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C O N F I D E N T I A L LONDON 003539 

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NOFORN 
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FOR SECRETARY PAULSON FROM AMBASSADOR TUTTLE 

E.O. 12958: DECL: 09/11/2017 
TAGS: ECON EFIN PREL UK
SUBJECT: SCENESETTER FOR SECRETARY PAULSON'S VISIT TO 
LONDON SEPTEMBER 17-18 


Classified By: Ambassador Robert H. Tuttle for reasons 1.4 b & d 

¶1. (C/NF) SUMMARY AND INTRODUCTION: Your visit is much 
welcomed. You come to London at a critical moment. The UK 
is adjusting to the change in leadership from Tony Blair to 
Gordon Brown, who has displayed calm confidence in addressing 
key domestic challenges in the short period he has been Prime 
Minister. The bilateral relationship is also adjusting to 
the change in leadership. Political commentators have 
speculated about Brown's need to appease his domestic 
audience with a cooler public stance towards the U.S. 
Administration. While his Scottish-demeanor is certainly not 
as openly warm as Tony Blair's, Brown and his team have been 
careful to assure us publicly and privately that our 
relationship is paramount. Brown is driven by a sense of 
purpose, rather than power. His impatience to press forward 
his own agenda in the absence of a clear timetable on his 
political future, combined with a more reserved temperament, 
will likely lead to the occasional tussle between our 
governments. 

¶2. (C/NF) The timing of your visit is also crucial given the 
turmoil in the financial markets, which is front page news in 
the UK. Both the Prime Minister and the Chancellor will be 
keen to discuss how to stabilize the markets and avoid 
liquidity problems, as well as let you know the results of 
the EU Finance Ministers meeting in Portugal this week-end 
and how they have handled the first request, from a major 
mortgage lender, of this crisis for liquidity support in the 
UK. The war in Afghanistan and in Iraq will be on Brown's 
mind with General Petraeus and Ambassador Crocker due in 
London just after your visit and Brown scheduled to present 
his plans for Iraq to Parliament in October. The British are 
also worried about Iran and how to ratchet up the pressure on 
the regime. You will find common ground with Brown and 
Darling on the importance of promoting free trade and open 
investment markets. Brown continues to place great emphasis 
on alleviating poverty in the developing world and has 
endorsed climate change as a key priority for his government. 


¶3. (C/NF) Your visit gives you the opportunity to gauge 
personally Brown's and Darling's commitment to the solid 
U.S.-UK relationship, and to convey to them and the British 
public our appreciation and support. Your joint press 
appearance with the Chancellor should go a long way to 
calming nervousness about the financial markets; the bankers 
are nervous and looking for leadership. This is an 
opportunity to show strength on Iran and Afghanistan and to 
move our agenda on Iran forward, to reiterate the importance 
of the Doha Development Agenda, to show a joint commitment to 
an open investment regime, and to continue to take on the 
tough issues that our nations have tackled so well together 
over the years. END SUMMARY AND INTRODUCTION 

PM Brown's strong start 
----------------------- 

¶4. (C/NF) Prime Minister Brown got off to a solid start upon 
succeeding Tony Blair in June. The British public welcomed 
his serious, workmanlike approach after the perceived 
slickness of his predecessor. They also liked his balancing 
act with President Bush after the perceived "subservient" 
Blair relationship with Washington: working together to 
advance shared interests, while maintaining some personal 
distance. Brown was seen to handle early 
challenges with calm competence: the attempted car bombings 
in London and Glasgow failed and a quick investigation 
produced results; one outbreak of foot-and-mouth disease was 
quickly contained (although another reared its head on 
September 12 with a confirmed case near the earlier 
outbreak); and the worst flooding in sixty years drew an 
energetic response from the Government. 

¶5. (C/NF) Meanwhile, the opposition Conservatives were in 
disarray over leader David Cameron's efforts to drag the 
party to the center. At one point, Brown's lead in the 
opinion polls (the "Brown Bounce") triggered speculation 
about a snap election this fall. That lead has now shrunk, 
and with it the prospect - never likely - of a fall election. 
Now, the trade unions affiliated with the ruling Labour 
Party are threatening an "autumn of discontent" over the PM's 
insistence on holding public-sector pay raises below the rate 
of inflation and his resistance to demands for a referendum 
on the EU Treaty. Standing up to the unions could actually 
help Brown with the wider public. 

Impact on London of turmoil in financial markets 

--------------------------------------------- --- 

¶6. (C/NF) The financial sector is nervous about the 
turbulence in the sector triggered by the subprime mortgage 
market problems in the United States. The issue in the UK is 
not that suspect U.S. lending practices to subprime borrowers 
have been adopted by UK lenders, but rather that the U.S. 
subprime problem has made UK banks cautious about interbank 
lending, which is drying up. Darling made his first public 
statement on this issue in a September 13 interview in which 
he said that primary responsibility for handling the credit 
crisis lay with the banks which need to examine carefully 
their lending policy. He said he would discuss with EU 
finance ministers over the weekend and with you on Monday 
proposals to help maintain global financial stability and 
avoid future liquidity crisis. Mervyn King, Governor of the 
Bank of England, signaled in a September 12 letter in advance 
of his September 20 appearance at a Parliamentary hearing, 
that the Bank would not bail out banks and financial 
institutions. Hector Sants of the Financial Services 
Authority (FSA) said privately that its "regulatory toolbox" 
is not lacking with regard to regulating the UK mortgage 
market and securitized mortgage lending. The issue may be 
one of better assessing and valuing the risks inherent in 
such lending. 

¶7. (C/NF) In a move that surprised both the market and the 
public, on September 14, the Bank of England, in consultation 
with the FSA and Her Majesty's Treasury, agreed to provide a 
"liquidity support facility" to Northern Rock, a large 
mortgage company in the UK. This decision is in keeping with 
what King said in his September 12 letter was appropriate for 
central banks. As a lender of last resort, the Bank provided 
this assistance against "good collateral at a penalty rate to 
an individual bank facing temporary liquidity problems, but 
that is otherwise regarded as solvent." Darling, and others, 
hit the media with the message that there is no need to 
panic, that Northern Rock is solvent but suffering from a 
short term squeeze, and that the Bank of England has an 
appropriate tool to address the situation, which it has done. 
Nonetheless, there is still a growing degree of nervousness, 
and London's over-heated property market may finally cool off 
a bit. 

Iraq 
---- 

¶8. (C/NF) General Peter Petraeus and Ambassador Ryan Crocker 
will stop over in London on their way back to Iraq on 
September 18 for meetings with Prime Minister Brown, Foreign 
Secretary David Miliband, and Defense Secretary Des Browne. 

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The fact that this is their only stop before returning to 
Baghdad underscores the importance both we and the British 
attach to our cooperation on Iraq. 

¶9. (C/NF) The UK response to the Petraeus/Crocker testimony 
has been positive, with Brown himself scheduled to make a 
statement in response on September 14. HMG continues to 
stress that it is in constant contact with the USG on all 
Iraq-related issues, and that the UK will not leave before 
the job is done. Nonetheless, the British drawdown of troops 
in the south and withdrawal to an airbase outside of Basra, 
at the same time as U.S. troops surge elsewhere in Iraq, has 
given rise to speculation that tensions are rising between 
Washington and London. An August op-ed piece in the "New 
York Times" co-authored by Browne and Miliband was designed 
to staunch these questions, but HMG contacts tell us they 
recognize it has not succeeded. Despite these efforts, 
although no decision has been taken, we assess that -- 
ultimately -- the Brown government will pull its remaining 
forces in Iraq out by spring, even at the expense of a strain 
in relations with the United States. An August op-ed piece 
in the New York Times co-authored by Defence Secretary Des 
Browne and Foreign Secretary David Miliband was designed to 
staunch these questions, but HMG contacts tell us they 
recognize it has not succeeded. A spokesman for PM Brown was 
forced to address the issue once again at a September 11 
press conference, insisting that the UK and U.S. are in 
continuous and open communication on all issues, and that the 
U.S. had been fully apprised of the withdrawal of UK forces 
from Basra Palace to the airbase outside the city beforehand. 

¶10. (C/NF) Media and public speculation continues to focus on 
why such close allies have taken such different approaches, 
with some speculating that PM Brown has struck an 
unidentified "secret deal" with President Bush to allow most 
UK troops to withdraw, while keeping some minimum in the 
south of the country. There is also a widely held assumption 
that Gordon Brown will reduce the UK presence in Basra to an 
absolute minimum by the end of 2007. Domestically, such a 
move has no downsides for Brown: the Labour Party, never 
entirely comfortable in supporting Blair on Iraq, will be 
relieved; the military leadership, which has tended recently 
to take public its grievances on being stretched
too far, 
will be placated; and the electorate, deeply unhappy over 
Iraq, will see Brown as the leader who undid Blair's mistake. 
Timing is important: a troop rotation is set to occur in 
November. A British departure from Basra by Christmas would 
be an asset in a spring general election. While we do not 
believe a decision has been made, we assess, that even with 
the USG urging that UK troops stay at current levels, Brown 
may pull them out by no later than Spring 2008. An important 
part of the justification will so that the UK can deploy more 
troops in Afghanistan. 

British military in Afghanistan 
------------------------------- 

¶11. (C/NF) The Brown Government is thinking carefully and at 
the highest levels about the current situation in Afghanistan 
and the UK's role in future engagement. The UK deployment in 
Afghanistan still has public and parliamentary support, but 
the longer the deployment goes on the more skeptical both HMG 
officials and the public become about prospects for success. 
Foreign Secretary David Miliband plans to deliver a copy of a 
UK interagency review paper to Secretary Rice on the margins 
of UNGA in New York later this month with a view towards 
eliciting a U.S. response on the way forward. The UK paper 
will reportedly conclude that we do not yet know how to 
create a "functioning Afghanistan at all levels" and that 
coalition forces need to better understand how to build 
functioning government at every level -- national, regional, 
local and tribal. It will also discuss ISAF support for 
Afghan counter-narcotics efforts. Counter-narcotics is one 
area where we have some disagreement with HMG: the British 
are totally opposed to aerial spraying, but lately have 
indicated more willingness to consider ground spraying on the 
opium crop, "under the right conditions." The British mantra 
is that counter-narcotics and all other efforts in 
Afghanistan must be integrated within a comprehensive 
counter-insurgency strategy. 

Iran - The British are worried 
------------------------------ 

¶12. (C/NF) Iran worries the British. They believe pressure 
on Iran is having an important affect, but in order to impact 
Iranian behavior we need to ratchet it up through the UN 
(where the UK is pessimistic about immediate prospects for a 
third UNSCR), other multilateral fora (the EU, with France as 
a strong ally on this issue now), and in more public 
pronouncements on possible sanctions. The UK emphasizes the 
need for unity among the "P5 plus 1" ("E3 plus 3" in its 
parlance), and is encouraged by France's willingness to take 
a tough line. In addition to briefing Brown and Darling on 
current U.S. thinking on Iran and a next UNSCR, you may want 
to raise with Darling the usefulness of financial supervision 
and regulatory tools in pressuring Iranian banks operating in 
the UK. Your Assistant Secretary Pat O'Brien was here last 
week to encourage the UK to step up efforts on Iran and on 
terrorist financing, and your FinCEN Director James Freis 
will be here at the same time of your visit. 

Close ally on terrorism finance 
------------------------------- 

¶13. (C/NF) Our governments cooperate at all levels across the 
inter-agency spectrum on combating terrorist financing (TF.) 
There is little daylight between our philosophies and our 
approach to using financial tools to stop terrorism. What 
differences do exist are mainly a result of a lack of 
resources the UK has traditionally made available in the TF 
fight and having to meet a high UK evidentiary threshold. 
Brown has increased the TF budget and re-organized his 
government's efforts. 

Promotion of the City 
--------------------- 

¶14. (C/NF) The UK continues to believe hedge funds provide 
valuable risk management options and do not need regulation 
beyond that to which all UK-based funds are subject. HM 
Treasury will decide this month whether to issue a 
shariah-compliant sukuk (bond), which Brown hopes will 
positively influence Middle Eastern investors and the 1.3 
million UK Muslim community. While an increasing number of 


officials claim London has surpassed New York as a financial 
center, many UK government stakeholders and UK-based 
financial companies view the chatter over Wall Street vs. The 
City as a fabrication of the financial media. UK officials 
contend that both New York and London must prosper in order 
to maintain their leadership positions in the face of 
emerging financial markets in China and India, but they also 
energetically support the City's growth. 

Brown and Darling Support DDA 
----------------------------- 

¶15. (C/NF) Brown and Darling continue to be a fervent 
supporter of the Doha round and open investment in the UK. 
Darling, as former Secretary of State for Trade and Industry, 
will have insight into internal EU dynamics on the Doha 
Development Agenda WTO negotiations which you may wish to 
explore with him and Brown. Brown and Darling may ask about 
the perceived rise in protectionism in the United States and 
Europe and how we can work together to counter public 
concerns about globalization. Brown has argued that the UK 
and the EU need to be open and competitive to meet the 
challenges of globalization. 

Development - critical issue for Brown 
-------------------------------------- 

¶16. (C/NF) Although only Prime Minister a short time, Brown 
has already made good on his desire to push development and 
climate change. After he met with the President in Camp 
David in July, he immediately gave a speech at the UN 
declaring his intention to push harder to achieve the 
Millennium Development Goals and released a Declaration to 
that effect, signed by President Bush and other leaders. He 
also launched an international health initiative on September 
5, which we are still analyzing and are not ready to endorse. 

Climate change - Brown government priority 
------------------------------------------ 

¶17. (C/NF) Along with development, climate change is a key 
item on Brown's "To Do" list. Climate change is a 
front-line, threshold in the UK, with strong support for 
action coming from across the political and social spectrum. 
All parties want to be seen as fully "green" on climate 
change. There is consensus for binding targets and a 
cap-and-trade system on carbon emissions. Many environmental 
financial services and trading programs reside in London. 
Environment Minister Phil Woolas will be Brown's personal 
representative to the President's September 27-28 Major 
Economies conference on climate change and energy security. 
However, the British are miffed that they were not invited as 
a sovereign nation, but rather as a part of the European 
Union's delegation, and have requested an individual 
invitation. 

Chancellor of the Exchequer Darling: "A safe pair of hands" 
--------------------------------------------- -------------- 

¶18. (C/NF) Chancellor of the Exchequer Alistair Darling, a 
fellow Scotsman and long-standing Brown ally, has been in the 
Cabinet since Labour took power in 1997 (a distinction he 
shares with the PM and Justice Secretary Jack Straw), as 
Chief Secretary to the Treasury, then Social Security 
Secretary, Transport Secretary, and (concurrently) Scotland 

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Secretary, then Trade and Industry Secretary. Darling is 

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seen as highly capable, experienced and reliable, and very 
discreet; he was once voted Britain's most boring politician. 
The relationship between Brown and his Chancellor is 
expected to be much smoother than the one Brown held with PM 
Blair. 

Visit London's Classified Website: 
http://www.state.sgov.gov/p/eur/london/index. cfm 
TUTTLE