Swiss banks reveal their dirty secrets

Swiss bank UBS is in deep trouble over its exposure to subprime debt. But, as David Stevenson explains, things could be about to get worse – so much for the famed superiority of Swiss banks.

Aren't Swiss banks ultra-safe?

That's what everyone thought. Banking information is given similar protection under Swiss law to the confidentiality afforded to doctors and patients, or lawyers and clients, i.e. it stays secret. And Switzerland's neutrality has created a prosperous and stable country in which banks have thrived for over 200 years. At the end of the 1990s the giant Swiss bank UBS was hitting the headlines for all the right reasons. Following its merger with rival Swiss Bank Corporation in 1998 and its takeovers of the likes of UK SG Warburg, and with its smart offices in midtown Manhattan and in the new Broadgate centre in the City of London, UBS smacked of Swiss bank solidity, quality and conservatism.

So what went wrong?

The American housing market. For many of the last six years, UBS has been pouring cash into complex asset-backed securities (ABS) linked to high-risk American home loans. Many of those who took out the loans had dubious credit histories and almost no chance of ever repaying their debts, particularly once house prices started falling. As the defaults mounted, UBS started counting the cost. On 1 October last year, the bank's first guess as to the extent of its losses was $4bn. At the time, that was a shocker. But a staggering $34bn more has been wiped off the balance sheet since.

And there's yet more pain on the way: Europe's biggest US subprime casualty confirmed last week that additional heavy hits (up to $7.5bn according to the FT) are on the cards. And the bank's reputation? Gone. "Over the past 12 months, what was once the epitome of a serious, solid Swiss banking house has turned into a symbol of greed and excess and become a byword for hubris in the world of fast money", says Lukas Hassig in The Daily Telegraph. "UBS's culture and reputation for prudence" has been "corroded by the short-term riches on offer during the good times".

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What were the directors thinking?

They were asleep on the job. In May 2002, Zurich-based risk managers reported that the bank's exposure to ABS totalled some $25bn, one of the biggest books on Wall Street and almost equal to the bank's entire CHF44bn capital. But a low-key reaction from senior management consigned the report to the top shelf, and on 13 October 2004, UBS proudly announced it had become one of the biggest ABS players in the world.

And it didn't stop there. Prior to his April departure, ex-chairman Marcel Ospel admitted that much of the crisis stemmed from "securities based on mortgages which were issued from 2006 to 2007, towards the end of the credit cycle when US mortgage lenders had lowered their standards too far and supplied credits to debtors with a poor credit rating".

What is UBS doing about it?

UBS has been on a balance-sheet bolstering trail this year and has managed to raise some $28bn so far. It has also cleared out the board. Three directors have been dumped and new chairman Peter Kurer told the FT he wanted to "strengthen the board with independent figures with top-class financial or audit experience".

The latest rumours are that the bank's US wealth-management division, Paine Webber, is to be unloaded. Although PW "would certainly fetch less than the $12bn UBS paid for it in 2000, and probably even less than the $6.6bn book value", says Jeffrey Goldfarb on, the bank "could use the extra cash". And as it typically accounts for just 5% of UBS's profits, "PW might be a distraction the bank could do without".

Can all this restore UBS's reputation?

Probably not. Already there are reports of high-net-worth individuals shifting their money into smaller 'boutiques' they consider more secure. Citigroup analyst Jeremy Sigee reckons that over CHF11bn was withdrawn from UBS's wealth-management unit in the second quarter of 2008, says Bloomberg. And while the board shake-up may help address criticisms of the bank's corporate governance, restoring confidence will take more than management change. The bank needs a fresh start with "tougher controls" and a move away from "traders notching up big bonuses from oversized bets", says Mike Verdin of

And even now UBS's reputation is taking another nasty hit. The US Internal Revenue Service (IRS), suspecting UBS of helping affluent Americans to evade tax (see below), has summonsed the bank for Swiss-based account details of American taxpayers. UBS may now say it is "working diligently" with Swiss and US authorities. But a fight with the IRS combined with the release of this information could do even more damage than all the write-offs put together: it puts the very future of Swiss banking secrecy under threat.

The man taking the tax rap

Former UBS banker Bradley C. Birkenfeld has been the first to suffer from the IRS crackdown on UBS. From 2002 to 2006 he looked after US clients with undeclared offshore accounts with UBS. More recently he was charged in the US with helping billionaire Igor Olenicoff evade millions of dollars of taxes. Last month he pleaded guilty and in his testimony which, says The New York Times, "reads like a how-to of high-end tax evasion" blew Swiss banking secrecy sky high. Think piles of cash stashed in safe deposit boxes, diamonds smuggled in toothpaste tubes and destroyed banking records. Olenicoff has pleaded guilty to filing a false tax return. But he probably won't be the last. Birkenfield had "numerous US clients".