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

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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