VZCZCXRO3994
PP RUEHIK
DE RUEHFT #3274/01 3571211
ZNR UUUUU ZZH
P 231211Z DEC 09
FM AMCONSUL FRANKFURT
TO RUEHC/SECSTATE WASHDC PRIORITY 2865
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCNMEM/EU MEMBER STATES COLLECTIVE
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 03 FRANKFURT 003274 
 
SENSITIVE 
 
STATE FOR EEB (NELSON, HASTINGS), EEB/IFD/OMA (WHITTINGTON), EUR/CE 
(HODGES, SCHROEDER) 
TREASURY FOR SMART, ICN (NORTON), IMB (MURDEN, MONROE, BEASLEY) AND 
OASIA 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PREL GM
 
SUBJECT: ECB'S EXIT STRATEGY AND REACTION TO GREECE 
 
FRANKFURT 00003274  001.2 OF 003 
 
 
¶1. (SBU) Summary: On December 8, European Central Bank (ECB) 
officials told a visiting Treasury delegation that the financial 
crisis will increase growth differentials among Eurozone countries, 
ultimately increasing pressure on the ECB to address imbalances. The 
ECB, however, remains committed to the idea that differentials must 
be resolved by national measures.  Regarding Greece, the ECB sees it 
as isolated in the Eurosystem and under pressure to reform. It rules 
out an IMF program for Greece, planning instead its own European 
"IMF-style" program (albeit without financial support.) The ECB is 
also starting to gradually phase-out its generous supply of 
liquidity, without regard to individual countries' needs.  The ECB 
officials further praised the establishment of the new European 
Systemic Risk Board (ESRB), noting that it will encourage closer 
interaction between central banks and national banking supervisors. 
End Summary. 
 
 
Growth Differentials and the Stability of the Eurozone 
---------------- 
2.(SBU) The ECB expects economic activity in the second half of 2009 
to improve unevenly with moderate growth rates in 2010 that remain 
subject to uncertainty.  The differing national causes of the 
financial crisis among Eurozone members pose a challenge for the 
ECB, but will not threaten the European Monetary Union (EMU). The 
causes include: a collapse of trade because of an overly high export 
dependence (Germany), overdependence on the construction and housing 
market for growth (Spain), and a lack of wage moderation and fiscal 
discipline (Greece). Structural reforms are needed and the ECB will 
urge members to adopt concrete measures. But as Frank Moss, ECB's 
Director General for International and European Relations, opined, 
the "onus is on the national government," which should take adequate 
measures to restore competitiveness when faced with growth 
differentials.  Doing so is "part and parcel of being in a monetary 
union." 
 
¶3. (SBU) Nevertheless, different national policy responses pose a 
potential problem for the ECB, ECB Governing Board member Juergen 
Stark reported.  The first ten years of the Euro worked better than 
expected, enabling the ECB to gain confidence.  This good track 
record will help it tackle future challenges, including the 
long-lasting effects of the crisis, such as reduced levels of output 
and a lower potential growth rate. Higher growth and inflation 
differentials could tempt governments to pressure the ECB, 
potentially calling into question the central bank's independence. 
Currently, ECB bankers reported, countries suffering most from the 
Euro's appreciation already try to pressure the ECB. Any discussion 
of a potential break-up of the monetary union, however, is unfounded 
and according to Jens Dallmeyer and Barbara Boettcher-Meier of 
Deutsche Bank Research, primarily driven by "Anglo-Saxon" outsiders 
from the Eurosystem.  They agreed that the next ten years will be 
more difficult for the ECB than the first. The challenge is "to 
ensure that the success story continues." 
 
 
Greece - A Special Case 
---------------- 
¶4. (SBU) Greece was a frequent topic of discussion in the meetings, 
since Fitch had downgraded Greece's rating the day before from A- to 
BBB+, making it the only eurozone country to fall below an "A."  ECB 
bankers saw Greece as a "peripheral" case. Its economic and fiscal 
position, "is and has been a disaster for years," Stark said. The 
country "lacks the strong institutions and political leadership 
necessary for maintaining fiscal control." Board member Stark 
pointed to the 100 percent increase of public sector wages, 
unreliable statistics, and an explosion of the country's deficit 
from four to twelve percent in just a few months. Furthermore, 
contrary to Ireland, whose crisis response has been exemplary and 
helped to restore the confidence of the markets, Greece has "done 
nothing so far." Even though it will be politically difficult for 
the Greek government to implement reforms given the fragile 
political situation, it has no choice: "They had fun. But now is the 
end of the party." Dallmeyer from DB Research concurred that 
disenchantment with Greece is very high. "I cannot remember a 
country ever as isolated in its peer group as Greece is now in the 
Eurosystem." 
 
¶5. (SBU) The Greek problem, however, will be resolved within the 
Eurosystem. "We will accept the IMF inside the EU but not inside the 
EMU," Director General Moss said.  Support from the IMF, Stark 
explained, "would be perceived as failure of the EMU project." 
Instead, the EU will put an "IMF-style program" without money 
transfers, which are prohibited under EMU rules, in place. The ECB 
is already working on developing the necessary program. "We can be 
 
FRANKFURT 00003274  002.2 OF 003 
 
 
clearer on measures to be taken including concrete numerical 
objectives by how much the deficit must be cut during what time span 
and what kind of institutional reforms must be implemented," Stark 
said. While ECB officials ruled out financial assistance to Greece, 
Deutsche Bank economists Jens Dallmeyer and Barbara Boettcher 
thought some bilateral support may be possible to enable Greece to 
meet the conditions imposed. 
 
¶6. (SBU) Greece has also been a prime beneficiary of the ECB's 
unlimited supply of liquidity and its broader definition of 
acceptable collateral. (Comment: As part of its so-called "enhanced 
credit facility" program initiated earlier this year, the ECB 
lowered the minimum rating requirement for assets from A- to BBB.) 
The ECB will return to the pre-crisis collateral requirements at the 
beginning of 2011, creating a serious risk to Greece if the other 
credit ratings agencies follow Fitch and downgrade the Greek 
sovereign to BBB+.  This would create difficulties both for the 
Greek sovereign and for Greek banks, since the ECB would no longer 
accept Greek sovereign bonds as collateral. Additionally, when the 
first and quantitatively largest of the three one-year unlimited 
tender operations of the ECB expires in June 2010, assets that are 
now on the books of the ECB will be back on the balance sheets of 
banks and could cause problems. Moreover, Frank Moss stressed that 
the ECB doesn't take country-by-country considerations into account 
in its decision making. It is therefore "up to Greece to adapt, not 
the ECB," Francesco Papdia, ECB Director General of Market 
Operations, noted. 
 
 
Phase-Out Strategy 
------------------ 
¶7. (SBU) The ECB will continue the gradual phase-out of 
extraordinary liquidity measures begun on December 3, but has no 
intention to change its monetary policy for the time being, Stark 
said.  The ECB will fully satisfy the banks' refinancing needs until 
the end of 2009.  When current tender operations expire, the 
liquidity will be taken out of the market automatically.  The 
expiration of the first of the three one-year, fixed-rate tender 
operations poses a problem, because allowing the 442 billion Euros 
to expire would withdraw 75 percent of the liquidity injected into 
the market.  The ECB instructed member states' central banks to 
issue warnings to their commercial banks to avoid an overreliance on 
central bank liquidity, but will still have to find a way to smooth 
the exit of that much liquidity at one point.  ECB Director General 
Market Operations Papadia said that although the ECB will 
discontinue one-year operations, there will be a higher share of 
three-month operations than before the crisis. 
 
¶8.  (SBU) Papadia noted that in hindsight, the ECB's liquidity 
supply was too generous.  Three one-year operations gave the banks 
too much of a sense of comfort instead of prompting them to address 
their underlying vulnerabilities.  Key issues to reconsider for the 
ECB in the future will be: a) the tightening of the collateral 
requirements and b) the future role of rating agencies in the ECB's 
collateral framework. (Comment: currently only four Eurosystem 
central banks prepare their own ratings for bank loans- Germany, 
France, Spain, and Austria.) The ECB's dominant consideration on 
collateral is the protection of their position, i.e. the reduction 
of risk to the ECB. Frank Moss noted that cross-border crisis 
management and the streamlining of national deposit guarantee 
schemes are also considerations. 
 
 
ECB and European Systemic Risk Board 
------------------ 
¶9. (SBU) While Frank Moss welcomed the overall new European 
regulatory architecture and the "creation of a common rule book," 
which he considered ECB's key achievement, he cautioned that the EU 
Parliament could further water down the reforms.  The other 
challenge is to forge a common interpretation of the new rules.  The 
European Systemic Risk Board (ESRB), Moss stated, will not have any 
real powers.  It will only issue warnings and recommendations and 
keep an eye on the financial sector. However, it will offer a forum 
for closer interaction between national central banks and 
regulators.  A decision on whether to set up the secretariat as a 
separate entity or to staff it with ECB personnel has not yet been 
reached. 
 
¶10. Comment: Despite the financial crisis and current decreased 
rating of Greece, ECB bankers remained confident in the ability of 
the Eurozone to manage its imbalances within its own system. ECB 
bankers made it clear that the ECB will define the conditionality of 
assistance provided to Greece. Their prognosis that the next ten 
 
FRANKFURT 00003274  003.2 OF 003 
 
 
years of the Eurosystem will actually be more difficult than the 
first ten raises questions for the future. 
 
¶11. (U) This cable has been coordinated with US Embassy Berlin and 
cleared with US Treasury. 
 
ALFORD