What happens when one zombie eats another? All the disgusting and fetid zombie parts of the consumed simply moves to the consumer. The same is true of zombie banks. When one zombie bank, full of death and corruption but better hiding it due to superior cosmetics, eats its more visibly ill and compatriot zombie bank, is the underlying rot somehow purified or made whole? Is the world a safer place? The answer is clearly no, and the below explains why. But first some background.
On Sunday, March 19, Union Bank of Switzerland (UBS) agreed to acquire Credit Suisse (CS) in a “take under” transaction that valued the equity of Credit Suisse at $3.3 billion, a sixty percent discount to Credit Suisse’s closing price on Friday. In addition to the wipe out of most of Credit Suisse’s equity value, $16 billion of Credit Suisse’s bonds “will be written off to zero.” Why shareholders should receive anything—let alone $3.3 billion of consideration—when more senior creditors take a goose egg remains a mystery, and litigation is sure to ensue.
UBS noted it will achieve $8 billion in annualized cost savings over the next five years, implicitly representing up to ten thousand job losses primarily at Credit Suisse. This will add to the wave of mass layoffs already impacting the global investment banking sector in 2023.
This was not a happy union, but rather a shotgun marriage arranged by the Swiss government and central bank. Credit Suisse, once the flagship and crown jewel of the Swiss financial economy, was desperate. Laden with losses and bad loans, undercapitalized and unable to raise funding, Credit Suisse was on the verge of failing outright. The sudden collapse of Credit Suisse could have triggered a global financial markets crisis even worse than was seen in 2008. Yet the idea of nationalization (the only viable alternative to an acquiror-rescue or bankruptcy) was unpalatable to Swiss government officials and taxpayers alike. So UBS was dragged—kicking and screaming—to the alter.
In violation of securities law or at least customary shareholder prerogatives, the Swiss government determined that no shareholder group (neither UBS nor Credit Suisse) will be able to exercise their rights to vote on the transaction. The merger is a done deal save for a few procedural steps. UBS was able to secure several concessions from the Swiss government, including a loss guarantee of up to $9 billion, nearly three times what UBS is paying for Credit Suisse’s equity. More importantly, the combined group can access over $200 billion of financial assistance from the Swiss National Bank, half of which comes with a guarantee from the Swiss federal government in the event of default.
Translation: even though UBS is issuing some $3.3 billion of its own shares to acquire Credit Suisse, it’s the Swiss government that is bearing much of the risk, and Swiss taxpayers who will ultimately pick up the tab if things go wrong.
UBS’s shareholders are now the owners of the mess, and will see their investment value diluted by the new share issuance, by any sustained negative market reaction to the deal (UBS share prices were initially down as by over eight percent on the news), and by future losses at Credit Suisse above the guarantee.
But that is not the main point. The real issue is that the underlying problems at Credit Suisse, including toxic assets, gross mismanagement, hidden losses, and unrealized counterparty exposure, have not been isolated as a result of this transaction. Those risks have simply been transferred from one to another too-big-to-fail bank, where CS’s and UBS’s risk assets will now be more heavily concentrated. The consequences of a misstep will be even more severe. This is a shuffling of the deck chairs, and the financial system remains as vulnerable as it was before.
UBS was itself bailed out by the Swiss government in 2008, and, while now profitable and better managed, has been plagued with problems ever since. This merger is akin to the proverbial two drunks holding each other up as they stumble down the street, and yet one of them still holds the keys to the car. UBS management have bitten off more than they can chew, and they know it. But they had little choice given overweening government and regulatory pressure.
The market believes that the merger increases riskiness at UBS. The cost of insuring against a credit default at UBS has increased by over 50 percent since last week. This reflects both merger specific concerns but also fear of financial contagion and a widening crisis in the banking sector generally.
While not officially a nationalization, the Swiss government, and thus its taxpayers, have assumed the ultimate financial responsibility of the combined entity, for better or worse.
Following the merger announcement, and anticipating an increase in market distress, the Swiss National Bank, alongside the Federal Reserve and five other central banks, announced late on Sunday a plan to enhance market liquidity by opening up daily swap lines to clear U.S. dollar transactions. This is another indication that financial markets are not functioning as they should. The coming days will test whether this past week’s combined actions of governments and central banks will be sufficient to calm the markets.
UBS’s acquisition of Credit Suisse was a necessary but not sufficient condition to address one particular element of distress in global financial markets. Yet nothing has essentially changed, and the risk of a widening crisis in the banking sector remains extremely elevated.
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