The Economist has put together an index that allows you to find everything they have written about a topic. Given the excellent lineup of bloggers the Economists has -Ryan Avent, Matt Steinglass, and Will Wilkinson, to name a few- I’ve always been a little underwhelmed, to put it gently, with the website.
This index is a big improvement and has allowed me to find in all of 45 seconds an article I spent some time searching for in the past but gave up on. I remembered the article was part of a bigger report on banking, and it was before the banking crisis, and the only detail I remembered was someone criticizing UBS for not taking on enough risk. Yes, the UBS that ended up like this:
The bank’s losses continued to mount in 2008 when UBS announced in April 2008 that it was writing down a further $19 billion of investments in subprime and other mortgage assets. By this point, UBS’s total losses in the mortgage market were in excess of $37 billion, the largest such losses of any of its peers….UBS announced, in February 2009, that it had lost nearly CHF 20 billion (US$17.2 billion) in 2008, the biggest single-year loss of any company in Swiss history. Since the beginning of the financial crisis in 2007, UBS had written down approximately $50bn of mortgage related assets and announced 11,000 job cuts.
Here is what the article had to say about UBS:
Mr Stuerzinger describes UBS’s approach to risk in stark terms: zero tolerance for fiefs; beware of tail risks, risk concentrations, illiquid risks and legacies; avoid risks that cannot be properly assessed or limited; and never be hostage to a single transaction or client. UBS sets its overall risk capacity on the basis that it wants to be able to pay dividends out of current earnings, not retained ones. But thanks to earnings growth and the divestment of its private-equity portfolio, its ability to take risks has grown much faster than its actual risk exposure. Indeed, it is sometimes criticised for not taking large enough punts. Earlier this year Ken Moelis, an investment banker prominent on Wall Street, left the firm, reportedly because he felt it was too conservative in using its own capital in private-equity deals.
The entire banking report, which was published in May 2007, will make an interesting document to future generations studying the financial crisis. It tells us what a smart unbiased analysis of the banking industry would tell you about looming risks on the precipice of the crisis. Overall, the report makes some crucial points about uncertainty, fat tails, and risk management that would be echoed repeatedly in hindsight. These paragraphs sum up well the hindsight conventional wisdom of what went wrong:
Banks are not helpless in the face of such uncertainty. One of the landmark changes of the past 20 years has been the development of risk-management systems that estimate potential market, credit, liquidity and operational losses and seek to impose appropriate limits. Investment banks, because of the complexity of their exposures, have been at the forefront of efforts to measure and manage risks, encouraged further by the approach of Basel 2. They have employed mathematicians and spent billions of dollars on computer systems. Barclays Capital has turned whole walls into whiteboards to accommodate the hugely complex formulas involved. But the results of all this effort are not quite as brilliant as might have been hoped.
The bond-market turmoil leading to the liquidation of Long-Term Capital Management (LTCM) in the summer of 1998 not only exposed the risk-management negligence of that institution, staffed by Nobel laureates and storied traders; many investment banks were caught out too. The lesson, learned at an exorbitant cost, was that models are only as good as what is fed into them. So risk management is as much about human judgment as about mathematical genius.
And there is always the million-to-one chance, far along one tail of the bell curve, that something will go disastrously wrong. There is a parallel here with climate change, where many previous sceptics are now in favour of taking preventive action—not so much because they think the world could not cope with the most widely expected rise in temperature, but because they fear that things might just possibly turn out very much worse.
There is even a criticism of VAR:
But VAR is clumsy, relies on historical data and works best when markets are stable. It does not capture the effects of highly stressed markets, nor what would happen if assets could not be quickly hedged or liquidated.
Pretty spot on.
Overall, however, one walks away from the article with the feeling that banks had one eye on tail risks, and were in fact prepared for potential doomsday scenarios. There are other articles in the bank report issue, and I’m curious to see whether the end conclusion one comes away with from the report is that the industry is safe or unsafe. Unfortunately, access to Economist articles online is limited to a few samples before the paywall comes up. Perhaps it is time to re-up that subscription that I let lapse a few years ago. A couple more improvements to the website like this and I just might have to.