Long-Term Capital Management and the price of integration

The losses of 1998

The first year of the new UBS brought a crisis that exposed the weaknesses of the merged risk management. Long-Term Capital Management, a hedge fund in Greenwich, Connecticut, founded by former Salomon Brothers traders and advised by Nobel laureates in economics, had built up enormous leveraged positions in bond and equity markets. When Russia defaulted on its domestic debt in August 1998, the markets moved against these positions. In September the fund had to be rescued by a consortium of banks organised under the auspices of the Federal Reserve Bank of New York.¹ The exposure of the new bank had its origins in transactions that the Bankgesellschaft had entered into with the fund in 1997, before the merger was agreed.² UBS proved to be the largest single loser in the collapse of LTCM and eventually wrote off CHF 950 million.³

On 2 October 1998 the chairman, Mathis Cabiallavetta, resigned together with three other senior managers: the chief risk officer and two senior executives of Warburg Dillon Read, the investment bank that had been formed from the combination of SBC Warburg Dillon Read with the investment banking activities of the Bankgesellschaft. Alex Krauer, the vice-chairman, became interim chairman. Krauer said that the news had struck the board like lightning and described the situation as “a crisis of confidence”. Ospel conceded that the bank had lacked an overall view that would have shown the risk, because the exposure had been spread across several accounts.⁴ The Russian crisis also cost Credit Suisse dearly. Blick puts its write-downs in connection with Russia in September 1998 at CHF 1.8 billion.⁵

Lessons that were not learned

The LTCM affair revealed several features of the new UBS that would recur ten years later on a much larger scale. The exposure had been created in the legacy Bankgesellschaft, but its full extent had not been understood by the management of the merged bank. Risk was spread across different units and accounts without a consolidated view. The investment bank had strong incentives to generate revenue, while the control functions lacked the authority and the information to limit exposure. Bilanz notes that the losses on LTCM and the further losses in the Asian and Russian crises significantly weakened the representatives of the Bankgesellschaft within the merged bank.⁶ The internal balance of power therefore shifted further towards the managers from the Bankverein, whose investment banking culture now defined the bank.

The departure of Cabiallavetta did not end his career. He later served as vice-chairman of the board of Swiss Re, where the business press criticised his pay, and as a board member of BlackRock.⁷ For the history of the financial centre, the resignations of October 1998 are significant as a precedent. The board of a Swiss big bank had accepted personal responsibility for a risk management failure within a few days. When UBS faced losses many times larger in 2007 and 2008, the reaction of its governing bodies was slower and more reluctant, as the following chapter shows.

Notes

1. President’s Working Group on Financial Markets, “Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management”, April 1999, https://www.cftc.gov/tm/tmhedgefundreport.htm. The report dates the Russian devaluation and debt moratorium to 17 August 1998 and describes the recapitalisation by a consortium of fourteen firms on 23 September 1998, for whose discussions the Federal Reserve Bank of New York provided the facilities. ↩
2. Euromoney, “Another fine mess at UBS”, https://www.euromoney.com/article/27bjsstsqxhkmh1336utk/banking/another-fine-mess-at-ubs/, stating that in the course of 1997 the Bankgesellschaft “struck up a relationship with LTCM by taking a combination of equity and equity option positions in the fund”. ↩
3. Wikipedia, “Union Bank of Switzerland”, as cited above. ↩
4. CBS News, “Bankers Resign Over Fund Debacle”, October 1998, https://www.cbsnews.com/news/bankers-resign-over-fund-debacle/. ↩
5. Blick, “Aufstieg und Fall des Lukas Mühlemann”, as cited above. ↩
6. Bilanz, “Wie vor 20 Jahren aus SBG und SBV die Grossbank UBS entstand”, as cited above. ↩
7. finews.com, “Swiss Re: Goodbye to Ex-UBS Boss”, https://www.finews.com/news/english-news/22321-swiss-re-board-mathis-cabiallavetta-jean-pierre-roth-paul-tucker. ↩

For general information only. This article does not constitute legal or tax advice, does not replace advice on an individual case and creates no lawyer-client relationship. It reflects the legal position as of September 2025.