SCENESETTER FOR SECRETARY PAULSON'S VISIT TO

C O N F I D E N T I A L LONDON 003539

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NOFORN
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FOR SECRETARY PAULSON FROM AMBASSADOR TUTTLE

E.O. 12958: DECL: 09/11/2017
TAGS: ECON EFIN PREL UK
SUBJECT: SCENESETTER FOR SECRETARY PAULSON'S VISIT TO
LONDON SEPTEMBER 17-18


Classified By: Ambassador Robert H. Tuttle for reasons 1.4 b & d


1. (C/NF) SUMMARY AND INTRODUCTION: Your visit is much
welcomed. You come to London at a critical moment. The UK
is adjusting to the change in leadership from Tony Blair to
Gordon Brown, who has displayed calm confidence in addressing
key domestic challenges in the short period he has been Prime
Minister. The bilateral relationship is also adjusting to
the change in leadership. Political commentators have
speculated about Brown's need to appease his domestic
audience with a cooler public stance towards the U.S.
Administration. While his Scottish-demeanor is certainly not
as openly warm as Tony Blair's, Brown and his team have been
careful to assure us publicly and privately that our
relationship is paramount. Brown is driven by a sense of
purpose, rather than power. His impatience to press forward
his own agenda in the absence of a clear timetable on his
political future, combined with a more reserved temperament,
will likely lead to the occasional tussle between our
governments.


2. (C/NF) The timing of your visit is also crucial given the
turmoil in the financial markets, which is front page news in
the UK. Both the Prime Minister and the Chancellor will be
keen to discuss how to stabilize the markets and avoid
liquidity problems, as well as let you know the results of
the EU Finance Ministers meeting in Portugal this week-end
and how they have handled the first request, from a major
mortgage lender, of this crisis for liquidity support in the
UK. The war in Afghanistan and in Iraq will be on Brown's
mind with General Petraeus and Ambassador Crocker due in
London just after your visit and Brown scheduled to present
his plans for Iraq to Parliament in October. The British are
also worried about Iran and how to ratchet up the pressure on
the regime. You will find common ground with Brown and
Darling on the importance of promoting free trade and open
investment markets. Brown continues to place great emphasis
on alleviating poverty in the developing world and has
endorsed climate change as a key priority for his government.



3. (C/NF) Your visit gives you the opportunity to gauge
personally Brown's and Darling's commitment to the solid
U.S.-UK relationship, and to convey to them and the British
public our appreciation and support. Your joint press
appearance with the Chancellor should go a long way to
calming nervousness about the financial markets; the bankers
are nervous and looking for leadership. This is an
opportunity to show strength on Iran and Afghanistan and to
move our agenda on Iran forward, to reiterate the importance
of the Doha Development Agenda, to show a joint commitment to
an open investment regime, and to continue to take on the
tough issues that our nations have tackled so well together
over the years. END SUMMARY AND INTRODUCTION

PM Brown's strong start
--------------


4. (C/NF) Prime Minister Brown got off to a solid start upon
succeeding Tony Blair in June. The British public welcomed
his serious, workmanlike approach after the perceived
slickness of his predecessor. They also liked his balancing
act with President Bush after the perceived "subservient"
Blair relationship with Washington: working together to
advance shared interests, while maintaining some personal
distance. Brown was seen to handle early
challenges with calm competence: the attempted car bombings
in London and Glasgow failed and a quick investigation
produced results; one outbreak of foot-and-mouth disease was
quickly contained (although another reared its head on
September 12 with a confirmed case near the earlier
outbreak); and the worst flooding in sixty years drew an
energetic response from the Government.


5. (C/NF) Meanwhile, the opposition Conservatives were in
disarray over leader David Cameron's efforts to drag the
party to the center. At one point, Brown's lead in the
opinion polls (the "Brown Bounce") triggered speculation
about a snap election this fall. That lead has now shrunk,
and with it the prospect - never likely - of a fall election.
Now, the trade unions affiliated with the ruling Labour
Party are threatening an "autumn of discontent" over the PM's
insistence on holding public-sector pay raises below the rate
of inflation and his resistance to demands for a referendum
on the EU Treaty. Standing up to the unions could actually
help Brown with the wider public.

Impact on London of turmoil in financial markets

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6. (C/NF) The financial sector is nervous about the
turbulence in the sector triggered by the subprime mortgage
market problems in the United States. The issue in the UK is
not that suspect U.S. lending practices to subprime borrowers
have been adopted by UK lenders, but rather that the U.S.
subprime problem has made UK banks cautious about interbank
lending, which is drying up. Darling made his first public
statement on this issue in a September 13 interview in which
he said that primary responsibility for handling the credit
crisis lay with the banks which need to examine carefully
their lending policy. He said he would discuss with EU
finance ministers over the weekend and with you on Monday
proposals to help maintain global financial stability and
avoid future liquidity crisis. Mervyn King, Governor of the
Bank of England, signaled in a September 12 letter in advance
of his September 20 appearance at a Parliamentary hearing,
that the Bank would not bail out banks and financial
institutions. Hector Sants of the Financial Services
Authority (FSA) said privately that its "regulatory toolbox"
is not lacking with regard to regulating the UK mortgage
market and securitized mortgage lending. The issue may be
one of better assessing and valuing the risks inherent in
such lending.


7. (C/NF) In a move that surprised both the market and the
public, on September 14, the Bank of England, in consultation
with the FSA and Her Majesty's Treasury, agreed to provide a
"liquidity support facility" to Northern Rock, a large
mortgage company in the UK. This decision is in keeping with
what King said in his September 12 letter was appropriate for
central banks. As a lender of last resort, the Bank provided
this assistance against "good collateral at a penalty rate to
an individual bank facing temporary liquidity problems, but
that is otherwise regarded as solvent." Darling, and others,
hit the media with the message that there is no need to
panic, that Northern Rock is solvent but suffering from a
short term squeeze, and that the Bank of England has an
appropriate tool to address the situation, which it has done.
Nonetheless, there is still a growing degree of nervousness,
and London's over-heated property market may finally cool off
a bit.

Iraq
--------------


8. (C/NF) General Peter Petraeus and Ambassador Ryan Crocker
will stop over in London on their way back to Iraq on
September 18 for meetings with Prime Minister Brown, Foreign
Secretary David Miliband, and Defense Secretary Des Browne.

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The fact that this is their only stop before returning to
Baghdad underscores the importance both we and the British
attach to our cooperation on Iraq.


9. (C/NF) The UK response to the Petraeus/Crocker testimony
has been positive, with Brown himself scheduled to make a
statement in response on September 14. HMG continues to
stress that it is in constant contact with the USG on all
Iraq-related issues, and that the UK will not leave before
the job is done. Nonetheless, the British drawdown of troops
in the south and withdrawal to an airbase outside of Basra,
at the same time as U.S. troops surge elsewhere in Iraq, has
given rise to speculation that tensions are rising between
Washington and London. An August op-ed piece in the "New
York Times" co-authored by Browne and Miliband was designed
to staunch these questions, but HMG contacts tell us they
recognize it has not succeeded. Despite these efforts,
although no decision has been taken, we assess that --
ultimately -- the Brown government will pull its remaining
forces in Iraq out by spring, even at the expense of a strain
in relations with the United States. An August op-ed piece
in the New York Times co-authored by Defence Secretary Des
Browne and Foreign Secretary David Miliband was designed to
staunch these questions, but HMG contacts tell us they
recognize it has not succeeded. A spokesman for PM Brown was
forced to address the issue once again at a September 11
press conference, insisting that the UK and U.S. are in
continuous and open communication on all issues, and that the
U.S. had been fully apprised of the withdrawal of UK forces
from Basra Palace to the airbase outside the city beforehand.


10. (C/NF) Media and public speculation continues to focus on
why such close allies have taken such different approaches,
with some speculating that PM Brown has struck an
unidentified "secret deal" with President Bush to allow most
UK troops to withdraw, while keeping some minimum in the
south of the country. There is also a widely held assumption
that Gordon Brown will reduce the UK presence in Basra to an
absolute minimum by the end of 2007. Domestically, such a
move has no downsides for Brown: the Labour Party, never
entirely comfortable in supporting Blair on Iraq, will be
relieved; the military leadership, which has tended recently
to take public its grievances on being stretched
too far,
will be placated; and the electorate, deeply unhappy over
Iraq, will see Brown as the leader who undid Blair's mistake.
Timing is important: a troop rotation is set to occur in
November. A British departure from Basra by Christmas would
be an asset in a spring general election. While we do not
believe a decision has been made, we assess, that even with
the USG urging that UK troops stay at current levels, Brown
may pull them out by no later than Spring 2008. An important
part of the justification will so that the UK can deploy more
troops in Afghanistan.

British military in Afghanistan
--------------


11. (C/NF) The Brown Government is thinking carefully and at
the highest levels about the current situation in Afghanistan
and the UK's role in future engagement. The UK deployment in
Afghanistan still has public and parliamentary support, but
the longer the deployment goes on the more skeptical both HMG
officials and the public become about prospects for success.
Foreign Secretary David Miliband plans to deliver a copy of a
UK interagency review paper to Secretary Rice on the margins
of UNGA in New York later this month with a view towards
eliciting a U.S. response on the way forward. The UK paper
will reportedly conclude that we do not yet know how to
create a "functioning Afghanistan at all levels" and that
coalition forces need to better understand how to build
functioning government at every level -- national, regional,
local and tribal. It will also discuss ISAF support for
Afghan counter-narcotics efforts. Counter-narcotics is one
area where we have some disagreement with HMG: the British
are totally opposed to aerial spraying, but lately have
indicated more willingness to consider ground spraying on the
opium crop, "under the right conditions." The British mantra
is that counter-narcotics and all other efforts in
Afghanistan must be integrated within a comprehensive
counter-insurgency strategy.

Iran - The British are worried
--------------


12. (C/NF) Iran worries the British. They believe pressure
on Iran is having an important affect, but in order to impact
Iranian behavior we need to ratchet it up through the UN
(where the UK is pessimistic about immediate prospects for a
third UNSCR),other multilateral fora (the EU, with France as
a strong ally on this issue now),and in more public
pronouncements on possible sanctions. The UK emphasizes the
need for unity among the "P5 plus 1" ("E3 plus 3" in its
parlance),and is encouraged by France's willingness to take
a tough line. In addition to briefing Brown and Darling on
current U.S. thinking on Iran and a next UNSCR, you may want
to raise with Darling the usefulness of financial supervision
and regulatory tools in pressuring Iranian banks operating in
the UK. Your Assistant Secretary Pat O'Brien was here last
week to encourage the UK to step up efforts on Iran and on
terrorist financing, and your FinCEN Director James Freis
will be here at the same time of your visit.

Close ally on terrorism finance
--------------


13. (C/NF) Our governments cooperate at all levels across the
inter-agency spectrum on combating terrorist financing (TF.)
There is little daylight between our philosophies and our
approach to using financial tools to stop terrorism. What
differences do exist are mainly a result of a lack of
resources the UK has traditionally made available in the TF
fight and having to meet a high UK evidentiary threshold.
Brown has increased the TF budget and re-organized his
government's efforts.

Promotion of the City
--------------


14. (C/NF) The UK continues to believe hedge funds provide
valuable risk management options and do not need regulation
beyond that to which all UK-based funds are subject. HM
Treasury will decide this month whether to issue a
shariah-compliant sukuk (bond),which Brown hopes will
positively influence Middle Eastern investors and the 1.3
million UK Muslim community. While an increasing number of


officials claim London has surpassed New York as a financial
center, many UK government stakeholders and UK-based
financial companies view the chatter over Wall Street vs. The
City as a fabrication of the financial media. UK officials
contend that both New York and London must prosper in order
to maintain their leadership positions in the face of
emerging financial markets in China and India, but they also
energetically support the City's growth.

Brown and Darling Support DDA
--------------


15. (C/NF) Brown and Darling continue to be a fervent
supporter of the Doha round and open investment in the UK.
Darling, as former Secretary of State for Trade and Industry,
will have insight into internal EU dynamics on the Doha
Development Agenda WTO negotiations which you may wish to
explore with him and Brown. Brown and Darling may ask about
the perceived rise in protectionism in the United States and
Europe and how we can work together to counter public
concerns about globalization. Brown has argued that the UK
and the EU need to be open and competitive to meet the
challenges of globalization.

Development - critical issue for Brown
--------------


16. (C/NF) Although only Prime Minister a short time, Brown
has already made good on his desire to push development and
climate change. After he met with the President in Camp
David in July, he immediately gave a speech at the UN
declaring his intention to push harder to achieve the
Millennium Development Goals and released a Declaration to
that effect, signed by President Bush and other leaders. He
also launched an international health initiative on September
5, which we are still analyzing and are not ready to endorse.

Climate change - Brown government priority
--------------


17. (C/NF) Along with development, climate change is a key
item on Brown's "To Do" list. Climate change is a
front-line, threshold in the UK, with strong support for
action coming from across the political and social spectrum.
All parties want to be seen as fully "green" on climate
change. There is consensus for binding targets and a
cap-and-trade system on carbon emissions. Many environmental
financial services and trading programs reside in London.
Environment Minister Phil Woolas will be Brown's personal
representative to the President's September 27-28 Major
Economies conference on climate change and energy security.
However, the British are miffed that they were not invited as
a sovereign nation, but rather as a part of the European
Union's delegation, and have requested an individual
invitation.

Chancellor of the Exchequer Darling: "A safe pair of hands"
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18. (C/NF) Chancellor of the Exchequer Alistair Darling, a
fellow Scotsman and long-standing Brown ally, has been in the
Cabinet since Labour took power in 1997 (a distinction he
shares with the PM and Justice Secretary Jack Straw),as
Chief Secretary to the Treasury, then Social Security
Secretary, Transport Secretary, and (concurrently) Scotland

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Secretary, then Trade and Industry Secretary. Darling is

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seen as highly capable, experienced and reliable, and very
discreet; he was once voted Britain's most boring politician.
The relationship between Brown and his Chancellor is
expected to be much smoother than the one Brown held with PM
Blair.

Visit London's Classified Website:
http://www.state.sgov.gov/p/eur/london/index. cfm
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