STEINBRUECK CALLS FOR TIGHTER BANKING

UNCLAS SECTION 01 OF 02 BERLIN 000161 SIPDIS SIPDIS 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 -------------- ¶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 -------------- ¶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 -------------- ¶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 -------------- ¶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