VZCZCXRO7984
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHRL #1746/01 2571552
ZNR UUUUU ZZH
P 141552Z SEP 07
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 9279
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHC/DEPT OF LABOR WASHINGTON DC
RUCNMEM/EU MEMBER STATES
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 04 BERLIN 001746 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
STATE FOR EUR/AGS 
LABOR FOR ILAB 
TREASURY FOR LUKAS KOHLER/OFFICE FOR EUROPE AND 
EURASIA 
 
E.O. 12958: N/A 
TAGS: ECON PGOV SENV ENRG EFIN ELAB PREL
GM 
SUBJECT:  THE GERMAN SUBPRIME BANKING CRISIS: 
HAND WRINGING AND SOUL SEARCHING, BUT NO REAL 
ANSWERS OR DECISIONS 
 
REF: Berlin 1621 
 
THIS IS A JOINT MESSAGE FROM CONGEN LEIPZIG, 
CONGEN FRANKFURT, AND EMBASSY BERLIN. 
 
¶1. (SBU) Summary: The U.S. subprime crisis 
continues to produce anxiety in Germany?s banking 
sector, but the exposure of German banks remains 
unclear. After the bailout of a second state-run 
bank, SachsenLB, in mid-August, pressure for a 
consolidation of Germany?s fragmented financial 
landscape has intensified.  The role of state- 
influenced or state-owned banks makes this 
process a politically sensitive one.  In the 
search for long-term solutions, the crisis has 
also triggered a debate about the need for more 
transparency ? of credit agencies, of banks? 
balance sheets, and of hedge funds -- and a more 
streamlined system of banking supervision.  The 
effect on the real economy appears limited so 
far.  However, analysts are increasingly 
concerned about the impact of a slowdown in U.S. 
growth on Germany?s export-driven economy.  Some 
analysts caution that the real culprit lies with 
structural imbalances in the global economy.  For 
now, the political climate does not appear 
favorable for far-reaching reform in the banking 
sector.  End Summary. 
 
---------------------------------------- 
Extra Liquidity to Troubled Banks 
---------------------------------------- 
 
¶2.  The European Central Bank (ECB) continues to 
watch German markets closely, ready to fend off 
liquidity squeezes by flooding the market with 
cheap short-term money.  Along with other central 
banks, the ECB stepped in repeatedly over the 
past weeks with one-day loans totaling hundreds 
of billions of Euros to bring the overnight rate 
back down into line with its main lending rate, 
which at present stands at 4 per cent. 
¶3.  German commercial banks, however, remain 
reluctant to lend to each other for longer 
periods.  On September 11, the ECB therefore 
offered European banks extra cash to try to cut 
the cost of longer-term credit, inviting them to 
bid for special three-month tenders. Analysts say 
the size of the refinancing operation shows how 
worried commercial banks remain that borrowers 
will be unable to repay loans.  Nonetheless, in a 
sign that short-term lending may be normalizing, 
the ECB drained 60 billion Euros in so-called 
overnight cash from the market on September 12. 
 
--------------------------------------------- ---- 
Multi-Dollar Bailouts of German State Banks 
--------------------------------------------- ---- 
 
¶4.  Two state-backed banks have had to be bailed 
out in the course of the current crisis.  In 
early August IKB Deutsche Industriebank AG was 
rescued from bankruptcy in an operation worth 
$4.8 billion by a group of banks led by state- 
owned KfW (see Reftel).  Recent reports indicate 
losses may rise further with IKB?s ?Rhinebridge? 
conduit unable to place commercial papers in the 
market.  Shortly later (mid-August), state-backed 
SachsenLB had to be bailed out in a $23.3 billion 
rescue operation. German financial watchdog 
Federal Financial Supervisory Authority (BaFin - 
Bundesanstalt fuer Finanzdienstleistungs- 
aufsicht) insisted on an immediate sale of the 
bank.  On August 26, wealthy state-backed Baden- 
Wuerttembergische Landesbank (LBBW) took over 
SachsenLB.  The second bail-out in three weeks of 
a German bank raised fresh questions about the 
country's banking system. 
 
¶5.  The subprime crisis precipitated, but did not 
 
BERLIN 00001746  002 OF 004 
 
 
by itself cause, the sudden collapse of 
SachsenLB.  The small size of the market in 
Saxony (population: 4.2 million) and indifferent 
management had plagued the bank for years, 
leading SachsenLB to begin exploring a 
partnership or merger with the North Rhine- 
Westphalian state bank WestLB or with LBBW as 
early as October 2005.  When the extent of 
Sachsen?s exposure to risky loans became known, 
it was not long before the State Finance Minister 
concluded he must resign. 
 
 
 
--------------------------- 
Structural Problems 
--------------------------- 
 
¶6.  Indeed, the current troubles highlight 
structural problems in the German banking sector 
that have been known for many years.  Germany is 
widely perceived as an "overbanked" country; 
there are more banks (2200) in Germany than in 
the U.K., France and Italy combined.  On 
September 3, Deutsche Bank AG CEO Josef Ackermann 
stated in Frankfurt that the worst of the banking 
crisis was over and that he did not expect far- 
reaching consequences for the German economy as a 
whole.  However, Ackermann emphasized that there 
are far too many small banks in Germany, and 
called on private and public/savings banks to 
combine forces.  Other analysts have contended 
that the proliferation of small and inefficient 
banks has reduced the profitability of all banks 
without measurably improving service to the 
customer. 
 
¶7.  As EU financial markets opened up to 
competition, largely due to pressure from the 
European Commission, banks reacted by 
diversifying their portfolios and becoming more 
aggressive in the search for higher yields. 
State-backed banks, such as the bailed-out IKB 
and SachsenLB, eagerly participated, but as small 
banks lacking the expertise and clout of the big 
boys, they overexposed themselves to risk. 
?Moral hazard? may have played a part, too, some 
analysts observe: officials at the state banks 
may have thought that no matter how reckless 
their behavior, they would be rescued if they got 
into trouble. 
 
--------------------------------------------- ---- 
Consolidation: Necessary but Politically 
Sensitive 
--------------------------------------------- ---- 
 
¶8.  With the takeover of SachsenLB, LBBW has led 
the way in what will likely be an ongoing process 
of consolidation that is fraught with political 
difficulties.  In addition to SachsenLB, LBBW 
pursued a merger with North Rhine-Westphalia?s 
state bank WestLB, which had suffered enormous 
losses in a series of bad investments unrelated 
to the current mortgage crisis.  LBBW is 
competing against Germany?s second largest bank 
Commerzbank AG and financial investors J.C. 
Flowers and Cerberus.  Taken with its acquisition 
of SachsenLB, a successful merger with WestLB 
would transform LBBW into Germany?s second 
largest bank after Deutsche Bank, with total 
assets of over 700 billion Euros. 
 
¶9.  State governments, however, are reluctant to 
give up control over ?their? bank for the benefit 
of another state.  North Rhine-Westphalia?s 
government led by Minister President Juergen 
Ruettgers has so far refused to conduct exclusive 
negotiations with LBBW.  Although Baden- 
Wuerttemberg Minister President Guenther 
 
BERLIN 00001746  003 OF 004 
 
 
Oettinger has played down the potential rift (?we 
are not forcing ourselves on WestLB?, he said 
after the SachsenLB takeover), Ruettgers traveled 
to Munich on September 12 to sound out options 
with Bayerische Landesbank, Bavaria?s state bank. 
It?s not just about Euros and cents: Ruettgers 
may feel more comfortable with Bayerische 
Landesbank, which although sizable, would be less 
likely to completely dominate WestLB.  The 
politics of state banking highlights the 
obstacles to consolidation in a country with a 
strong federal tradition. 
 
¶10.  IKB, the first bank bailed out in this 
crisis, is also a takeover target.  The federal 
bank German Development Bank (KFW-Kreditanstalt 
fuer Wiederaufbau), which holds a 38% stake in 
IKB, may now be willing to sell in what seems to 
be an about-face by (SPD) Finance Minster Peer 
Steinbrueck, who after initially hesitating now 
says that a sale depends on ?timing and how 
pretty the bride looks?.  Interested banks 
include Commerzbank, Hypo-Vereinsbank, and the 
U.S. private equity firm Cerberus. 
 
---------------------------------------- 
Transparency and Better Supervision 
---------------------------------------- 
¶11. Chancellor Merkel and Finance Minister 
Steinbrueck have called repeatedly for more 
transparency in international financial markets. 
Details are sketchy as to whether this would 
apply to banks, rating agencies, hedge funds -- 
or the entire industry.  In an Embassy discussion 
with Deutsche Bank Research, the bank?s Berlin 
representative interpreted these statements as a 
way of encouraging the financial industry to draw 
up and self-impose ?code of conduct,? rather than 
submit to mandatory government rules. 
¶12.  The institutional framework for banking 
supervision in Germany and Europe is also under 
scrutiny. In Germany, responsibility for 
supervising the financial sector is shared by the 
independent central bank Bundesbank and the 
Federal Financial Supervisory Authority BaFin 
under the auspices of the Federal Ministry of 
Finance.  Both institutions have lived uneasily 
with overlapping responsibilities and guard their 
prerogatives closely. 
¶13.  Finance Minister Steinbrueck has rejected 
calls for abolishing Germany?s dual system saying 
that ?it has served us well in the past?.  Some 
analysts have proposed replacing national systems 
with a unified European system of supervision 
that would involve central banks and independent 
watchdogs to varying degrees.  Under Germany?s 
Grand Coalition (CDU-CSU-SPD) government, 
fundamental reform is unlikely as any decision 
might work to the advantage of one or the other 
partner, CDU or SPD, or so some observers say. 
 
--------------------------------------------- ---- 
Worries about the Impact of the Crisis on the 
Real Economy 
--------------------------------------------- ---- 
¶14.  Meanwhile, concerns that the global 
financial crisis may affect overall economic 
growth in Germany and the Eurozone are 
increasing.  The optimistic mood at the beginning 
of this year received a blow when both the OECD 
and the EU Commission revised German GDP growth 
downward, from 2.9% to 2.6%.  Growth had already 
slowed in the first half of the year, both 
organizations emphasized, but the prevailing 
uncertainty was likely to drag on the economy in 
the second half of the year.  According to the 
Berlin-based economic research institute DIW, the 
key will be whether the financial crisis and 
subsequent slowdown in the U.S. hit German 
exports. 
 
BERLIN 00001746  004 OF 004 
 
 
 
------------- 
Comment 
------------- 
¶15. (SBU) There is a growing recognition that 
Germany?s banking system must play by a different 
set of rules in a highly globalized financial 
industry where markets are quickly impacted by 
developments around the world. The question is 
what the new rules should be and whether 
Germany?s state banking system is up to the task 
of undertaking reforms that are economically 
necessary but politically unpalatable.  The sense 
we get here is that these types of decisions will 
be postponed for as long as possible.  End 
Comment.