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OO RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHFT #3103/01 2881259
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O 141259Z OCT 08
FM AMCONSUL FRANKFURT
TO RUEHC/SECSTATE WASHDC IMMEDIATE 8261
INFO RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RUCNMEM/EU MEMBER STATES  IMMEDIATE
RUCNFRG/FRG COLLECTIVE IMMEDIATE

UNCLAS SECTION 01 OF 02 FRANKFURT 003103 
 
DEPARTMENT FOR EUR/AGS 
TREASURY FOR LUKAS KOHLER/OFFICE FOR EUROPE AND EURASIA 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EU GM
SUBJECT: MERKEL AND STEINBRUECK UNVEIL FINANCIAL RESCUE PACKAGE 
 
ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED.  NOT FOR INTERNET 
DISTRIBUTION 
 
REF: (A) BERLIN 1389; (B) BERLIN 1366 
 
This is a joint message from Embassy Berlin and AmConsulate 
Frankfurt. 
 
¶1.  SUMMARY:  Chancellor Merkel and Finance Minister Steinbrueck 
announced the details of Germany's financial rescue packge October 
13, following the French-led effort t coordinate efforts among the 
15 euro zone member at this weekend's Paris summit.  The so-called 
Financial Market Stabilization Fund gives the government 
unprecedented power, allowing it to guarantee 400 billion euros 
($544 billion) in loans between banks, use up to 80 billion euros 
($109 billion) for capital injections and use an undisclosed amount 
to buy up toxic assets.  In return, the government will collect fees 
on guarantees and assume discretionary powers in the institutions 
that it funds directly. 
 
¶2.  Coming shortly after Germany's political guarantee of domestic 
savings deposits and its rejection of a euro zone rescue fund, the 
plan is a clear policy about-face, as Merkel and Steinbrueck came to 
accept the French position that a coordinated response with European 
partners was necessary following last week's sharp downturn in 
equity markets.  Despite the change in position, the consensus 
between Merkel, Steinbrueck and Foreign Minister Steinmeier showed 
strong unity in the face of emergency in the CDU-SPD Grand 
Coalition, even with impending elections in September, 2009.  Both 
houses of the parliament, will vote on the plan by the end of the 
week.  Some resistance may appear among the state representations in 
the upper house, although passage appears likely.  The German 
business community has responded enthusiastically to the 
government's actions. END SUMMARY. 
 
State Guarantees to Restore Interbank Lending 
--------------------------------------------- 
 
¶3.  The most significant element of the package, 400 billion euros 
in loan guarantees, aims to revitalize interbank lending by 
restoring confidence among banks and ending the near-total 
dependency on European Central Bank (ECB) liquidity operations for 
short-term funds.  The government will charge at least a 2% fee for 
the guarantees which will be available on a 36 month basis to all 
banks.  The state will set aside 20 billion euros ($27.2 billion), 
or 5% of the total guarantee, in its budget for potential losses 
stemming from defaults. 
 
Recapitalization for Troubled Banks, Buy-Up of Toxic Assets 
--------------------- ------------------------------------- 
 
¶4.  In the second part of the plan, the Finance Ministry will work 
with the Bundesbank (the German Central Bank) to inject up to 80 
billion euros ($108.8 billion) in capital in banks and insurance 
companies.  Troubled banks as well as insurance companies will be 
able to tap into the fund; in return, the government can take an 
equity position through preferential shares or certificates of 
participation.  The Finance Ministry and the Bundesbank will reserve 
the right to determine if an injection is in the state's interest 
and whether other market solutions have already been exhausted.  The 
80 billion is in addition to the 50 billion euros ($68 billion) 
supplied by the government and a banking consortium last week to 
recapitalize Hypo Real Estate.  Additionally, the government can buy 
toxic assets from financial institutions, mirroring the U.S. 
Treasury Department's asset rescue plan, but details on the size of 
this part of the plan are still sketchy.  The Bundesbank will manage 
a special vehicle to hold the assets. 
 
¶5.  The government will reserve the right to influence decisions 
within institutions that accept capital.  The Finance Ministry will 
have the right to order institutions taking part in the plan to 
offer loans to corporations in the real economy.  Goldman Sachs 
Germany Chief Economist Dirk Schumacher referred to this condition 
as "the government's quid pro quo" suggesting that the Finance 
Ministry will also use the fund as a way to stimulate the real 
economy.  The plan also envisages a 500,000 euro ($680,000) ceiling 
on executive pay, a ban on bonuses, and a ban on dividends. 
Schumacher worried that banks have been "late to come for help" and 
that these provisions, if applied too harshly, would also discourage 
banks to reach out for assistance because of the high price to pay. 
 
 
Fair-Value Accounting, Regulation and Burden-Sharing 
--------------------------------------------- ------- 
 
¶6.  The plan also calls on international authorities to relax 
mark-to-market accounting rules in cases where the value of the 
asset cannot be determined in time for third-quarter reporting, only 
 
FRANKFURT 00003103  002 OF 002 
 
 
a few weeks away.  It promises that German authorities will make 
improvements to supervision and regulation, including formalizing 
higher deposit insurance, by the end of 2008. 
 
¶7.  All financial institutions operating in Germany (including 
U.S.-subsidiaries) are eligible to take part in the plan.  As 
envisaged, all aspects of the fund would expire at the end of 2009, 
at which point the government would take account of its gains or 
losses.  State governments will assume 35% of the burden of the plan 
and any losses from state banks (Landesbanken).  The state 
governments of Bavaria, Thuringia and Hesse have already expressed 
concern about this aspect of the package.  The plan will be 
expedited through both houses of parliament as a bill by the end 
week, but approval in the upper house of parliament (Bundesrat) is 
not assured with the concerns raised by the individual states. 
Steinbrueck also conceded that the rescue package would upset the 
federal government's attempt to balance the budget by 2012. 
 
Business and Banking Community Reacts Positively to Bail-Out 
----------------------- ------------------------------------ 
 
¶8.  The rescue package was greeted with wide approval by the German 
business and banking community and leading economists.  The 
Federation of German Employers' Associations (BDA) and the 
Association of German Chambers of Industry and Commerce (DIHK) 
welcomed the joint package of measures adopted by the euro-zone 
states as an "absolutely imperative step" to end the financial 
crisis.  The President of the Association of German Banks (BdB), 
Klaus-Peter Mueller (who is also the supervisory board chair of 
Commerzbank) said the rescue package was important for two reasons: 
1) the plan would depart from previous practices to tackle a problem 
only when it becomes apparent, i.e., on a case- by-case basis; and 
2) the international financial crisis always has been an 
international crisis, requiring international answers.  Mueller 
added that the talks on the margins of the IMF and World Bank 
meetings in Washington and the subsequent meeting at the European 
level, had brought major progress toward an internationally 
coordinated approach.  Defying a deeply-rooted skepticism about 
state intervention, many German financial experts are now calling 
for a greater role of the government, major reforms to the German 
banking system, and even a European financial supervision 
authority. 
 
Comment 
------- 
 
¶9. The stabilization fund reflects an abrupt departure from the 
government's earlier "go-it-alone" strategy which rejected a 
European-wide rescue fund.  Chancellor Merkel and Finance Minister 
Steinbrueck, however, increasingly recognized the need for 
coordinated European action after last week's precipitous drops in 
global financial markets.  Their partnership demonstrates that the 
CDU and SPD, though political rivals in the run-up to the September 
2009 elections, are still capable of effective joint governance. 
Capital markets in Germany have so far embraced the plan 
enthusiastically (with the DAX increasing by a whopping 11.4% Monday 
and a further gains Tuesday, but the plan's success is by no means 
assured as financial institutions may find they are unwilling or 
unable to accept the government's terms and fees.  The plan, which 
still needs to pass in the parliament, also raises moral hazard 
concerns as the Finance Ministry assumes ownership stakes in 
financial institutions and, more importantly, decision-making powers 
in private entities.  End Comment. 
POWELL