Barry Ritholtz recently pulled back the curtain to reveal one of the mechanisms behind the credit crisis.  No surprise: the problem was good old short term personal greed and lack of concern for customers or long term reputation on the part of everyone from the Chairman to the floor clerk.  Here is his fascinating little post:

UBS $37B Write Down, Part II

Posted: 26 Apr 2008 10:26 AM CDT

Buried at the end of the report discussed earlier is the specific criticism of the financial compensation system in place at UBS for traders and the engineers of structured products.

The bigger question is how little their quaint little system differs from any other large bank or brokerage firm on Wall Street. Remind me to ask Johns Thain & Mack about that.

Excerpt:

6.3.8 Compensation

UBS has identified the following contributory factors related to compensation and incentives:

• Structural incentives to implement carry trades: The UBS compensation and incentivisation structure did not effectively differentiate between the creation of alpha (i.e., return in excess of a defined expectation) versus the creation of return based on a low cost of funding.

• Asymmetric risk / reward compensation: The compensation structure generally made little recognition of risk issues or adjustment for risk / other qualitative indicators (e.g. for Group Internal Audit ratings, operational risk indicators, compliance issues, etc.). For example, there were incentives for the CDO structuring desk to pursue concentrations in Mezzanine CDOs, which had a significantly higher fee structure (approximately 125-150 bp) than High-Grade CDOs (approximately 30-50 bp).

• Insufficient incentives to protect the UBS franchise long-term: Under UBS’ principles for compensation, deferred equity forms a component of compensation that generally increases with seniority. Essentially, bonuses were measured against gross revenue after personnel costs, with no formal account taken of the quality or sustainability of those earnings.

Gee, with that compensation structure in place, how could anything possibly go awry . . . ?

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Tags: peak oil energy investments

This entry was posted on Sunday, April 27th, 2008 at 9:00 am and is filed under Investment Ideas. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.