Banking & Capital Markets

More Holes Than Thou

The guessing game continues.
Economist StaffFebruary 22, 2008

Yet another knock to Switzerland’s reputation as a place where money is lovingly and carefully looked after by bankers. A week after Credit Suisse’s chief executive Brady Dougan boasted of the firm’s risk-management culture, on February 19th he was forced to acknowledge a $2.85 billion mistake in the firm’s trading valuations in the first quarter.

As the bank prepared a bond offering, senior staff apparently discovered the hole at the end of last week. They were reviewing the books of people in London trading collateralised-debt obligations and residential mortgage-backed securities. The prices used were out of date in a market that had rapidly deteriorated in January and February. A handful of dealers have been suspended while Credit Suisse investigates whether the tardy valuations were deliberate—perhaps with an eye to year-end bonuses—or just sloppy.

For all the embarrassment, Credit Suisse has still performed better during the crisis so far than UBS, its Swiss rival, which has written down $18.4 billion on credit-market securities. But its disclosure shows why there is so much mistrust in the credit markets about banks’ accounts, and why transparency is now being used as a competitive weapon.

In comparatively good results this week Barclays, the British bank, and France’s Barclaysgave elaborate details of their net year-end exposures to leveraged-loan commitments and subprime assets. But shares of British banks Alliance & Leicester and Bradford & Bingley have been clobbered by unexpected write-downs on subprime-related investments, and there are fears other European banks have plenty more explaining to do.

The trouble is, in today’s illiquid trading environment, such Barclays judgments are based as much on educated guesswork as market prices, which leaves plenty of room for error. (AIG, an American insurance group, owned up to a further $4 billion loss in its portfolio of credit derivatives to the end of November, though under protest: unlike PwC, its auditor, it believes the price of these assets will bounce back.) Accounting lore recommends a procedure that includes “making assumptions about the assumptions market participants would use”; that leaves plenty of room for disagreement with auditors.

Which is why risk officers are facing demands for ever more detail from analysts. “If I give you more numbers,” protested Hugo Bänziger, chief risk officer of Deutsche Bank, at a recent analysts’ meeting, “you end up doing my job.”

There were hopes that year-end results would provide some respite. But the Credit Suisse shock reminded the market that the year-end was only a snapshot of a moving target, and perhaps not a very accurate one. (Credit Suisse is still checking whether the mispricing began last year and will affect its 2007 results.) Moreover the year-end results have not yet been signed off by auditors. That suggests there will be plenty more uncertainty between now and April.