TREASURY DELEGATION MEETS WITH THE ECB AND GERMAN BANKS

UNCLAS SECTION 01 OF 02 FRANKFURT 000276 SIPDIS DEPARTMENT FOR EUR/AGS TREASURY FOR LUKAS KOHLER/OFFICE FOR EUROPE AND EURASIA SIPDIS E.O. 12958: N/A TAGS: EFIN ECON EU GM SUBJECT: TREASURY DELEGATION MEETS WITH THE ECB AND GERMAN BANKS ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET DISTRIBUTION ¶1. A Treasury Department delegation recently visited Frankfurt to discuss global financial turmoil with the ECB, the Bundesbank and representatives of Germany's private banks. The ECB bemoaned a lack of information on the full extent of the turmoil, but none of the interlocutors foresaw an impending credit crunch or a banking crisis in Europe spinning out of control, agreeing that conditions were tightening but the situation was manageable. All sides agreed that banking regulation and supervision in Germany was in need of some adjustment but the system had worked well through the turbulence. Investors eagerly await fourth-quarter reports from German banks but no major disturbances are expected. Helaba Bank executives said that the planned takeover of WestLB was only in its initial stages and would go forward after the Hesse state election. THE VIEWS FROM THE ECB AND THE BUNDESBANK -------------- ¶2. Treasury officials met with a senior official at the European Central Bank (ECB) on January 17 in Frankfurt to get his view on the subprime turmoil. He complained that information on European banks was not up to date and that European statistics are unreliable and hard to compare between countries. The official complimented the U.S. system for its precise reporting standards and deadlines and attributed the ECB's lack of information to the fact that supervisory authority remained with the national central banks, creating a situation where not all member states have the same standards. He cited a study from September, which indicated that the fifteen biggest banks in Europe had a combined direct exposure of 27.4 billion euros ($40 billion) to subprime entities, 148.5 billion euros ($217 billion) in entities with partial subprime components and 114 billion euros ($166.5 billion) in other off-balance sheet vehicles. The ECB also pointd to private-sector estimates which put world-wie exposure between $200 million and $400 million. ¶3. The official worried about contagion to othr economic sectors such as corporate real estateand credit card debt, but saw no signs yet that he situation was unmanageable. He said that lendig standards had tightened and were continuing to o so but that was "not a bad thing" after the exremely loose standards of last summer. One posiive side was that U.S. banks came into the crisis in a relatively strong position after enjoying seeral years of high returns. The official predictd 2% growth in the euro area for 2008, based on he assumption of continued growth in emerging makets and high profitability among European corporaions. He said the ECB would continue to pressur the private sector to contain wage growth and prdicted a "protracted, temporary surge in inflatin" ebbing at the end of 2009. ¶4. The delegation discussed banking supervision in Germany with a senior official at the Bundesbank. The official saw no need for further regulation in the wake of the turmoil saying that the Bundesbank and BaFin were able to react quickly and effectively last summer because supervisory power is held at the national level. He felt that a EU supervisory authority would only slow reaction times. He conceded that the Bundesbank and BaFin had overlapping supervisory responsibilities and it was often unclear which institutions had which competency. The process of delineating responsibilities was "controversial" and therefore not likely to be resolved soon. Commenting on the turbulence, the Bundesbank official foresaw more moderate growth in 2008 but no impending credit crunch and characterized the direct effects of the losses as manageable. GERMANY PRIVATE BANKS PREPARE 4Q REPORTS -------------- ¶5. At Deutsche Bank, senior executives asserted that their bank "had no skeletons in its closet" which would be reflected in their February 7 fourth-quarter report. (NOTE: This conversation took place before the bank's announcement of a $760 million default on a loan in Las Vegas.) They claimed that Deutsche Bank currently held 30 billion euros ($41.1 billion) in asset-backed commercial paper, a third of which was already on balance sheet and half of which Deutsche Bank had originated. Going forward, they argued that banks should modify the originate-and-distribute model by always retaining a piece of the original asset. In so doing, the banks would show investors that they had confidence in their own products. The officials also felt that the ECB should relax its collateral standards, but the ECB had only promised so far to consider this. Seeing no impeding credit crunch, they described current lending standards as normal after a period of excessive looseness. ¶6. Dresdner Bank executives told the delegation that their bank had misjudged the subprime turmoil, which would be reflected in the banks fourth-quarter report. They criticized what they saw as FRANKFURT 00000276 002 OF 002 fraudulent lending practices in the U.S. mortgage industry and failures in the rating agencies. In the troubled collateralized-debt obligation (CDO) market, they faulted the U.S. rating agencies, echoing comments by others that investors like Dresdner could not conduct their own analysis on products they held for such a short period. However, this problem has been overcome now that CDOs are no longer tradable assets. Responding to reports of trouble in Dresdner's K2 special investment vehicle, they said the bank would "manage it down" but that the bank itself had only a 3% stake in the vehicle it managed. On January 25, Dresdner preemtively announced an annual profit of 8 billion euros ($11.8 billion) to calm market worries. The officials weighed in on recent reports of losses at the Bavarian-based German bank Hypo Real Estate saying that the losses were not so great, but rather the poor communication by the bank had destroyed investor confidence. They worried about wage increases in Germany saying an overall increase of even 4% would be too high. They also saw further bank consolidation in Germany as unlikely because severance costs were too high. HELABA: SITES SET ON WESTLB -------------- ¶7. Helaba Bank senior executives expressed confidence in their bank and its proposed takeover of troubled state bank WestLB. Helaba has the second-best rating of any German state bank as it has pursued a model based in retail and wholesale banking. They characterized WestLB as overly ambitious in its attempt to act like an investment bank. The executives said that Helaba has only 200 million euros ($294 million) in exposed off-balance sheet conduits and no direct exposure to subprime debt. Negotiations on the takeover would resume after the January 27 Hesse state election, but they were still in their initial stages. Helaba wants to see a risk assessment carried out by WestLB, but the biggest issue at the moment is that WestLB has not accepted that this will not be "a merger of equals." Not only will WestLB have to accept Helaba's preeminence, but the bank will also have to align its investment strategy with that of Helaba. On bank regulation, Helaba wants to see supervisory authority remain at the national level, but the executives complained about the division of responsibilities between the Bundesbank and BaFin, saying BaFin should have primacy. They also talked about ECB dollar-operations in December, saying small German banks needed dollars after dangerously issuing off-balance dollar credit lines. ¶8. This cable was coordinated with Embassy Berlin and cleared with the Treasury Department. POWELL