We and our systems failed


On April 23, 2008, the annual meeting of the Union Bank of Switzerland (UBS) took place. Many of the 4000 shareholders assembled in Basel were in a state of high agitation, attacking the UBS management which had literally vaporized 27 billion euros ($38 billion) since the last general meeting (and further write-offs are quite likely). Only a few months ago, screaming and yelling at the general meeting of the biggest Swiss bank would have been completely inconceivable. But with the financial crisis, things have profoundly changed – also in Switzerland.

by Michael Liebig

Marcel Ospel, the “strong man” at UBS for the past decade, had to resign as the Chairman of the Board. Ospel had been CEO until 2001 and then became Chairman of the Board. His protégé, Peter Wuffli, had been sacked as CEO already in July 2007. Ospel himself had tried to hold on to his post, declaring he would “not steal away from responsibility in difficult times,” but when UBS announced a $11 billion loss for the first quarter on April 1, his fate was sealed. That day, the Neue Zuercher Zeitung wrote: “Within a very short period of time, Ospel has squandered the reputation of the bank which had been build up over so many years.”

UBS is the largest bank in the world in terms of wealth management with deposits of $3 trillion by wealthy clients from around the world, who have viewed the bank as the prime representative of “Swiss banking culture”: Quiet, smooth efficiency in protecting and (usually moderately) increasing the clients’ assets. The opposite of Wall Street’s glamour, the guarded top management of UBS used to consist of men who were also senior officers in the Swiss (militia) army.

While the tradition of “Swiss-Romand” banking in Geneva goes back to the 16th century, in German-speaking Switzerland, banking has evolved only since the mid-19th century in Zuerich and Basel. Then the predecessor banks of UBS were founded, and over the past 150 years, Schweizer Bankgesellschaft (SBG/UBS) and Schweizer Bankverein (SBV/SBC) have steadily grown stronger, making Zuerich an international financial center.

In 1998, Ospel, then CEO of the smaller SBV/SBC in Basel, engineered the merger with the much larger SBG/UBS and became the CEO of the new bank with the name UBS. Ospel was not content with (rather unspectacular) wealth management and other “traditional” forms of banking, he wanted UBS to become one of the world’s leading “investment banks.” To that end, UBS bought the Wall Street investment firm PaineWebber, sections of Charles Schwab Corp. and Piper Jaffray in the USA. In Europe, UBS bought up sections of ABM Amro, Lloyds TSB, Dresdner Bank, and Bank Julius Baer. In Brazil, UBS took over Banco Pactual SA.

In 2007, of UBS’ total staff of 78.000 internationally, 27.000 were working in Switzerland, but 31,000 in North and South America, most of them in the USA. In 2005, UBS established the Dillon Reed Capital Management (DRCM) unit in New York as its “in-house hedge fund.” Just two years later, DRCM would become the “in-house detonator” for UBS as whole. DRCM, which had massively engaged in subprime-related “structured securities” was shut down in June 2007 – but then it was too late.

“The trust we lost”

Bankers, in particular the “post-modern” variety, use a particular “newspeak.” The April 23 speech of UBS CEO Marcel Rohner, who followed the ousted Wuffli last July, is no exception. Yet, Rohner’s speech to the UBS general meeting is something special. It is more than a general mea culpa in terms of prevailing “corporate communication” techniques for presenting an outrageous loss of $38 billion. What Rohner said is an indicator of things to come – and not just for UBS. What happened to UBS, really is a pars pro toto for European (not to speak of American) banking as a whole. Rohner stated:

“We and our systems failed… We could not see the forest for the trees… As painful – if not embarrassing – as this realisation may be, the conclusion it suggests is all the more important. The problem was not a failure to appreciate complexity, but rather the opposite – it was a lack of simplicity and critical perspective which prevented the right questions from being asked while there was still time.”

Then Rohner acknowledged, “we cross-subsidized certain businesses,” i.e. investment banking. “Surplus cash flow from the wealth management business” was used to finance “investment banking” activities. “That was where we went wrong.” He later specified: “Proprietory trading with high concentration of risk and illiquid positions is not sustainable.” Proprietory trading means speculative trading – mainly derivatives and other “structured products” – by and for the bank itself, not for clients commissioning the bank to undertake such transactions.

Rohner’s third point was: ”We tried to generate growth by copying the strategy and processes of the competition instead of relying on our own inner strength and identity.” He did not say Anglo-American competition, but that’s what is meant. “There is tremendous pressure to deliver earnings growth… One of the responsibilities of leading a company is to resist exactly this sort of temptation, and not to give in to the pressure to deliver short-term earnings at the expense of sustainable growth.”

Then Rohner announced that “the focus on risk control will be squarely on risk reduction.” Moves towards “considerably simplifying and reducing” investment banking activities will be undertaken. Here, “we have identified areas where we no longer want to operate.” The bank will “bring costs of the Investment Bank [within UBS] into line with our new positioning and prevailing market conditions” – i.e. staff of UBS’ investment banking arm, mostly in New York and London, will be fired.

Rohner concluded: “We know which mistakes were made. The far-reaching consequences of our misjudgement have already taken hold, and we cannot turn back the clock. But we have embarked on measures to correct our errors and avoid them in the future… I ask you to give us a chance to win back the trust we have lost.”

The wind is changing

Of course, Rohner’s self-criticism, his admission of strategic, not just tactical failure, comes post festum. And indeed, what he said is contained in a 42-page report that UBS had to deliver to the Swiss Banking Commssion (EKB) prior to the general meeting. The NZZ article on the report on April 22 was headlined “The Story of a Complete Failure.”

I don’t think that it is an over-interpratation if one concludes that Rohner’s speech indicates a policy reversal. A shift in the sense of a return to “traditional, prudent and long-term” banking practices. This policy shift, however, is not the result of a deliberate rethinking of policy, it comes involuntarily after the damage had been done and the very existence of the bank was threatened.

But now, it seems, some reason is returning – and not only at UBS. We are at the beginning of a bitter “learning process” in Europe. And this painful “learning process” will preoccupy European banks – and governments – probably for years to come. That the financial system in Europe will collapse is most unlikely, but it will change radically. This radical change, however, will not come with great fanfare, it will more likely “come through the backdoor.”

A closer look at the European press shows that the relevant questions are increasingly being asked. And they center on one central issue: The real economy must be shielded from the financial crisis and the ensuing “restructuring” of the banking system.

The largest German weekly Der Spiegel wrote on April 2: „The financial crisis will have much more profound consequences than most bankers and politicians believe. The undisputed domination of the Anglo-Saxon money-dealers is coming to an end. The global economy is regrouping – and old virtues are being rediscovered… The continental European (and Japanese) market economy model, as opposed to the Wall Street variation, was not dominated by money alone. This economic culture is not fixated on shareholder value, but is focused on products and services, is concerned about customers, employees and society – not only about balance sheet figures, Ebita or ROI [return on investment]… The conclusion must be: Back to the roots! Go back to the basics of the economy: Production of goods and providing services. The financial sector must again be the servant, not the master of production. Banking is no end in itself, but must provide the money flows for the real economy and society. Bankers who see their earning coming primarily from proprietory trading are out.”

This article is not an isolated one. Two days after this Spiegel article, the Neue Zuercher Zeitung carried a lengthy editioral, titled “The Financial Sector needs the Virtues of Industry,” noting that industrial processses of production are intrinsically an antidote to “greed, hybris and excesses.”

In Germany, the April 21-25 Hannover Fair, the world’s biggest exhibition on industrial technologies with 5,100 firms from 60 countries, provided a stark contrast to the financial “industry.” Across the board, “contact leads” and contracts signed were rising, in particular in the machine tool and energy sectors. The German machine tool sector is operating at full capacity, its main problem being the lack of engineers and skilled workers. And, industry leaders noted a “changed attitude” by the banks which have become almost generous in providing – mostly longer-term – credits to industrial and Mittelstand firms.

One can argue that the overall condition of the European banking system is relatively better than that of the America, where the epicenter of the financial crisis is located. With the financial crisis, the banking systems in Europe and the United States have been moving further apart. The policy direction of the European Central Bank (ECB) is markedly different from that of the Federal Reserve; the Bank of England standing somewhere in between.

Nevertheless, even though the linkage between production and finance is closer in Europe than in the USA, we see right now a probably irreversable shift in world finances. The transatlantic financial system – in the USA and the European Union – has lost its hegemonic position in world finances. The world financial system is becoming truly “multipolar.” Asia, Russia, the Gulf states or Brazil are increasing their financial clout, while the relative weight of the transatlantic financial system as a whole is declining. The bankers on both sides of the Atlantic may pretend otherwise, but probably for years to come, the leading banks in the United States and only slightly less so the big banks in Europe will be absorbed with “crisis management,” “clearing the rubble” and “restructuring.”

The transatlantic banking community has “lost the mandate of heaven”, their reputation has been wrecked. These bankers are in no position any longer to tell the rest of the world what’s right or wrong. And no more do they have the strength to force upon others their – failed – policies. Instead, they will have to prove to the rest of world that they can learn from their mistakes.

On April 14, the NZZ carried an article titled: “China sees herself vindicated by the financial crisis.” The head of China’s Financial Supervisory Agency is quoted saying that China’s “restraint” in matters of financial deregulation have been proven right and that emerging market economies in general ought to carefully reconsider financial liberalisation. To come back from where we started: In December 2007 the Government of Sinagpore Investment Corporation (GSIC) made a $10 billion capital injection into UBS and an unnamed “investor from a Gulf state” added another $2 billion, which spared the bank missing the 8% reserve capital requirement.

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