TREASURY DEPUTY SECRETARY KIMMITT'S MEETING WITH

C O N F I D E N T I A L MADRID 000286

SIPDIS

SIPDIS

TREASURY FOR DEPUTY SECRETARY KIMMITT, ALSO FOR
DO/W.LINDQUIST; STATE FOR EEB/IFD/OMA, EEB/ESC, AND EUR/WE

E.O. 12958: DECL: 03/05/2013
TAGS: ECON EFIN KTFN IR SP
SUBJECT: TREASURY DEPUTY SECRETARY KIMMITT'S MEETING WITH
CENTRAL BANK DEPUTY GOVERNOR VINALS

REF: STATE 21770

Classified By: DCM Hugo Llorens for Reasons 1.5(b) and (d)


1. (C) Summary: On March 5, visiting Deputy Treasury
Secretary Kimmitt, accompanied by DCM, discussed with Bank of

SIPDIS
Spain (central bank) Deputy Governor Jose Vinals the U.S. and
Spanish economic situations, sovereign wealth funds, and
Iran. The Deputy Secretary said that the U.S. economy was
expected to continue growing and not enter a recession,
though growth was slowing. Vinals expected Spanish growth
rates to gradually decline during 2008, with full-year growth
of between 2.5 and 2.7 percent. He was less concerned about
Spain's housing and real estate slowdown than about the
drying up of international credit markets, saying that if the
current situation continued through 2008 and well into 2009,
Spain - and many other countries - would face serious
trouble. He also expressed concern about what he termed
misleading British press reports about the Spanish economy.
The Deputy Secretary emphasized the importance of close
scrutiny of Iranian banks and noted his concern that two
Spanish banks maintained correspondent banking relationships
with Iranian banks, including one cited in UNSCR 1803 as
warranting particular vigilance. Vinals promised to
investigate, and on March 7, his office sent us information
obtained from the two banks. Post is analyzing that
information and will report it septel. End Summary.

U.S. and Global Economic Situations
--------------

2. (C) The Deputy Secretary began by reviewing the state of
the U.S. economy. The Treasury and most economists expected
the economy to continue to grow and not enter a recession,
although growth was slowing. He explained the consumer and
business components of the recently enacted stimulus package,
saying that its impact would begin to be felt in the second
quarter. He noted that the job creation effects of the
business component were especially important, as employment
had declined in January, the first decline after a record 51
consecutive months of growth. The economy was facing three
headwinds - the housing crisis, the credit crunch, and high
commodity/natural resource prices. By the end of the year,
he expected the economy to return to its trend growth rate.
The next few quarters would be difficult, though. He
outlined the Administration's efforts to keep homeowners,
especially first-time homeowners, in their homes through the
HOPE NOW program of voluntary mortgage revisions. He noted
two reports coming out in the next month, one from the
President's Working Group on Financial Markets and the other
a blueprint for regulatory reform for bank supervision, that
would help address regulatory problems that had been revealed
by recent developments. He said the budget deficit would
grow from its 2007 figure of 1.2 percent of GDP, in part
because of the stimulus package, but would stay below 3
percent in 2008. For the medium term, he noted the
importance of promoting growth, including making the
Administration's tax cuts permanent, addressing entitlements,
and encouraging savings as relevant to the Administration's
goal of achieving a balanced budget in 2012.


3. (C) Vinals expressed confidence in the USG's judgment and
ability to decide on the appropriate actions. He agreed that
it was important to prevent future crises but also emphasized
Spain's concern about the present one. He said financial
capital was being "renationalized" as international credit
markets were drying up. He expressed concern that if trends
continued, a global credit crunch could result. He
acknowledged the importance of transparency but said other
measures would be necessary to restart global markets. He
called for a global solution and for countries' domestic
solutions to be consistent. He said it looked like the
problem had been spreading since July, with different markets
being affected in turn, including stocks, banks, monolines,
exchange rates, with commercial property and other markets of
securitized assets possibly to follow. He welcomed U.S.
initiatives to stabilize the housing market but noted that it
might take a long time for confidence to return. He
expressed relief that the U.S. economy had been resilient and
that emerging markets were "holding on." He said Spain could
take some actions to address its problems but that if global
markets deteriorated significantly, Spain could only hope to
limit the damage. In discussing Spain's concerns, Vinals
noted that Spain was not in the G7 but would like to be one
day; the Deputy Secretary acknowledged Spain's longstanding
interest in G-7 membership and its important role in the ECB
and the BIS. He also noted that we were lucky that the world
economic growth environment was the best in the last 30
years.

Sovereign Wealth Funds
--------------

4. (C) The Deputy Secretary said U.S. banks were
acknowledging their problems and were strengthening their
balance sheets by adding capital. One important source of
capital was sovereign wealth funds (SWFs). He explained that
most SWFs were passive investors, for example, not seeking
board seats, seeking to diversify their assets without
causing political controversy. The USG had encouraged a
process led by the IMF on best practices by SWFs and hoped to
keep support from the public and Congress despite what
appeared to be rising "investment protectionism."

Spanish Economic Situation
--------------

5. (C) Vinals reviewed Spain's economic history, saying that
over the past 24 years growth had averaged nearly 3.5
percent. The only interruption had been a short but deep
recession in 1992-93. 2007 growth had been higher than
trend, at 3.8 percent, but growth had decelerated steadily
since the summer. The Bank had long expected an adjustment
in 2008-09 as the result of the end of the decade-long
housing boom, but it had not expected the external pressure
that began to be felt in August. He expected 2008 growth to
be 2.7 or 2.8 percent, with the risk on the down side. He
then said, not for attribution, that even 2.5 or 2.6 percent
would not be bad. He expected the deceleration through 2008
to be gradual, with year-on-year fourth quarter 2008 growth
of 2.4 percent. He hoped the government that took office
after the March 9 elections would take only temporary
stimulus measures, and he noted the GOS's healthy 2007 budget
surplus of 2 percent of GDP. The banking sector was in good
shape; bank profits were up 27 percent last year, and bank
provisions were very high, around 2.5 percent of doubtful
loans. The Bank had run stress tests and was confident that
the banking system could survive any negative surprises in

2008. He was not as concerned about the housing sector as
about the lack of international credit. He added that if
international markets remained "closed" through 2008 and much
of 2009, many banking systems around the world would have
serious trouble, and Spain would be no exception. On the
other hand, if the international difficulties could be
resolved, Spain's housing and real estate adjustment would be
manageable.


6. (C) Vinals expressed frustration that international
markets were not distinguishing between what he said was
Spanish paper with high underlying asset quality and that of
other countries. He later said that "the British press" had
been giving Spain's construction slowdown a lot of attention
and were saying that had Spain not been a Euro member, its
banks "would have been big Northern Rocks." He said
commentators were confusing Spanish banks' going to the ECB
to build up reserves with going to the ECB because nobody
else would lend to them. (Comment: By the British press he
mainly meant the Financial Times, whose coverage has
attracted criticism from the Spanish banking association and
others. In the March 3 presidential debate, opposition
candidate Mariano Rajoy quoted from a pessimistic FT op-ed.)

Iran
--------------

7. (C) The Deputy Secretary emphasized the importance of
keeping financial systems safe from abuse by terrorists,
proliferators, drug dealers, criminals, and other illicit
actors, such as Iran. He said cooperation with Spain was
good. He noted the three Security Council resolutions on
Iran and that the Financial Action Task Force had reported
that Iran was lacking an anti-money laundering regime. He
described UNSCR 1803's call (reftel) for authorities to
exercise particular vigilance over activities of Iranian
financial institutions, especially Banks Melli and Saderat.
Bank Director General of Banking Supervision Javier Ariztegui
said that as far as the Bank knew, the situation with respect
to Iran was fully under control. Vinals added that fighting
terrorism and money laundering was a top priority of the Bank
and of GOS authorities. The Deputy Secretary noted that as
the UK, France, and Germany cracked down on Iranian
activities, Iran was moving to Switzerland, Austria, and
Italy. There was no evidence that they were moving to Spain,
but vigilance was important.


8. (C) The Deputy Secretary noted that two Spanish banks,
Santander and Sabadell, had correspondent relationships with
Iranian banks. Santander had a relationship with Melli,
which had been cited in UNSCR 1803. He noted that the banks
would need to be careful carrying out even routine
transactions given Iran's history of using routine
transactions to conceal illicit ones. He also noted that

Santander was expanding in the U.S. and that we would not
want it to be the subject of reputational harm because of
links to Iran. He said we would like to see the two Spanish
banks' relationships with Iran ended and that we would not
want to see Spanish banks being unwittingly involved in
illicit transactions. Vinals promised to check on the two
banks' relationships with Iranian entities.


9. (C) Comment: At a lunch hosted by the Ambassador the
following day, the Deputy Secretary spoke privately with the
president of Sabadell, who indicated that the Bank of Spain
had spoken with his bank that morning. He appeared
responsive to USG concerns and requested more information.
On March 7, the Central Bank sent post information it had
obtained from the two banks. Post is analyzing that
information and will report septel. End Comment.


10. (U) Deputy Secretary Kimmitt has cleared this cable.
AGUIRRE