STEINBRUECK CALLS FOR TIGHTER BANKING

UNCLAS SECTION 01 OF 02 BERLIN 000161

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TREASURY PASS TO FEDERAL RESERVE

E.O. 12356: N/A
TAGS: EFIN EINV ETRD PREL PGOV GM
SUBJECT: STEINBRUECK CALLS FOR TIGHTER BANKING
REGULATION



1. SUMMARY: For months, German Finance Minister Peer
Steinbrueck (SPD) refrained from commenting on the
sub-prime mortgage crisis in the U.S. and possible
measures to prevent similar turbulences in the future.
Now, in the week leading up to the G-7 Finance
Minister meeting in Tokyo he finally broke his
silence. In a series of interviews with German and
international media, Steinbrueck vented his anger over
what he characterized as the careless behavior of
banks and called for regulation that goes beyond the
Basel II accord that would require more equity for
risk-intense financial activities. Steinbrueck
believes the German system of state banks is in
desperate need of consolidation but stresses that it
should be up to the German states to implement any
changes. Embassy contacts have said that Steinbrueck
had been looking forward to an opportunity to speak
out for some time and feels very strongly about the
points he made, especially those with respect to
equity held by banks. He also reportedly feels
vindicated, having warned that lacking transparency in
the international financial system would make it
vulnerable to a crisis. END SUMMARY.

BANKS HAVE TO COME CLEAN
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2. Steinbrueck puts much of the blame for the current
crisis on the behavior of the banks involved,
particularly U.S. banks. "In a careless way," he
said, the U.S. banks gave mortgages to clients that
were not really credit-worthy. "Those banks then
bundled the loans and sold them off to profit-hungry
investors around the world." In Steinbrueck's view,
the banks were only able to do these transactions
because they could keep the risks off their balance
sheets. "We have to close this accounting loophole,"
Steinbrueck said, criticizing the fact that bank
managers are forced to acquire business by volume,
regardless of the risks attached. In order to calm
the financial markets again, it is time for the banks
to come clean and disclose all of their losses. He
accused the banks of taking a piecemeal approach to
the disclosure of their sub-prime exposure, which
contributed to market volatility.

MORE REGULATION NEEDED
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3. Steinbrueck proposes several measures to prevent
future financial crises similar to the one triggered
by the sub-prime mortgage crisis. Like many experts,
Steinbrueck views the introduction of the tougher
Basel II credit rules as an important step and calls
on the U.S. to quickly implement these rules.
However, he is now calling for measures beyond Basel
II and wants to require banks to hold two percent in
additional equity for risk-prone financial
transactions. In Steinbrueck's view this would keep
banks from taking on risks beyond their means -- as
was the case with several German banks. While
Steinbrueck stressed he would look to the G-7 and
international fora for a joint introduction of such
measures, he also expressed his intention to make
changes in Germany alone if no consensus can be
reached. Finance Ministry experts confirmed to us
that there would be room -- even within the EU
framework -- to further tighten Basel II rules.


4. The association of private German banks told
EconOff it will wait for Steinbrueck's proposal to be
spelled out in detail at the G-7 meeting before taking
an official position, but already rejected in
principle the idea of additional equity requirements.
"We did not spend years in the Basel round to figure
out just the right percentage of equity needed...to
now simply put two percent on top (of it)," an
association spokesman told Embassy. "The beauty of
the Basel II accord is that it leaves breathing room
for the banks to freely operate." He also rejected
the notion of a risk-dependent equity buffer saying
that Basel II already incorporates such an element.
The association spokesman also warned that higher
equity requirements meant less investment. "We should
take such 'pro-cyclical' measures at a time of slowing
growth."

A CRISIS FOR THE U.S. BUT NOT FOR EUROPE

BERLIN 00000161 002 OF 002


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5. Steinbrueck considers the financial crisis to be
far from over, predicting it will be "with us for most
of 2008." Separately, he told the Ambassador on
February 1 that the ongoing turmoil in the markets has
had "a deep impact on the German banking sector."
However, he stressed that there were differences
between the economic situation in the U.S. and Europe.
"In Germany the fundamental indicators are still
positive," he insisted. Steinbrueck believes the
downward correction of the government's growth
forecast from 2 percent to 1.7 percent is realistic.
He pointed out that he had no interest in being overly
optimistic since it would cause his fellow cabinet
members to increase their financial demands.
Steinbrueck -- and also Economics Minister Glos --
rejected the idea of a German stimulus package.
Steinbrueck pointed out that the Merkel government had
already introduced a 25 billion euro-investment
program for 2007 - 2009 which was beefed up by
additional state measures of another 10 billion euros.
Furthermore, the lowering of the unemployment
insurance rate from 4.2 percent to 3.6 percent at the
beginning of 2008 together with the introduction of
the corporate tax reform (also taking effect this
year) were additional stimulus injections of 26
billion and 5 billion euros respectively. Anything
beyond those measures would actually jeopardize the
budget consolidation course "and such a signal would
increase market volatility," Steinbrueck fears.

THE GERMAN BANKING SYSTEM
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6. Steinbrueck did not exclude the German banks from
his criticism. He particularly targeted the German
state banks (Landesbanken) which engaged heavily in
structured investment vehicles (SIV),a product "they
were not properly familiar with." Steinbrueck
expressed disappointment over the failure of state
banks to consolidate. "This is a failure of the state
governments. Now the consolidation will come anyway,
but it will take place in a moment of weakness of the
state banks." He made clear though that he had no
intention of engaging the Federal Government in the
process except for use of "moral persuasion."
Steinbrueck fears that the minute the Federal
Government gets involved it will be called upon to
cover Landesbank losses. "This is a problem created by
the states and will have to be solve by the states."

TIMKEN, JR