Kids, we have some fascinating reading in store for you this weekend.
The "conservative" Swiss banking giant UBS — and I put that in quotes for obvious reasons — wrote down a previously unimaginable $37 Billion dollars. Their shareholders were (ahem/cough) quite perturbed. So the nice folks at UBS, with an assist from KPMG, put together a 50 page report detailing the hows and whys UBS took such a humungo hit.
For what you would expect to be a dry report, it is absolutely compelling reading. It explains much more than the subprime fiasco. The report implies that management didn’t really understand what the hell they were getting into with their purchases of Warburg/Dillon Read Capital Management. This unit eventually became UBS’ internal hedge fund (it has since been shut down).
I wonder if management ever truly understands the nuts and bolts of these large acquisitions. We will find out if JPM knew what they were
getting into getting the Fed into with the Bear Stearns (BSC) acquisition.
The report includes an indictment of the firm’s compensation packages. The current structure — big salaries and bigger bonuses — encourages the riskiest and most short term of strategies. Prudence, risk management, and long term thinking were not money makers for employees. When the time came for the company to take its writedowns, many of these bad actors were long since gone. Go on, take the money and run.
You may not be surprised to learn that external consultants were involved and recommended "streamlining of risk processes." I don’t know if these unnamed consultants were McKinsey & Co., but the whole description has a faint Enron-like smell to it.
A few other questions arise from the report:
Why do very risky strategies seem to end up in Fixed Income ?
How did Risk Control fail so badly?
Why was there an "Absence of risk management" and "Incomplete risk control methodologies" ?
Who created these compensation system ?
Again, this is just the tip of the iceberg in terms of asking what went wrong.
I wonder if this the inevitable banking equivalent of the Minsky moment. Perhaps these megabanks are simply too big, too unwieldy to be appropriately managed as hedge funds, rather than sleepy conservative banking institutions. The perverse incentives encourage reckless behavior.
Fascinating stuff . . .
Shareholder Report on UBS’s Write-Downs
18 April 2008
UBS ShareholderReport.pdf (download)
A good name sliced, diced and traded
FT, April 24 2008 03:00 | Last updated: April 24 2008 03:00
How UBS came undone
Fortune, APRIL 23, 2008: 4:38 PM
Too many risks, too few controls, says UBS report on write-downs
David Gow in Brussels
The Guardian, Tuesday April 22 2008