On August 29th, I penned “Lagarde Confused, Again.” In it, I argued that Christine Lagarde, the new managing director of the International Monetary Fund, misdiagnosed Europe’s banking crisis.
Ms. Lagarde’s assertion that Europe’s banks “need urgent recapitalization” is based on faulty economics. While the higher capital-asset ratios that Ms. Lagarde extols are intended to strengthen banks (and economies), higher ratios destroy money and are “deflationary.” This is not what a struggling Europe needs. Indeed, higher capital-asset ratios imposed on Europe’s banks at this juncture would virtually ensure that Euroland would take another dive. In consequence, some of the banks that were made “safer” by Ms. Lagarde’s medicine would go to the wall.
Today, the Wall Street Journal’s lead editorial “A TARP for Europe?” adds to the confusion by enthusiastically endorsing Ms. Lagarde’s prescription.