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PP RUEHAG RUEHROV
DE RUEHLO #2760/01 3051347
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P 311347Z OCT 08
FM AMEMBASSY LONDON
TO RUEHC/SECSTATE WASHDC PRIORITY 0283
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
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C O N F I D E N T I A L SECTION 01 OF 02 LONDON 002760
SIPDIS DEPT FOR PDAS NELSON, MSAKAUE TREASURY FOR MURDEN, CARNES, E.O. 12958: DECL: 10/30/2015
TAGS: ECON EINV UK
Classified By: Economic Minister Counselor Mark Tokola for reasons 1.4 b and d
1.(C) Summary: Political leaders must tackle not only the liquidity and solvency of financial institutions, but also
must now confront significant currency volatility and a deepening cross-border contagion. While acknowledging there are
no quick fixes, officials from two leading financial institutions - Stephen King, Chief Economist, HSBC and William
Chalmers, Managing Director, Investment Banking Division, Morgan Stanley - identified several possible policy
prescriptions in October 28th meetings with emboffs: injection of cash into economic systems, full disclosure of toxic
assets, and the creation of a framework for a supra-national regulatory agent. They also explained why, in their view,
government recapitalization efforts have failed to stabilize markets. End Summary. Currency Stability
2.(C) In today's turbulent times, cash is paramount and governments must ensure that as much money as needed is
available, said King. Political leaders need to indicate that they are prepared to inject cash into the economy without
limit and regardless of inflationary concerns to assuage fears of investors and prevent cash hoarding. He cautioned,
however, that no one country should proceed unilaterally. Coordination among the G7 would limit the danger of
cross-currency contagion. He also noted that central banks, ability to increase the money supply through open market
operations has been only nominally successful during the crisis, given the paralysis of inter-bank borrowing. The
European Central Bank (ECB) is also more hamstrung than the Federal Reserve in terms of increasing liquidity through
cash injections, since the ECB is built to deal with inflation and has little authority independent of member state
governments in matters of liquidity, King stated. In his view, governments need to bypass the banking system and inject
liquidity directly into the economy via increased government project spending.
3.(C) The spillover of currency volatility on trade and the global de-leveraging process is also of significant concern,
observed Chalmers. The valuation of toxic assets is more difficult when the currency in which those assets are
denominated is unstable. He also argued that political leaders need to make both a verbal and concrete pledge to ensure
currency stability. Without such an assurance, the contagion effect has the potential to cripple European banks.
4.(C) Governments also have been unable to control the speed of de-leveraging - the selling of commodities and assets to
reduce risk and raise capital, said Chalmers. The market panic of recent weeks is evidence that statements by political
leaders have proven to be ineffective in controlling the pace of de-leveraging. Political leaders need to issue a
coherent, strong and combined message that measures in place will work and seek patience from investors and savers, he
stated. Toxic Assets - Fuller Disclosure
5.(C) Many banks have not come clean about the extent of their toxic assets on their balance sheets, said King.
Political leaders and regulators should underscore the need for greater transparency and establish mechanisms to force
fuller disclosure, if not voluntarily done by the banks. He argued that there is a need for an independent authority to
investigate each bank as well as a cross-border evaluation process.
6.(C) Fuller disclosure about assets is necessary but there is a potential trade off between greater transparency and
liquidity, said Chalmers. The real value of assets, if disclosed, could make those assets illiquid. He also argued that
non-regulated instruments - such as hedge funds - also need to be subject to greater transparency requirements.
Regulatory Framework
7.(C) The industry expects more rigorous regulation, remarked King. But he warned that regulators need to really LONDON
00002760 002 OF 002 understand market instruments before developing and imposing new regulations. Some of these
regulators need to have been market insiders and not just government technocrats. "Poachers need to become the
ranchers," if governments are to stay ahead of market mechanisms.
8.(C) Going a step further, King said that the architecture of the global financial system needs to change so that there
is a single global capital market with sovereign nations managing their individual economies. This will require a new
global framework, a Bretton Woods Two, he said. He warned however, that if this is not done skillfully, there is a
danger that nations will revert to capital market protectionism. This would have the same adverse impact on world
economic growth as the Smoot-Hawley Tariff Act of 1930, but the mechanism would be through the capital markets rather
than trade.
9.(C) Chalmers argued that there is a need for a supra-national structure in place of the independent, loosely
coordinated responses of sovereign states. He stated that this could through greater formalized process of cooperation
among national regulators - a "college of regulator" such as PM Brown has proposed - or through the ceding of some
sovereign authority to a supra-national organization. Investors Remain Skeptical
10.(C) The gyrations of the world's financial markets demonstrate that recent policy decisions have not been correct,
argued King. Interest rate cuts have had negligible effect since the real root of the crisis is solvency, not liquidity,
he argued. Governments, recapitalization plans also have had a minimal effect since the markets are skeptical about
whether the amounts will prove to be sufficient. What is the right amount of money - USD 700 billion, GBP 500 billion?
queried King. The capital injections were needed to prevent institutions from going bust, but he warned that there are
many Zombie Banks,, with crippling levels of loans to securitization, that still haven't come to light. How much could
governments borrow to resuscitate these banks? he asked. Without an open-ended funding commitment for recapitalization,
the markets will remain skeptical that there will be enough funding for the distressed banks.
11.(C) The lack of clarity of how and when governments will divest themselves from the troubled banks also is sending a
negative signal to the market, said Chalmers. Potential investors in these banks want a timetable - such a timetable
will also show confidence in the markets and that recovery is attainable, he argued. Visit London's Classified Website:
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