The Senator and the Swiss Bank

Former Texas Sen. Phil Gramm has emerged as the key behind-the-scenes economics/Wall Street guy for John McCain and is being touted as the treasury secretary in waiting. Since 2002, Gramm has been an executive with the U.S. operations of UBS, the giant Swiss Bank. An unintentionally hilarious interview with Gramm on the Wall Street Journal editorial page last week asserted that Gramm has "been a key instigator of some of the biggest money-making UBS deals of recent years." The interview was noteworthy not just for first-class butt-kissing, but for deliberately gliding over the avalanche of disasters in the past year that has turned UBS from a respected Swiss titan of discretion and risk management into a laughingstock. As this one-year chart shows, UBS's stock lost nearly 70 percent of its value and now stands at levels not seen since 2002, when Gramm signed up.

OK, the entire investment banking business in the past year has been an international clown show. Virtually every U.S. and European institution has been laid low by badly placed bets on subprime mortgages and forced into humiliating rounds of dilutive capital raising. Bear Stearns was clearly the worst. Citigroup, Merrill Lynch and Lehman Brothers have taken large hits. But among foreign institutions, none has fared worse in the United States than UBS. And its employees seem to have compounded their violations of common sense with violations of more serious laws.

UBS's investment banking unit made disastrous forays into subprime lending. Last December, having already announced a third-quarter loss, UBS raised about $13 billion to replenish its balance sheets, mostly from the Government of Singapore Investment Corp. In the fourth quarter of 2007 and the first quarter of 2008, it racked up Mont Blanc-sized losses on subprime debt of nearly $32 billion. In May, it sold about $15 billion worth of mortgage-related assets to the investment firm BlackRock—but only after it agreed to finance most of the purchase price. In June, UBS raised another $15.5 billion in a rights offering. The credit losses—some $38 billion so far, according to UBS—caused the bank to replace its chairman and install new leadership at its investment bank.

UBS was hardly alone in getting caught up in the global credit bubble, although its losses are truly impressive. But UBS has suffered further reputation damage. Late last month, the state of Massachusettscharged UBS with screwing over well-heeled customers who had purchased auction-rate securities. The mechanics of auction-rate securities—instruments that pay a slightly higher rate of interest than municipal bonds or cash deposits and were thought by many purchasers and brokers to be as safe as cash—are complicated. But the issue is relatively simple and familiar to anyone who has combed through the Spitzer Wall Street research settlement of 2003. UBS stands accused of selling retail brokerage customers products that turned out to be profitable for the bank's investment banking unit but caused the customers to suffer significant losses. (Read some of the internal e-mails here.)

These charges, levied by a state regulator, are already causing reputation damage to UBS. (Dow Jones reported today that retail brokers are fleeing.) UBS's asset management business is likely to suffer further from an ongoing federal investigation, in which Bradley Birkenfeld, an American UBS private banker who was busted on tax-evasion charges, has plead guilty and is cooperating. Among the revelations so far: Birkenfeld helped a client bring in diamonds from abroad by stashing them in a tube of toothpaste.

The carnage at UBS is far from over. Last Friday, on July 4, when U.S. markets were conveniently closed, it announced preliminary second-quarter results, which indicated the possibility of further losses. Over the weekend, the Financial Times reported that UBS's write-downs could total another $7.5 billion. Evidently, traders read the news on the way in to work, as UBS's stock fell 7 percent in trading on Monday.