Opinion on  UBS AG (UBS)     Sector: Financial  >  Industry: Money Center Banks
UBS and why there is no bottom in sight

When considering if financial stocks have hit bottom first consider this research piece by Bridgewater , the worlds 2nd largest hedge fund.   It doesn't bode well for  UBS, the financial industry, the US Dollar, or the  US economy in general.  This is no time to be taking speculative positions in securities that neither you or I have the ability to analyze completely enough to  make a sophisticated investment decision.  In markets like these you are far better off protecting your capital than trying to catch falling knives.

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U.S. study estimated losses of financial institutions at $1.6 trillion dollars

by Marco Zanchi

Those that assume the misery is coming to an end are wrong. When it comes to writedowns, losses and raising fresh capital, the crisis has only just begun for banks. Losses are expected t reach $1.6 trillion, only a fraction of which have been uncovered. This is the conclusion of a confidential study made available to Sonntagszeitung.

But that is not everything. While banks give their word of honor that no further capital is needed, the paper by Bridgewater Associates says: "We have big doubts that financial institutions will be able to obtain enough new capital in order to cover the losses. This will worsen the credit crunch. "

"If everything they say is true," says Charles Wyplosz, a professor at the University of Geneva, " a number of financial institutions will face bankruptcy." The research paper is ‘hot ‘in professional circles not only because of its content, but also because of the originator; Bridgewater Associates is the second-largest hedge fund in the world. The people behind it are brilliant, first among them Ray Dalio, who founded the company more than thirty years ago.

$26.6 trillion of debt is considered risky

The company is one of the big names in the industry. Their macro-analyses especially have weight in central banks - some central banks are customers of Bridgewater. When asked, the Swiss National Bank replied that they do not comment on such studies on principle.

What is at risk for the banks? In order to identify the dimensions of the crisis for financial institutions, Bridgewater has calculated the expected losses on a wide range of risky credit-based U.S. assets such as mortgages, credit- or credit card-receivables. Then, one would need to know basically who had how much on the books. The total value of these risky comes to $26.6 trillion dollars. The losses on these assets would then sum to $1.6 trillion dollars, if all of the assets were valued at market prices and not marked to model, writes Ray Dalio.

Traditional credit loans are not on the balance sheet at market prices, because they are not traded. The loss, when applied to the $26.6 trillion face value of assets, is an impairment of 6 percent. If market prices rise, the size of the loss is reduced; If prices fall, the losses increase.

US credit institutions are holding the largest losses.

Bridgewater has calculated that, so far, financial institutions have only acknowledged losses of $400 billion. Non-US banks - especially UBS - have provided the lion’s share of that at $238 billion. Therefore, the greatest expected future losses should be at U.S. credit institutions. This includes names such as Citigroup, Bank of America and JP Morgan Chase and many smaller institutions unknown here in Switzerland.

Why? That’s because lending is their core business, and they hold the majority of the assets. But, it is also because a large part of the losses are in the form of traditional bank loans, and, unlike securitized mortgages, these are not traded. So, their value has not been corrected on the balance sheet. "If we assess [the validity of] current market prices, we have a long way to go, because these institutions have only acknowledged one-sixth of their expected losses resulting from the credit crisis," writes Bridgewater. Five-sixths comes to nearly $500 billion.

The big question is: Can the banks plug these holes from the losses with new equity capital? Alone for the U.S. banks named above, we are talking about $400 billion, estimates Bridgewater. The banking industry does not have enough healthy institutions to absorb the sick. Meanwhile bank shares are in freefall. And the Middle Eastern Sovereign Wealth Funds have lost the appetite.

The international interdependence makes everything much more complicated

If the banks, as Dalio fears, do not succeed in mobilizing enough fresh capital, they would be forced to sell assets - and in a cyclical downturn at that. That could trigger a classic death spiral downwards, as sales of assets would pressure their share prices, which in turn weakens the banks' balance sheets and further sales would be necessary. "Once again we have a mountain of distressed assets to sell, which is enormous in comparison with any conceivable demand [for those assets]," says Dalio.

Exacerbating the situation is the fact that, in the Spring, "smart" investors bought large quantities of securitized loans, as their prices fell - in the hope of snapping up a bargain. If the prices continue to drop, these investors will come under severe pressure, especially many who are using borrowed funds.

What’s gotten Dalio so pessimistic? The United States is stuck in a large debt-relief process, a "classic deleveraging," as Japan was in the nineties or as many countries during the world economic crisis in the 30s or developing countries during their debt crises. Only this time everything is much more complex, primarily because of the enormous international interdependence of the financial services industry. Making things worse, U.S. consumers are overly indebted and access to cheap money is blocked now.

Moreover, the United States is dependent on foreign capital in order to finance their lifestyle. "The outlook for the dollar is bleak. Very, very bleak, " a former central banker said to Sonntagszeitung.

The real downturn in the U.S. is only beginning

So far, the financial problems resulting from the financial crisis have been large , but the economic ones have been small, because economic problems follow financial ones with a time delay. After liquidity injections by the U.S. central bank induced a short uptick from March to June, the economy and financial system of the USA should now be on the threshold of a real slowdown, he says. The poor credit environment crisis in the real economy resulting from the financial crisis will now have a negative reciprocal effect on the financial sector.

Phase one of the credit crisis was marked by the collapse of the real estate market in the U.S. and the crash in the market for subprime mortgages. Phase two - a kind of calm before the storm - began with the rescue of the U.S. investment bank Bear Stearns in mid-March. This phase came to an end in June, when optimism in the financial markets waned again. Now phase three is set to start. "Bridgewater is on the pessimistic side, no question," says George Magnus, Senior Economic Adviser at UBS in London, "but Bridgewater is absolutely right."

Thinking of investing in finacial stocks.  Consider Bil Gross's comments first.

When considering weather bottoms are in or not you should first try to understand what is driving the madness. To put it simply the market is wringing the leverage out of the market. The problem with the financial stocks is that they run highly leveraged balance sheets. Since the model is to borrow short and invest long the absence of available credit is causing leveraged balance sheets to contract. Libor spreads have blown out meaning banks aren't lending to banks. The commercial paper market is frozen up so companies cannot roll their CP when it comes due. For companies that must roll CP they have an immediate and sometimes (AIG, LEH, BSC) contraction. How low can they go? The answer is zero because if you have for example a 20 billion equity cap but a 100 billion balance sheet that is short term financed and you can't roll your cp then you rapidly become illiquid. Lenders who are senior to the equity see their debt becoming impaired so they buy CDS and short equity to try to limit their exposure. Since the dollars on the debt side are so large in comparison to the equity the equity gets squished. So just because GS and AIG are fundamentally sound given a normal operating environment they aren't in an environment where credit is unavailable. This can and will get a lot worse. Don't be quick to jump in because it will be hard to tell who was dumber the person who lost the first 90% or the person who jumped in just in time to lose the last 10%. This is no time to be speculating in the equity of highly leveraged balance sheets.  This isn't a bottom it is the edge of the abyss.