TREASURY A/S LOWERY MEETING WITH SPANISH SECRETARY

C O N F I D E N T I A L MADRID 000499

SIPDIS

TREASURY FOR IA/OEE:W.LINDQUIST
STATE FOR EUR/WE, EEB/IFD

E.O. 12958: DECL: 05/05/2013
TAGS: ECON EFIN SP
SUBJECT: TREASURY A/S LOWERY MEETING WITH SPANISH SECRETARY
OF STATE FOR ECONOMY VEGARA

REF: A. MADRID 285


B. MADRID 286

Classified By: Charge d'Affaires Hugo Llorens, for reasons 1.4(b) and (
d)


1. (C) Summary: Spanish Secretary of State for the Economy
Vegara told Assistant Secretary Lowery that he expected
Spanish growth rates to fall below two percent as a result of
the housing slump, which had been complicated by
international credit market difficulties. He cited as
helpful the government budget surplus and a sound financial
system. While the Spanish adjustment would be painful in
some areas, he said the economy could cope. In response to
questions from Vegara, the Assistant Secretary discussed the
U.S. policy response to housing and financial market turmoil
and the Administration's blueprint for financial regulatory
reform. Vegara also made a pitch for European Commission
participation in the Financial Stability Forum, and the
Assistant Secretary emphasized the importance of robust IMF
surveillance of China's exchange rate regime in the upcoming
Article IV consultations. End Summary.


2. (U) Assistant Secretary of the Treasury for International
Affairs Clay Lowery met with Spanish Secretary of State (vice
minister) for the Economy David Vegara on May 4 at the Asian
Development Bank Annual Meeting in Madrid. Assistant
Secretary Lowery was accompanied by Multilateral Development
Banks office director Mark Jaskowiak and East Asia office
director Mathew Haarsager. Vegara was accompanied by
Director General for International Financing Isabel Riano and
Deputy Director General for Multilateral Financial
Institutions Luis Orgaz.

Spanish Housing Market and Growth
--------------

3. (C) Vegara described Spain,s recent rapid reduction in
housing starts. Demographic factors led generated an average
demand of 400-500,000 new residences a year, but 700,000 had
been built in 2006 and only slightly fewer in 2007. A
significant adjustment had been inevitable, and with
residential construction accounting for 8 or 9 percent of
GDP, the adjustment would affect the whole economy. Even if
the international credit market situation did not deteriorate
further, Vegara expected a rapid decline in the next two to
three quarters to where Spanish growth would be below 2
percent. (Note: This is on a year-on-year basis, and
quarter-on-quarter growth would be somewhat lower at the
lowest point.) If the rest of the economy performed
reasonably well, Vegara expected around 350,000 housing
starts per year until 2010, when the rate would return to the
400-500,000 level.


4. (C) Spain had two noteworthy advantages, Vegara said. The
first was the public sector budget surplus, which was around
2.2% of GDP last year. While he acknowledged that the
surplus could be eroded quickly, it was much better to enter
&complex8 times with a surplus than a deficit. Although
there was talk in the press of additional public works,
public investment already was high at 4% of GDP, and he did
not expect a major increase. The GOS would focus its efforts
on increasing the amount of public housing and on encouraging
renovation of existing housing. He said the GOS could help
make the market adjustment a little less painful but could
not prevent the adjustment.


5. (C) Spain,s second advantage was that its financial
system was &pretty sound.8 Spain,s financial market had
been growing so rapidly that banks had not needed to get into
products like foreign mortgage-backed securities. He said
the Spanish regulatory requirement for cyclical provisioning,
in which the faster credit increased, the higher amount of
provisions were required, had resulted in more than
sufficient provisions for the current situation. Vegara
concluded the adjustment would be painful in some areas, but
that the economy could cope.


6. (C) In response to questions from Assistant Secretary
Lowery, Vegara said Spanish banks had no off-balance sheet
vehicles because they would be required to consolidate them.
This had not limited securitization to date, as Spain,s
secondary mortgage market was Europe,s second largest. Over
the last decade, Spanish banks had not had trouble selling
mortgages, but recently Spanish mortgages had been
contaminated by the U.S. subprime market. He did not expect
this to be a long-term problem, and he said the issue was not
asset quality but liquidity, as funds from elsewhere in
Europe had stopped suddenly. He noted that large Spanish
banks and savings banks were reporting strong first quarter

results and were doing so quickly in an effort to show
markets that they were in good shape. While the rate of
nonperforming loans had risen, it was still low, especially
compared to the rates elsewhere in Europe.

USG Policy Response to Economic Situation
--------------

7. (SBU) Vegara expressed interest in the U.S. policy
reaction to housing market difficulties. The Assistant
Secretary explained the administrative action to eliminate
taxation of foreclosures and the Administration,s efforts to
work with Congress on expanding FHA authority. He described
the HOPE Now program for encouraging voluntary debt workouts
between mortgage originators and homeowners. He also
explained the Federal Reserve,s actions to provide
liquidity, lower interest rates, and help make possible the
sale of Bear Stearns. He also noted that the Administration
had not used taxpayer funds or set up anything like the
Resolution Trust Corporation. The Assistant Secretary and
Secretary Vegara also discussed Congressional views.

U.S. Regulatory Reform
--------------

8. (SBU) In response to questions from Secretary Vegara,
Assistant Secretary Lowery discussed the Administration,s
proposal for regulatory reform. He noted the variety of
different regulators that existed in different sectors for
historical reasons. He said plans for the reform blueprint
had been underway for some time but that recent developments
had strengthened the case for reform. He noted that getting
any legislation passed this year would be difficult. He
thought the U.S. needed more efficient regulation, but he did
not have a view on whether the U.S. needed more regulation,
and he warned of the temptation to swing the pendulum toward
overregulation.

Multilateral Institution Issues

--------------

9. (SBU) Secretary Vegara cited the importance of
international coordination and information exchange in the
current situation. He chaired the EU Financial Services
Commission and welcomed the good flow of information with the
U.S. Assistant Secretary Lowery noted that the U.S. had
worked with the Financial Stability Forum. Vegara said it
was important for the European Commission to participate in
the Forum, though he acknowledged that the large number of
European members already on the Forum could be a problem.
The Assistant Secretary emphasized the importance of the IMF
carrying out robust surveillance of China,s exchange rate
regime in the upcoming Article IV consultation. Vegara
acknowledged the importance of a serious IMF review, and he
said he hoped the final result would recognize some positive
Chinese movement, indicating that to do otherwise would be
counterproductive.


10. (U) Assistant Secretary Lowery has cleared this message.
Llorens