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Cablegate: U.S. Subprime Market Fallout Reverberates In

VZCZCXRO4299
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHRL #1575/01 2320541
ZNR UUUUU ZZH
P 200541Z AUG 07
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 9050
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCNMEM/EU MEMBER STATES
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 02 BERLIN 001575

SIPDIS

SENSITIVE
SIPDIS

TREASURY PASS TO FEDERAL RESERVE

E.O. 12356: N/A
TAGS: EFIN PREL PGOV GM
SUBJECT: U.S. SUBPRIME MARKET FALLOUT REVERBERATES IN
GERMANY


ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED. NOT FOR
INTERNET DISTRIBUTION

1. (SBU) SUMMARY. Fall out from the U.S. subprime
mortgage market continues to reverberate in Germany.
IKB, a Dusseldorf based bank, has chalked up losses of
approximately 3 billion euros ($4.1 billion), staving
off insolvency due to a bailout of 3.5 billion euros
($4.79 billion) led by state-owned KFW. Contacts at
IKB believe that banking losses will lead to more
regulation by the German government. The ECB
responded to the crisis by pumping more than two
hundred billion euros into European financial markets,
but remains sanguine that market disruptions are
temporary. Contacts within the German government
agree the fundamentals of the U.S. and global
financial system remain strong. They support the
USG's call for calm and the need to ensure liquidity
in global markets. Contacts at the Chancellery, while
supportive of U.S. policy in general, question whether
such crises could be avoided in the future with
stronger regulation of hedge funds. The Finance
Ministry believes policymakers should work to
stabilize markets and determine the root causes only
after the crisis has passed. In contrast, Economic
Ministry officials are concerned about the impact of a
major market downturn on the German economy as a
whole. END SUMMARY

IKB
- -
2. (SBU) The German bank most affected by the fallout
of the U.S. subprime market is Duesseldorf-based IKB
Deutsche Industriebank AG. The bank invested a total
of 7.8 billion euros ($10.68 billion) in risky
subprime mortgages. Its estimated total losses are
approximately 3 billion euros ($4.1 billion).
Traditionally, a steep loss like this would have meant
bankruptcy for the bank, and might have sparked a
deeper financial crisis. To avoid this, KFW, a state-
owned lender, and other German banks offered a 3.5
billion euro ($4.79 billion) bail out, with guarantees
totalling 8.3 billion euros ($11.37 billion).

3. (SBU) German Federal Financial Supervisory
Authority (BaFin) auditors are reviewing IKB books and
are expected to issue a detailed report on the extent
of losses by the end of August. IKB expects a broad
political debate in the Bundestag and at the state
level about KFW's intervention and whether new
regulations are necessary to avoid future crises.

4. (SBU) On August 15, CG Dusseldorf spoke with
Clemens Jahn, the head of IKB Private Equity, a
subsidiary of IKB. According to Jahn, other affected
banks in North-Rhine Westphalia are WestLB, Postbank,
and Sal Oppenheim. All banks in Germany are being
hit in one way or another, at least in terms of the
general level of trust in the financial system - and
thus their willingness to lend to each other. It is
too early to tell if there are more serious problems
waiting to be discovered. Jahn believes the bank will
survive the crisis. However, if losses at IKB are
higher than 3 billion euros, pressure will build for a
political debate over the appropriateness of spending
more KFW money to cover further losses.

5. (SBU) IKB expects the crisis will result in more
regulation for the German financial industry. The
bank believes BaFin will take measures to enhance
transparency, such as requiring off-balance-sheet
activities to be listed on financial institutions'
balance sheets. These regulations will be on top of
those already in place and, IKB argues, will impose a
further burden on smaller banks such as itself. IKB
does not believe more regulation is the answer,
however, as regulators usually respond to the last
crisis and are notoriously bad at anticipating new
movements in the financial sector.

THE ECB STEPS IN
- - - - - - - - -
6. (SBU) The Frankfurt-based European Central Bank
(ECB) has taken strong action to limit the extent of
the fallout on European markets by injecting over two
hundred billion euros into financial markets to ensure
liquidity. On August 15, CG Frankfurt met with

BERLIN 00001575 002 OF 002


Francesco Papadia, Director General for Market
Operations at the European Central Bank, to discuss
the subprime crisis. Papadia described the current
situation as "close to normal," and said that the
situation was probably a needed correction to the
recent "Panglossian days." The ECB would prefer not
to keep injecting liquidity in the market, but would
do whatever is necessary to stabilize the market. He
added that technically there is no limit to ECB
infusions.

7. (SBU) Papadia said that banks probably overreacted
to the liquidity crisis. He felt a certain amount of
the demand was based on panic, as evinced by the
precipitous decline in liquidity at the beginning of
the crisis. He described this situation as a market
inefficiency that the ECB had to help alleviate.
Papadia believes that any structural problems that
contributed to the crisis were in the U.S. fund rating
system and mortgage market and therefore not European
in origin.

THE VIEW FROM THE CHANCELLERY
- - - - - - - - - - - - - - -
8. (SBU) On August 17, EconOff met with Ludger
Schlief, Head of the Chancellery's Finance Policy
Division, to discuss the crisis. The Chancellery
believes that global actions taken to stabilize
markets and reassure investors of the overall
soundness of the U.S. economy are working. They
support the ECB's move to inject much needed liquidity
into financial markets. The German government
however, is concerned that problems in the subprime
market could lead to a crisis in confidence in the
U.S. economy that could spread to Europe. For that
reason, Schlief said that it is important for major
economies to work together to coordinate responses to
send a clear message to the markets.

9. (SBU) The Chancellery also raised the issue of the
underlying causes of the crisis. Returning to a theme
often raised by the Chancellor during Germany's G-8
presidency, Schlief speculated that requiring more
regulation of hedge funds could be one way to ensure
transparency and avoid further such crises.

THE FINANCE MINISTRY
- - - - - - - - - - -
10. (SBU) Dr. Thorsten Poetzsch, Deputy Director
General for Banking and Finance Issues at the Ministry
of Finance, expressed confidence that international
markets will survive the current volatility with no
long term impact. Poetzsch said it is important to
ensure the problems in the subprime market do not
spread to other sectors. He added, however, that it
is too early to speculate on the impact of the crisis
on German policy and financial regulations. At this
stage the most important task for governments is to
contain the crisis and restore confidence in global
financial markets.

THE ECONOMIC MINISTRY
- - - - - - - - - - -
11. (SBU) Dr. Albert Caspers, Head of the
Macroeconomic Division of the Ministry of Economics,
echoed the opinion of the Chancellery and Finance
Ministry. He is satisfied that everything is being
done to stabilize markets and ensure confidence. The
Economic Ministry believes the U.S. and German
economies are fundamentally strong and can weather
this crisis. Caspers noted that the German economy is
in the midst of a robust upswing and believes the
crisis should have no immediate impact. However, he
did express concern over the danger to the German
economy of a global slowdown.

11. This cable was coordinated with consul generals
Dusseldorf and Frankfurt.

KOENIG

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