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Economist: The Higher They Climb

In the April 3rd 2008 edition of The Economist, there is an article entitled The Higher They Climb about Swiss banking giant UBS and its former Chairman Marcel Ospel. The article starts with the following paragraphs:

A YEAR ago Marcel Ospel, the chairman of UBS, and his chief executive, Peter Wuffli, surveyed the financial world from the very heights. As well as having the biggest wealth-management operation on the planet, their Swiss bank was a force to be reckoned with in big-league investment banking. It had turned in profits for 2006 of SFr12.3 billion ($9.8 billion). Mr Ospel was handsomely rewarded, to the tune of SFr26.6m.

It was an impressive vantage point for a poor boy from Basel, who had clawed his way up without the benefit of a university degree or the near-mandatory rank of officer in the Swiss military reserve. On his third marriage and having put the red Range Rovers and green Ferraris behind him, Mr Ospel had climbed at last to the top of his world.

Mr Ospel's ascent had been matched by the no less striking transformation of the lacklustre number-three bank in Switzerland, Swiss Bank Corporation (SBC), through merger and assimilation, into a global powerhouse. From 1996 Mr Ospel had presided over the hitching of SBC to such illustrious names as S.G. Warburg, a British merchant bank; Union Bank of Switzerland, then Switzerland's biggest; and two American brokers, PaineWebber and Dillon Read. Mr Ospel's ambition was paired with ruthlessness and ability. When he bought Warburg in 1995 he sacked 1,000 employees outright. His critics said integration would not work, but it did. Moreover, SBC, which changed its name to UBS in 1998, had a reputation for highly effective risk management. Its motto: if you don't understand the business, you don't do it. [Emphasis added]

As the article adroitly states, earlier this month it became clear to the world about how completely those words had been forgotten. Several members of Toomre Capital Markets LLC ("TCM") used to work for the predecessor UBS investment bank before it was acquired by Swiss Bank Corporation after UBS' disastrous foray into hedge funds with Long-Term Capital Management. At that time back in the early 1990s, UBS knew what it did not know and kept its positions relatively small and proportional to what it could sell through its institutional distribution system. In recent years, it strayed very far from those roots.

This article goes on to explain that with hindsight, Marcel Ospel and his chief executive Peter Wuffli made their fatal error in 2005, when they tried to retain John Costas, the head of investment banking, by letting him set up an in-house hedge fund called Dillon Read Capital Management (DRCM). Unfortunately Mr Costas went headlong into American subprime mortgages. Worse still, the dealers at UBS, bedazzled by his genius, followed him into the quagmire. DRCM was unceremoniously closed in May 2007, with a published loss of SFr384m, and Mr Wuffli was fired. UBS was saddled with huge toxic positions on which it has continued to take losses."

The article continues with "Perhaps Mr Ospel's ambition for UBS to count in the world appealed in a country that has to shout to make itself heard. But the risks he needed to take were hard to reconcile with those other Swiss virtues of prudence and sobriety—virtues on which the banking industry had been founded. The damage to UBS, and to the reputation of Swiss banking in general, has been palpable—though UBS is not alone in getting caught out by the American mortgage market. Understandably EBK, the Swiss banking watchdog, has made it clear that prudence and sobriety are to be the watchwords once more. When UBS and Credit Suisse, the other big Swiss bank, recover from this crisis it will put tougher controls and higher capital charges on high-rolling investment banking. If that sends the business offshore, says Daniel Zuberbühler, director of the regulator and the self-styled Rhett Butler of supervision, then "frankly...I don't give a damn".

With the likelihood of significantly higher capital requirements for investment banks worldwide, there are strong arguments for UBS to scale down, sell or shut its investment-banking business. Mr Ospel's designated successor, Peter Kurer, a corporate lawyer by background, is no friend of investment bankers. But getting out is easier said than done. Both UBS and Credit Suisse have plugged the "one bank" model, whereby seekers and placers of investment-banking products are matched internally. Breaking the one bank into its components without bloodshed, great internal resistance, or more losses would be difficult. However, given all that has transpired in the past six quarters, Toomre Capital Markets LLC strongly suspects the Swiss will find a way – and UBS will be a shell of its former 2006 size.