She is approx 90% right, however, she must resort to a sledgehammer next time she addresses the ‘experts’ … hope is not a strategy amigo. Lets not morph the EU in to Japan 2.0

Posted by FunnyYuan | Report as abusive