VZCZCXRO7984
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHRL #1746/01 2571552
ZNR UUUUU ZZH
P 141552Z SEP 07
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 9279
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHC/DEPT OF LABOR WASHINGTON DC
RUCNMEM/EU MEMBER STATES
RUCNFRG/FRG COLLECTIVE
UNCLAS SECTION 01 OF 04 BERLIN 001746
SIPDIS
SIPDIS
SENSITIVE
STATE FOR EUR/AGS
LABOR FOR ILAB
TREASURY FOR LUKAS KOHLER/OFFICE FOR EUROPE AND
EURASIA
E.O. 12958: N/A
TAGS: ECON PGOV SENV ENRG EFIN ELAB PREL
GM
SUBJECT: THE GERMAN SUBPRIME BANKING CRISIS:
HAND WRINGING AND SOUL SEARCHING, BUT NO REAL
ANSWERS OR DECISIONS
REF: Berlin 1621
THIS IS A JOINT MESSAGE FROM CONGEN LEIPZIG,
CONGEN FRANKFURT, AND EMBASSY BERLIN.
1. (SBU) Summary: The U.S. subprime crisis
continues to produce anxiety in Germany?s banking
sector, but the exposure of German banks remains
unclear. After the bailout of a second state-run
bank, SachsenLB, in mid-August, pressure for a
consolidation of Germany?s fragmented financial
landscape has intensified. The role of state-
influenced or state-owned banks makes this
process a politically sensitive one. In the
search for long-term solutions, the crisis has
also triggered a debate about the need for more
transparency ? of credit agencies, of banks?
balance sheets, and of hedge funds -- and a more
streamlined system of banking supervision. The
effect on the real economy appears limited so
far. However, analysts are increasingly
concerned about the impact of a slowdown in U.S.
growth on Germany?s export-driven economy. Some
analysts caution that the real culprit lies with
structural imbalances in the global economy. For
now, the political climate does not appear
favorable for far-reaching reform in the banking
sector. End Summary.
----------------------------------------
Extra Liquidity to Troubled Banks
----------------------------------------
2. The European Central Bank (ECB) continues to
watch German markets closely, ready to fend off
liquidity squeezes by flooding the market with
cheap short-term money. Along with other central
banks, the ECB stepped in repeatedly over the
past weeks with one-day loans totaling hundreds
of billions of Euros to bring the overnight rate
back down into line with its main lending rate,
which at present stands at 4 per cent.
3. German commercial banks, however, remain
reluctant to lend to each other for longer
periods. On September 11, the ECB therefore
offered European banks extra cash to try to cut
the cost of longer-term credit, inviting them to
bid for special three-month tenders. Analysts say
the size of the refinancing operation shows how
worried commercial banks remain that borrowers
will be unable to repay loans. Nonetheless, in a
sign that short-term lending may be normalizing,
the ECB drained 60 billion Euros in so-called
overnight cash from the market on September 12.
--------------------------------------------- ----
Multi-Dollar Bailouts of German State Banks
--------------------------------------------- ----
4. Two state-backed banks have had to be bailed
out in the course of the current crisis. In
early August IKB Deutsche Industriebank AG was
rescued from bankruptcy in an operation worth
$4.8 billion by a group of banks led by state-
owned KfW (see Reftel). Recent reports indicate
losses may rise further with IKB?s ?Rhinebridge?
conduit unable to place commercial papers in the
market. Shortly later (mid-August), state-backed
SachsenLB had to be bailed out in a $23.3 billion
rescue operation. German financial watchdog
Federal Financial Supervisory Authority (BaFin -
Bundesanstalt fuer Finanzdienstleistungs-
aufsicht) insisted on an immediate sale of the
bank. On August 26, wealthy state-backed Baden-
Wuerttembergische Landesbank (LBBW) took over
SachsenLB. The second bail-out in three weeks of
a German bank raised fresh questions about the
country's banking system.
5. The subprime crisis precipitated, but did not
BERLIN 00001746 002 OF 004
by itself cause, the sudden collapse of
SachsenLB. The small size of the market in
Saxony (population: 4.2 million) and indifferent
management had plagued the bank for years,
leading SachsenLB to begin exploring a
partnership or merger with the North Rhine-
Westphalian state bank WestLB or with LBBW as
early as October 2005. When the extent of
Sachsen?s exposure to risky loans became known,
it was not long before the State Finance Minister
concluded he must resign.
---------------------------
Structural Problems
---------------------------
6. Indeed, the current troubles highlight
structural problems in the German banking sector
that have been known for many years. Germany is
widely perceived as an "overbanked" country;
there are more banks (2200) in Germany than in
the U.K., France and Italy combined. On
September 3, Deutsche Bank AG CEO Josef Ackermann
stated in Frankfurt that the worst of the banking
crisis was over and that he did not expect far-
reaching consequences for the German economy as a
whole. However, Ackermann emphasized that there
are far too many small banks in Germany, and
called on private and public/savings banks to
combine forces. Other analysts have contended
that the proliferation of small and inefficient
banks has reduced the profitability of all banks
without measurably improving service to the
customer.
7. As EU financial markets opened up to
competition, largely due to pressure from the
European Commission, banks reacted by
diversifying their portfolios and becoming more
aggressive in the search for higher yields.
State-backed banks, such as the bailed-out IKB
and SachsenLB, eagerly participated, but as small
banks lacking the expertise and clout of the big
boys, they overexposed themselves to risk.
?Moral hazard? may have played a part, too, some
analysts observe: officials at the state banks
may have thought that no matter how reckless
their behavior, they would be rescued if they got
into trouble.
--------------------------------------------- ----
Consolidation: Necessary but Politically
Sensitive
--------------------------------------------- ----
8. With the takeover of SachsenLB, LBBW has led
the way in what will likely be an ongoing process
of consolidation that is fraught with political
difficulties. In addition to SachsenLB, LBBW
pursued a merger with North Rhine-Westphalia?s
state bank WestLB, which had suffered enormous
losses in a series of bad investments unrelated
to the current mortgage crisis. LBBW is
competing against Germany?s second largest bank
Commerzbank AG and financial investors J.C.
Flowers and Cerberus. Taken with its acquisition
of SachsenLB, a successful merger with WestLB
would transform LBBW into Germany?s second
largest bank after Deutsche Bank, with total
assets of over 700 billion Euros.
9. State governments, however, are reluctant to
give up control over ?their? bank for the benefit
of another state. North Rhine-Westphalia?s
government led by Minister President Juergen
Ruettgers has so far refused to conduct exclusive
negotiations with LBBW. Although Baden-
Wuerttemberg Minister President Guenther
BERLIN 00001746 003 OF 004
Oettinger has played down the potential rift (?we
are not forcing ourselves on WestLB?, he said
after the SachsenLB takeover), Ruettgers traveled
to Munich on September 12 to sound out options
with Bayerische Landesbank, Bavaria?s state bank.
It?s not just about Euros and cents: Ruettgers
may feel more comfortable with Bayerische
Landesbank, which although sizable, would be less
likely to completely dominate WestLB. The
politics of state banking highlights the
obstacles to consolidation in a country with a
strong federal tradition.
10. IKB, the first bank bailed out in this
crisis, is also a takeover target. The federal
bank German Development Bank (KFW-Kreditanstalt
fuer Wiederaufbau), which holds a 38% stake in
IKB, may now be willing to sell in what seems to
be an about-face by (SPD) Finance Minster Peer
Steinbrueck, who after initially hesitating now
says that a sale depends on ?timing and how
pretty the bride looks?. Interested banks
include Commerzbank, Hypo-Vereinsbank, and the
U.S. private equity firm Cerberus.
----------------------------------------
Transparency and Better Supervision
----------------------------------------
11. Chancellor Merkel and Finance Minister
Steinbrueck have called repeatedly for more
transparency in international financial markets.
Details are sketchy as to whether this would
apply to banks, rating agencies, hedge funds --
or the entire industry. In an Embassy discussion
with Deutsche Bank Research, the bank?s Berlin
representative interpreted these statements as a
way of encouraging the financial industry to draw
up and self-impose ?code of conduct,? rather than
submit to mandatory government rules.
12. The institutional framework for banking
supervision in Germany and Europe is also under
scrutiny. In Germany, responsibility for
supervising the financial sector is shared by the
independent central bank Bundesbank and the
Federal Financial Supervisory Authority BaFin
under the auspices of the Federal Ministry of
Finance. Both institutions have lived uneasily
with overlapping responsibilities and guard their
prerogatives closely.
13. Finance Minister Steinbrueck has rejected
calls for abolishing Germany?s dual system saying
that ?it has served us well in the past?. Some
analysts have proposed replacing national systems
with a unified European system of supervision
that would involve central banks and independent
watchdogs to varying degrees. Under Germany?s
Grand Coalition (CDU-CSU-SPD) government,
fundamental reform is unlikely as any decision
might work to the advantage of one or the other
partner, CDU or SPD, or so some observers say.
--------------------------------------------- ----
Worries about the Impact of the Crisis on the
Real Economy
--------------------------------------------- ----
14. Meanwhile, concerns that the global
financial crisis may affect overall economic
growth in Germany and the Eurozone are
increasing. The optimistic mood at the beginning
of this year received a blow when both the OECD
and the EU Commission revised German GDP growth
downward, from 2.9% to 2.6%. Growth had already
slowed in the first half of the year, both
organizations emphasized, but the prevailing
uncertainty was likely to drag on the economy in
the second half of the year. According to the
Berlin-based economic research institute DIW, the
key will be whether the financial crisis and
subsequent slowdown in the U.S. hit German
exports.
BERLIN 00001746 004 OF 004
-------------
Comment
-------------
15. (SBU) There is a growing recognition that
Germany?s banking system must play by a different
set of rules in a highly globalized financial
industry where markets are quickly impacted by
developments around the world. The question is
what the new rules should be and whether
Germany?s state banking system is up to the task
of undertaking reforms that are economically
necessary but politically unpalatable. The sense
we get here is that these types of decisions will
be postponed for as long as possible. End
Comment.