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Back in August as this credit crunch was picking up speed UBS reported earnings that included mortgage write downs on its mortgage backed securities holdings that were applauded by Wall Street for their “conservative” nature. The general bull’s line was that $3.4 billion was a lot of money but the bank should be applauded for purging the system and over-estimating the potential losses now instead of covering up and taking “best-case” estimates in their write downs.
I argued at the time that it was impossible to know the true value of the assets because they weren’t being sold; they were only being marked down internally which of course would lead to a best-case bias in the value.
Well I hate to say I told you so, but a week ago UBS wrote off an additional $10 billion in mortgage related losses due to the worsening performance of the underlying mortgage securities. That’s an additional 300 percent folks. So much for conservative in their initial assessment. But of course we all knew that back when I wrote the initial article.
The next chapter is unfolding now as UBS faces a federal inquiry that it - SURPRISE - didn’t accurately report the value of the assets that it held when it made its initial mark down estimates.
U.S. government prosecutors are investigating whether Swiss banking giant UBS misled investors by reporting inflated prices of mortgage-backed securities it held despite knowing those valuations had eroded, the Wall Street Journal said on Saturday.
UBS, Europe’s hardest-hit bank from the credit crisis, last week raised its subprime write-downs to $18.4 billion.
The U.S. Justice Department on Wednesday said it was looking into whether fraud occurred in the packaging and selling of complicated mortgage securities like collateralized debt obligations (CDOs), the Journal said.
You can’t exactly hide $18 billion in losses after saying that you were aggressive in taking write downs totaling 1/6th of the current amount during a previous earnings report and expect to get away with it.
They’re No Different than Any other Bank
The scary (or obvious) part of this is that UBS is not special in this regard. All banks that are taking write downs are taking them on non-liquid assets that aren’t for sale. Of course there will be a bias towards “best case” pricing for a couple of reasons.
- The banks have no idea what this stuff is really worth. And an accurate assessment is that they are probably worth pennies on the dollars in this market.
- They haven’t sold any of it in months so they can’t accurately predict a fair market value for the asset.
So in light of those two impairments they will of course look towards models that seem reasonable (although that definition is illusive in the current market) and look to paint a better picture of the situation to protect themselves from shareholder activism, regulatory investigation and rating agency downgrades - all massively detrimental to their business.
While UBS is the current whipping boy I expect that the 14 banks being investigated for mortgage securitization fraud will be all of the big household names that you and I are used to hearing. These big banks had every reason to not mark to market accurately and therefore committed some level of fraud or shareholder subterfuge at one point or another. I would almost guarantee it.
Stay tuned as the big bank parade in front of Congress and judges across the country begins in earnest the second quarter of this year.
