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Cablegate: The Ecb Steps in As Germany's Largest Bank Feels Subprime

VZCZCXRO1551
OO RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHFT #4624/01 2900857
ZNR UUUUU ZZH
O 170857Z OCT 07
FM AMCONSUL FRANKFURT
TO RUEHC/SECSTATE WASHDC IMMEDIATE 3680
INFO RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RUCNMEM/EU MEMBER STATES IMMEDIATE
RUCNFRG/FRG COLLECTIVE IMMEDIATE

UNCLAS SECTION 01 OF 02 FRANKFURT 004624

SIPDIS

DEPARTMENT FOR EUR/AGS
TREASURY FOR LUKAS KOHLER/OFFICE FOR EUROPE AND EURASIA

SIPDIS
SENSITIVE

E.O. 12958: N/A
TAGS: EFIN ECON GM

SUBJECT: THE ECB STEPS IN AS GERMANY'S LARGEST BANK FEELS SUBPRIME
STING


ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET
DISTRIBUTION

REF: a) 07 Berlin 1574, b) 07 Berlin 1746

1. (SBU) SUMMARY: On October 3 Deutsche Bank, Germany's largest
commercial bank, announced it would write off 2.2 billion euros
($3.12 billion) in losses based in investments in U.S.
mortgage-backed securities, ending several weeks of speculation
about the bank's exposure to subprime debt. The financial world was
surprised to learn that Deutsche Bank, with its reputation as a
shrewd and conservative actor, was the most deeply invested in
subprime vehicles of all of Germany's large commercial banks.
Deutsche Bank's overall financial position remains healthy with
third-quarter net profits expected at 8.4 billion euros ($12
billion). The announced write-offs have contributed to the crisis
of confidence in the banking sector. Interbank lending, even among
the major German banks, has ceased, with the European Central Bank
plaYing a key intermediary role in providing liquidity to the
market. END SUMMARY.

2. (U) In a series of meetings in Frankfurt on October 11-12, EMIN
and Congen Econoff met with executives and senior officials at
Commerzbank, Deutsche Bank, Morgan Stanley, the Bundesbank, and the
European Central Bank (ECB). Discussions ranged from the recent
troubles of German banks to the role played by the ECB during the
ongoing subprime crisis.

DEUTSCHE BANK: FIREMAN OR ARSONIST?
-----------------------------------

3. (SBU) The declared insolvency and subsequent bail-outs of two
small German state-backed banks, SachsenLB and IKB Deutsche
Industriebank AG, in August prompted widespread speculation about
the health of Germany's banking system and its exposure to subprime
debt (see reftels). Media sources reported that these small German
banks were driven by low returns on investments at home to invest
heavily in U.S. mortgage-backed securities that seemingly promised
the impossible: high returns and low risk. Germany's three largest
commercial banks (Deutsche Bank AG, Commerzbank AG and Dresdner Bank
AG) were believed to be better protected from the subprime plague
due to their larger size, greater diversification and perceived
long-standing aversion to high-risk investments.

4. (SBU) In a September 4 article in Handelsblatt, Deutsche Bank
Chief Executive Officer Josef Ackermann weighed in to calm panic in
the financial community, saying: "I am optimistic about the
environment globally for financial institutions." Ackermann argued
that, in the current crisis, the bad debt in the U.S. was shared
more widely due to the dispersal of risk worldwide and thereforethe
system was more stable. In a nod to the perceived need for banking
consolidation in Germany, he said "Progress is a continuous process
of creative destruction. The present subprime crisis and its
consequences, harbors, like all crises, not only risks, but also
opportunities." His statements as "Germany's top banker" buoyed
markets in Frankfurt, and led to Deutsche Bank's shares rebounding
2.6% that day.

5. (SBU) Despite Ackermann's attempt to calm the panic, he came
under fire for his apparent lack of sympathy for banks in trouble
and Deutsche Bank's own role in selling high-risk products to small
banks such as IKB. On the same day Ackermann's article came out,
Heinrich Haasis, the President of the German Savings Bank Federation
(DSGV), said of Deutsche Bank at a conference in Frankfurt, "You
should not give advice on putting out fires when, in the past, you
not only did not put the fire out, but also sold the wood for the
fire and profited from it." Ackermann later rejected the criticism,
rejoining that "of course we sold all sorts of products to IKB.
That is our business. They made a lot of money for a long time."

DEUTSCHE BANK'S OWN FIRE
------------------------

6. (SBU) Deutsche Bank's own exposure became apparent on September
20. In an address to German broadcaster ZDF, Ackermann admitted
that the bank had "made mistakes during this crisis," and that third
quarter profits would reflect those mistakes. Ackermann stated that
29 billion euros ($40.5 billion) yn credit agreements needed to be
"reassessed" thanks to high risk investing in the United States
housing market. He said that Deutsche Bank would most likely not
hire 4,000 additional staff by the end of the year as originally
planned. This preliminary statement caused Deutsche Bank shares to
drop by 3% on the Frankfurt stock exchange. Seeking to calm any
panic, Germany's Finance Minister, Peer Steinbruck, weighed in later
in the day, reassuring markets that "Deutsche Bank stands on a solid

FRANKFURT 00004624 002 OF 002


foundation."

7. (SBU) On September 24, a Reuters report claimed that Deutsche
Bank was faring far worse than Ackermann had admitted. According to
the report, Deutsche Bank's credit was actually worth between 4% and
6% less than face value, nearly twice as bad as Ackermann's
predictions. On the same day, Commerzbank, Germany's second largest
bank, reiterated its announced profit target for 2007 in order to
diffuse rumors that it too was suffering from the subprime collapse.
Several papers reported that Ackermann, who in November 2006
survived widespread public criticism for his role in the Mannesmann
affair, would be forced to step down earlier than the planned end of
his term in 2010. An executive at Deutsche Bank, told EMIN and
Econoff that there was a misperception in the media that Ackermann
either did not know about his bank's exposure when he made his
remarks in early September or did not want to admit it, when in fact
Ackermann had been consistent all along in his message,
acknowledging that Deutsche Bank, too, had made mistakes.

8. (SBU) On October 3, Deutsche Bank announced that it would write
off 1.5 billion euros ($2.1 billion) in residential mortgage-backed
securities and structured credit products, as well as 700 million
euros (nearly $1 billion) in leveraged loans. The announcement of
the losses was offset by the news that other gains in asset sales
and tax credits will lead to a third-quarter profit of 1.4 billion
euros ($2 billion). The announcement helped bring clarity to the
question of Deutsche Bank's exposure. Nevertheless, Deutsche Bank's
shares are down 9% since the beginning of August. Deutsche Bank
officials told us that the write-offs were not so much a result of
the fact that the securities were all that risky, but rather of
Deutsche Bank's inability to find a buyer during the current
turbulence.

WEATHERING THE STORM
--------------------

9. (SBU) A senior official at the European Central Bank, confirmed
to EMIN and Econoff that "lending markets between banks are still
functioning poorly in Europe due to the crisis of confidence."
Germany's other large commercial banks appear to have weathered the
storm better than Deutsche Bank. The chief executive of
Commerzbank, Klaus-Peter Mueller, said on September 20 that the bank
would set aside a comparatively small 92 million Euros ($128
million) for possible losses from the subprime crisis, although it
has been rumored that this sum may not be enough. Dresdner Bank set
aside an equally small 70 Million Euros ($100 million). An
executive at Commerzbank, confirmed to us that, although he does not
believe the crisis is over, it poses no threat to Commerzbank (which
reportedly owns very few mortgage-backed securities). The
securities that it does hold were mostly originated by the bank and
not purchased from other institutions. Deutsche Bank's greater
exposure results mainly from a difference in investment strategy:
Deutsche Bank under Ackermann's leadership has focused on capital
markets, while Commerzbank and Dresdner Bank retain a stronger
focus on private banking.

10. COMMENT. Deutsche Bank, which has enjoyed a reputation for
prudence and foresight, is clearly the most exposed of Germany's
large co-mercial banks. While its balance sheet remains well in the
black, the subprime crunch has left its financial position and
Ackermann's image bruised, if not badly damaged. The bank's
write-offs may not be so large, but Ackermann's comments have fueled
rather than alleviated the crisis of confidence that still has
European banks uneasy. Global investors will keep a close eye on
the third quarter profit reports of Deutsche Bank and its
competitors. END COMMENT.

11. This cable has been coordinated with Embassy Berlin.
POWELL

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