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German Bank Deal

Is a new battle over Iraq unfolding in the U.N. Security Council? The council was the scene of fierce debates before the U.S. abandoned efforts to win U.N. backing for an attack on Saddam Hussein and went to war in March with a "coalition of the willing." Now that Saddam's regime has fallen, the Bush Administration wants the U.N. to lift economic sanctions imposed on Iraq 13 years ago, after Saddam attacked Kuwait. France and Russia -- council members with veto power who opposed the war -- are willing to go along. But they want to link a lifting of sanctions to the return of U.N. weapons inspectors to Iraq.

It's a complicated dance that could again rile tempers on both sides of the Atlantic. At stake is Iraq's ability to sell oil freely, which the Bush Administration thinks is vital to rebuilding the country. And if the council again deadlocks, as it did over the war, its role as a decision-maker on international security may be in doubt. "If the Security Council cannot compromise over Iraq, it could be marginalized on first-order security issues in the future," says David M. Malone, president of the International Peace Academy in New York and a former Canadian U.N. Ambassador.

Negotiations among diplomats are just beginning. A key deadline is June 3. That's when the U.N.'s special oil-for-food program for Iraq goes out of business if the Security Council doesn't renew it. Since it was created in 1996, that program has allowed Iraq to sell oil and import $26 billion in food and other goods from companies in France, Russia, China, and neighboring Arab states. On Apr. 22, France's U.N. Ambassador, Jean-Marc De La Sabli?re, called for gradually phasing out the oil-for-food program, which the U.N. has been operating on an emergency basis since the war began. And he suggested that Hans Blix, the chief U.N. weapons inspector, and his team return to Iraq to work with U.S. specialists seeking weapons of mass destruction. Technically, U.N. resolutions say sanctions can't be lifted until U.N. inspectors certify that Iraq's weapons have been destroyed. As an interim measure, De La Sabli?re suggested the Security Council suspend sanctions.

But such an approach, which French diplomats are calling "pragmatic," is unlikely to win favor with Washington. The U.S. is sticking to its argument that sanctions no longer make sense since Saddam is gone. And Administration officials won't allow Blix, whom they blame for derailing U.S. pre-war diplomacy, to go back to Iraq -- partly for fear he might declare Iraq free of weapons of mass destruction or drag out the hunt. "I don't see the inspectors going back in. There is no taste for that in Washington," says Nancy Soderberg, vice-president of International Crisis Group and former U.S. Ambassador to the U.N. She sees the French and Russians resisting Washington for a while, then trying to get their interests served in return for bowing to the U.S. "It's a question of what bilateral deals the [French and Russians] can cut, and that means a piece of the post-Saddam pie, whether economic or political," she adds. France and Russia are keenly interested in developing Iraq's oil industry. And both want the U.N. to play a central role in rebuilding Iraq.

If the U.S. can't win U.N. backing for lifting sanctions, can it rebuild Iraq without such a decision? Some experts say that's legally possible, though controversial. Most diplomats hope it won't come to a unilateral move by the U.S. Britain, in particular, is trying to forge a compromise on the U.N.'s role. But the Administration has flexed its muscles once already -- and it could do so again. Five of Germany's leading banks announced on Apr. 23 that they would jointly shift up to $55 billion of loans off their balance sheets, turn them into securities, and sell them to investors. The move by Deutsche Bank, Dresdner Bank, Commerzbank, HVB Group, and DZ Bank is designed to strengthen the banks' finances, which have been weakened by a slump in profits and a rise in bad debts. Under the plan, the banks will pool the loans in a new joint venture to be run by Kreditanstalt f?r Wiederaufbau, the state-owned development bank.

The move is likely to draw criticism from European Union officials in Brussels. Some may argue that the involvement of KfW, which will take a 20% stake in the new operation and oversee the securitization of the loans, is tantamount to state backing -- which is not allowed under EU rules. Because its operations are guaranteed by the state, KfW has an AAA credit rating that it could use to make the securitized loans more attractive to investors. As a result, EU Competition Commissioner Mario Monti, who has taken a tough line against state backing for banks, may decide to investigate the deal.

Germany's hard-pressed bankers argue that KfW's rating is unimportant because the loans that they'll be transferring to the new operation will all be investment-grade. "We are not setting up a so-called Bad Bank where we can ditch nonperforming loans," says one bank board member. "There is no reason for Brussels to be concerned." The ball is now in Monti's court.

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