Cablegate: Merkel and Steinbrueck Unveil Financial Rescue Package

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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: MERKEL AND STEINBRUECK UNVEIL FINANCIAL RESCUE PACKAGE

ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET
DISTRIBUTION

REF: (A) BERLIN 1389; (B) BERLIN 1366

This is a joint message from Embassy Berlin and AmConsulate
Frankfurt.

1. SUMMARY: Chancellor Merkel and Finance Minister Steinbrueck
announced the details of Germany's financial rescue packge October
13, following the French-led effort t coordinate efforts among the
15 euro zone member at this weekend's Paris summit. The so-called
Financial Market Stabilization Fund gives the government
unprecedented power, allowing it to guarantee 400 billion euros
($544 billion) in loans between banks, use up to 80 billion euros
($109 billion) for capital injections and use an undisclosed amount
to buy up toxic assets. In return, the government will collect fees
on guarantees and assume discretionary powers in the institutions
that it funds directly.

2. Coming shortly after Germany's political guarantee of domestic
savings deposits and its rejection of a euro zone rescue fund, the
plan is a clear policy about-face, as Merkel and Steinbrueck came to
accept the French position that a coordinated response with European
partners was necessary following last week's sharp downturn in
equity markets. Despite the change in position, the consensus
between Merkel, Steinbrueck and Foreign Minister Steinmeier showed
strong unity in the face of emergency in the CDU-SPD Grand
Coalition, even with impending elections in September, 2009. Both
houses of the parliament, will vote on the plan by the end of the
week. Some resistance may appear among the state representations in
the upper house, although passage appears likely. The German
business community has responded enthusiastically to the
government's actions. END SUMMARY.

State Guarantees to Restore Interbank Lending
---------------------------------------------

3. The most significant element of the package, 400 billion euros
in loan guarantees, aims to revitalize interbank lending by
restoring confidence among banks and ending the near-total
dependency on European Central Bank (ECB) liquidity operations for
short-term funds. The government will charge at least a 2% fee for
the guarantees which will be available on a 36 month basis to all
banks. The state will set aside 20 billion euros ($27.2 billion),
or 5% of the total guarantee, in its budget for potential losses
stemming from defaults.

Recapitalization for Troubled Banks, Buy-Up of Toxic Assets
--------------------- -------------------------------------

4. In the second part of the plan, the Finance Ministry will work
with the Bundesbank (the German Central Bank) to inject up to 80
billion euros ($108.8 billion) in capital in banks and insurance
companies. Troubled banks as well as insurance companies will be
able to tap into the fund; in return, the government can take an
equity position through preferential shares or certificates of
participation. The Finance Ministry and the Bundesbank will reserve
the right to determine if an injection is in the state's interest
and whether other market solutions have already been exhausted. The
80 billion is in addition to the 50 billion euros ($68 billion)
supplied by the government and a banking consortium last week to
recapitalize Hypo Real Estate. Additionally, the government can buy
toxic assets from financial institutions, mirroring the U.S.
Treasury Department's asset rescue plan, but details on the size of
this part of the plan are still sketchy. The Bundesbank will manage
a special vehicle to hold the assets.

5. The government will reserve the right to influence decisions
within institutions that accept capital. The Finance Ministry will
have the right to order institutions taking part in the plan to
offer loans to corporations in the real economy. Goldman Sachs
Germany Chief Economist Dirk Schumacher referred to this condition
as "the government's quid pro quo" suggesting that the Finance
Ministry will also use the fund as a way to stimulate the real
economy. The plan also envisages a 500,000 euro ($680,000) ceiling
on executive pay, a ban on bonuses, and a ban on dividends.
Schumacher worried that banks have been "late to come for help" and
that these provisions, if applied too harshly, would also discourage
banks to reach out for assistance because of the high price to pay.

Fair-Value Accounting, Regulation and Burden-Sharing
--------------------------------------------- -------

6. The plan also calls on international authorities to relax
mark-to-market accounting rules in cases where the value of the
asset cannot be determined in time for third-quarter reporting, only

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a few weeks away. It promises that German authorities will make
improvements to supervision and regulation, including formalizing
higher deposit insurance, by the end of 2008.

7. All financial institutions operating in Germany (including
U.S.-subsidiaries) are eligible to take part in the plan. As
envisaged, all aspects of the fund would expire at the end of 2009,
at which point the government would take account of its gains or
losses. State governments will assume 35% of the burden of the plan
and any losses from state banks (Landesbanken). The state
governments of Bavaria, Thuringia and Hesse have already expressed
concern about this aspect of the package. The plan will be
expedited through both houses of parliament as a bill by the end
week, but approval in the upper house of parliament (Bundesrat) is
not assured with the concerns raised by the individual states.
Steinbrueck also conceded that the rescue package would upset the
federal government's attempt to balance the budget by 2012.

Business and Banking Community Reacts Positively to Bail-Out
----------------------- ------------------------------------

8. The rescue package was greeted with wide approval by the German
business and banking community and leading economists. The
Federation of German Employers' Associations (BDA) and the
Association of German Chambers of Industry and Commerce (DIHK)
welcomed the joint package of measures adopted by the euro-zone
states as an "absolutely imperative step" to end the financial
crisis. The President of the Association of German Banks (BdB),
Klaus-Peter Mueller (who is also the supervisory board chair of
Commerzbank) said the rescue package was important for two reasons:
1) the plan would depart from previous practices to tackle a problem
only when it becomes apparent, i.e., on a case- by-case basis; and
2) the international financial crisis always has been an
international crisis, requiring international answers. Mueller
added that the talks on the margins of the IMF and World Bank
meetings in Washington and the subsequent meeting at the European
level, had brought major progress toward an internationally
coordinated approach. Defying a deeply-rooted skepticism about
state intervention, many German financial experts are now calling
for a greater role of the government, major reforms to the German
banking system, and even a European financial supervision
authority.

Comment
-------

9. The stabilization fund reflects an abrupt departure from the
government's earlier "go-it-alone" strategy which rejected a
European-wide rescue fund. Chancellor Merkel and Finance Minister
Steinbrueck, however, increasingly recognized the need for
coordinated European action after last week's precipitous drops in
global financial markets. Their partnership demonstrates that the
CDU and SPD, though political rivals in the run-up to the September
2009 elections, are still capable of effective joint governance.
Capital markets in Germany have so far embraced the plan
enthusiastically (with the DAX increasing by a whopping 11.4% Monday
and a further gains Tuesday, but the plan's success is by no means
assured as financial institutions may find they are unwilling or
unable to accept the government's terms and fees. The plan, which
still needs to pass in the parliament, also raises moral hazard
concerns as the Finance Ministry assumes ownership stakes in
financial institutions and, more importantly, decision-making powers
in private entities. End Comment.
POWELL

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