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