One of the big issues concerning Lehman’s collapse—and UBS’ role in selling toxic securities to its clients—concerns what UBS knew about Lehman’s spiraling out of control and when it knew it.

Beginning in the summer of 2007, the cost of insuring short-term obligations (a/k/a, credit default swaps) for Bear Stearns and Lehman Brothers began to increase steadily.  The rise reflected the growing concern over solvency of such companies, particularly on the part of those entities who traded with them or loaned them money.  Lehman in particular was highly leveraged, owing an inordinate amount of money to third parties and collateralizing it with mortgage-related assets.  In fact, Lehman was one of the largest underwriters of mortgage-backed securities in 2007.

UBS understood very well the problems associated with the mortgage sector.  On February 14, 2008, UBS reported a fourth-quarter (2007) loss of $11.3 billion after writing down $13.7 billion of investments in U.S. mortgages.  UBS’s chief, Marcel Ospel, stated that 2007 had been “one of the most difficult in our history” based on “the sudden and serious deterioration in the U.S. housing market.”  Altogether, UBS wrote down over $40 billion of investments in U.S. mortgages.

Apparently UBS saw something, because at some point in 2008 it began reducing its own risk exposure to Lehman Brothers.  As a matter of fact, when Lehman first collapsed, the Sanford Bernstein analyst who covered UBS stated that UBS stood to lose up to $4 billion due to its exposure to Lehman.  In an attempt to calm its shareholders and stave off a precipitous fall in its stock price, UBS quickly countered on September 16, 2008, with a press release that announced it expected its direct and counterparty risk, net of hedges, would be limited to only $300 million. 

So it would appear that UBS had the foresight, due it its own experience with “the deterioration” of mortgage-related assets, to radically reduce its risk exposure to them, in part, extinguishing a good part of its exposure to Lehman—Wall Street’s biggest underwriter of mortgage-backed securities.  What seems so disturbing is that UBS continued to provide Lehman with capital by soliciting its own client base to purchase and hold principal protected notes and preferred shares.  The sales of these products are what kept the Lehman afloat—especially during the last several months of its existence, when other financial institutions refused to lend it money.