Sunday, September 18, 2011

Oops!--The Truth Slips Out

It has been well known for some time that European banks were in shakier condition than U.S. banks after the financial crisis of 2008.  Even though U.S. banks have succeeded in weakening proposed regulations that were intended to prevent a similar crisis, the U.S. bank bailout kept major U.S. banks viable.  In Europe, however, banks have had a much smaller financial cushion against losses, and regulators have been slow to require the shoring up of capital positions.  That has been part of the recurring concern over the European financial system.

Christine Lagarde, the new president of the International Monetary Fund, recently slipped a rare bit of candor into the discussion.  An IMF report indicated that European banks had a huge capital shortfall--an estimated $273 billion.  She quickly retracted the estimate and said the report was still in the draft stages, while the IMF worked with European governments on the matter of adequate capital levels.

It would be enormously dilutive to reported bank earnings for the banks to issue billions of euros of new stock to raise capital levels enough to likely avert risks to the entire European financial system.  As in the U.S., the political strength of the banks might again put in jeopardy the entire financial system.

As for Ms. Largarde's candor, I'd urge her to persevere and keep in mind the great U.S. central banker, Paul Volcker, whose integrity and determination were largely responsible roughly thirty years ago for gaining the confidence of market participants and launching years of prosperity.

Steve Lehman

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