UBS Turns a Corner
By - October 03, 2008

Swiss banking giant UBS on Thursday said it would swing into profit in the third quarter, as it seeks to regain client trust after successive quarters of losses on massive asset writedowns. UBS last year posted its first-ever full-year loss, followed by two successive negative quarters this year after writing down more than 42.5 billion dollars' worth of subprime-related assets. With the financial turmoil in the United States worsening over the past two weeks, some analysts had expected UBS to post further writedowns when it reports its third quarter results on November 4. But even as the contagion spread from the United States to Europe this week, with governments having to step in to save European banks Fortis and Dexia, UBS said it was turning a corner. … UBS had disposed of many of its US commercial and residential mortgage-related positions, said Kurer, a move that Bank Helvea's analyst Peter Thorne described as "particularly encouraging." "Risk positions on our balance sheet have been written down, closed out or sold. Headcount and operating costs are in the process of being reduced," Kurer said. The bank has also embarked on a programme to reposition itself and take remedial measures following the crisis, including the way it apportions risks. Kurer also cited as a priority the settlement of major legal cases such as a US investigation into whether the bank had helped its US clients to evade taxes. It would stop offering cross-border services to clients in the United States through entities that were not regulated there, it said. "We will completely exit this business and have established a project team to implement this in the fastest and most efficient way within the confines of the law," he said. – AFP

Dominant Social Theme: Hallelujah! The Swiss are a thrifty bunch.

Free-Market Analysis: It must be great for those of the "Swiss persuasion" who identify with large banks to see that UBS is back on track. Everything sounds really good. After a loss of only US$43 billion, the great Swiss bank has turned the corner. Its management expects it to be profitable shortly, has put new risk management controls in place and is exiting risky businesses of all kinds, including, most prominently, those that offered tax avoidance to US citizens.

At the risk of being labeled a "party pooper" let's examine some of the above solutions to the problems that UBS faced. Bear in mind, this is an idiosyncratic perspective, apparently not shared by UBS shareholders themselves. Here is what the above article had to say about these shareholders:

"Despite recent extremely volatile market conditions, UBS currently expects to report a small profit for the third quarter, based on preliminary estimates," said a statement summarizing Chairman Peter Kurer's address to shareholders. The bank, whose shares have been wildly volatile in recent weeks, would also turn a profit in 2009, Kurer told more than 2,300 shareholders who attended the bank's extraordinary general meeting. The bank's moves appeared to satisfy shareholders, as the meeting was significantly calmer than the last session when dozens of investors took to the podium to vent their frustration at the bank's management.

Before we get to the modest points we want to make, we can't resist floating a theory about these "satisfied" UBS shareholders. Surely they cannot be satisfied that UBS lost "only" $43 billion in the past 12 months or so. No, the satisfaction must lie somewhere else. The Swiss on the whole are an educated bunch and we believe they must have been reading about America's Lehman Brothers and AIG shareholders who are basically wiped out. Here is how bad it is for some American shareholders, courtesy of a witty email response to the situation that was posted at the London Times:

If you had purchased $1,000 of AIG stock one year ago, you would have $42 left. With Lehman, you would have $6.60 left. With Fannie or Freddie, you would have less than $5 left. But if you had purchased $1,000 worth of beer one year ago, drank it, and recycled the cans, you would have had $214 – Steven, Colorado, USA

That's the only conclusion we can reach, given the bald statistics. If Swiss shareholders really are satisfied that UBS has "only" lost $43 billion, we are even more eager to start a banking business in the Alps, where the scenery is nice. Let's see, given a year's time, that works out to almost $4 billion a month. Some chunk of change.

As far as the other elements that are making UBS shareholders happy, well, we are not as sure we would be as happy. Yes, UBS is exiting risky businesses, but what exactly does this leave for the large bank to do? Collect savings accounts? That's a pretty low-margin business. And UBS says it has risk controls in place and more capital as well to back up its lending. But how much is enough? And how is it so sure these risk controls will work.

As we have pointed out, all of these elements are just great – until the next mania. For a mania implies a loss of control. In other words, a time when greed overwhelms fear. During a buying mania, risk controls tend to be ignored and regulations and laws are reconsidered or done away with.

Now, we are aware that UBS management is chastened and that what has occurred will never happen again – according to UBS. But not so fast. It is the NATURE of fiat money generated by central banks to cause manias. You cannot provide an unlimited amount of money and credit to a banking system without having too much money and credit at some point. And when there is too much money and credit, sooner or later you will experience a mania because all that money and credit has to go somewhere – and it does, and badly.

Unless Switzerland and the West in general rids itself of central banking, there will be another mania and another and another. Each one likely more destructive than the last. UBS will find that all of its wonderfully complex risk controls will go away at the earliest opportunity. Shareholders will lose money again. UBS will founder again and be in danger of bankruptcy. And given how much money it lost this time, and how central banking crises "ratchet up" from crisis to crisis, next time, or the time after that, it will go broke, or be nationalized. That's what is going on in America right now with many major banks. How happy will UBS shareholders be in that situation?

After Thoughts

UBS sounds like it has removed itself from numerous businesses, which means the bank has reduced profit opportunities. It has imposed risk controls that almost certainly won't work in the next mania and while it is turning a profit next quarter we wonder what the bank's outlook is long term.

We have a modest suggestion to make. Unilaterally declare that a portion of assets are now backed by gold (six percent might be a good number to start with – and then maybe more) and begin to offer various banking businesses with a kind of gold surety. This would play to Switzerland's reputation as an honest money environment and help UBS attract accounts the world over. Why wouldn't UBS adopt such an obvious solution to its current woes? It worked in the past didn't it?

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