SUMMARY: From the past few days, we have been hearing a lot about UBS bailing out Credit Suisse, but there was a time when UBS was on the verge of collapse and the Swiss government had to step in for a bailout.
“It was very interesting to work in an institution which was basically going through the convulsions of the crisis. I will tell you first the things that everybody knows. The fact that UBS was one of the first large banks who admitted our losses, UBS was one of the first banks that went out and raised substantial amount of equity to actually cover ourselves against those losses. And what is less known, and I think I can honestly say because all the leadership is now gone at the bank is that there was genuine panic at the bank, genuine panic at the time, at the highest level, at chairman level the bank did things that was unheard of at that time which was basically calling every single central bank in the world before we went out to the world and said that. I think our 1st announcement was about $17 billion. I lost track. It eventually ended up being $51 dollar losses. Another interesting fact was that how the Swiss bank, its partly cultural but mostly because of rigorous framework that they are used to, is in how they approach the prob. Problem was that there was an internal hedge fund in the bank, and there was also the bank’s own balance sheet and losses were coming from both sides so I think the bank did a very good job and acted very decisively by cutting the hedge fund off immediately and shutting it down. I thought that was the right decision, it wasn’t an easy decision. I have a lot of respect for that leadership at the time for doing that and then basically restructuring right away. Before any European banks even started admitting the problem, UBS was already done over with it”.
This is an excerpt from the interview of Asli Ay (given to Carnegie Council for Ethics in International Affairs), former employee of UBS who was a part of it when the crisis happened. This basically sums up the entire situation.
She talks about a hedge fund. It was nothing but Dillon Read Capital Management (DRCM). In what the media called an embarrassing admission of defeat, on 3rd May, 2007, UBS announced that it was shutting Dillon Read Capital Management, a fund established just two years ago by the bank's former head of investment banking, John Costas, with an investment of between $3bn and $3.5bn. After profits of $1.2 billion in 2006, the venture ran up losses of 150m Swiss francs (£62m), primarily due to bets in the subprime mortgage industry, during the first quarter, contributing to a 7% drop in the bank's overall profits. Dillon Read's assets were transferred into UBS's main asset management business. But even then, the bank officials did not acknowledge the fact that the losses were due to subprime mortgage crisis. UBS had launched Dillon Read with some 250 employees from various bank proprietary trading operations in a bid to co-manage internal and outside money. But the combination of the two businesses was unique on Wall Street, and the model proved costly and unwieldy, bank officials said. While Dillon Read lost about $124 million from trades in the U.S. subprime lending market in the first quarter, UBS said growing logistical and regulatory costs were the main reason for its closure.
BAD BANK TO THE RESCUE
In 2008 when the financial crisis arrived, Switzerland’s major bank UBS was threatened with bankruptcy. With UBS serving 1 in 2 companies, small businesses were threatened with collapse. And many would lose their jobs, account holders were suddenly faced with losing all their savings. Government had to intervene together with Swiss national bank, and together they created a stability fund (bad bank) which would absorb all toxic assets that threatened to bring down UBS. These assets were mainly loans people had defaulted on and were therefore rapidly losing value. The national bank covered the lion share of the potential losses with a loan to the stabilizing fund (25.8 billion dollars). A smaller amount was paid by the govt which it had to lend to UBS (6 billion dollar) which means a lot of tax payer’s money was put at risk. But saved UBS from going bust and a lot of people could keep their jobs and savings.
But what happened to the bad bank?
As the markets recovered, those toxic assets gained value and could be sold off. This along with the interest on its loan, generated quite a bit of profit for the Swiss national bank and also the government got profit from the interest on its loan to UBS which made the taxpayers happy.
UBS: les dessous d’un scandale
This is the title of a French Book written by author Myret Zaki which roughly translates to ‘UBS: The underside of a scandal’. This was a very talked about book and a best seller because it argued that it is not the Swiss government that should have bailed out UBS because the bank is not just a territorial bank unlike other European banks, and the bank's Swiss operations like retail banking, commercial banking etc. were stable but the Swiss taxpayers ended up bearing the risks of US investment banking.
Due diligence, better risk management, diversification, the advices and comments from finance experts kept pouring in and still are. But was this really a process failure? Reports suggest that highly paid people at the investment bank who had huge specialized products and operations going on were earning so much that they could never allow anyone to withdraw this activity from them. So, they let the operations continue in spite of the dead end awaiting them on the other side of the tunnel. Also, most Swiss managers were replaced by Americans in key positions, which changed the culture of the bank dramatically. The biggest question even till today is, was it a failure from finance perspective or was it a human resource failure?
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