AFP

HOW did UBS, a Swiss bank whose core business is the staid one of wealth management, manage to lose $38 billion betting on American mortgage-backed assets, battering its core capital and share price in the process? Shareholders, out in force at the bank's annual meeting on Wednesday April 23rd in Basel, asked just that question.

The mystery is being resolved. On Monday the bank released a summary of an internal investigation into the causes of the write-downs that had been demanded by the Swiss Federal Banking Commission. The 400-page report is now being chewed over by the regulator. Rivals should read it too. The report gives three broad explanations for the bank's woes. The investment-banking arm's preoccupation with growth, the reliance of the control team on flawed measures of risk and the culture of the bank.

Start with those growth plans. Many had assumed that Dillon Read Capital Management (DRCM), a hedge fund set up by UBS in 2005 and closed in 2007, was the primary culprit for the write-downs; in fact its contribution was modest. The more pernicious effect of DRCM was to deprive UBS of some of its most experienced people and to distract its senior management at a time when the investment bank was pursuing a strategy of rapid expansion.

The growth was focused on fixed income, an area where UBS particularly lagged competitors. The goal was to drive itself up the league tables by expanding in areas such as structured credit and commodities. The effect, says the report, was to grow too fast and emphasise revenue at the expense of risk. The end result: a desk that numbered just 35-40 people at its peak was responsible for write-downs of some $12 billion in 2007, two-thirds of the total.

If the bank's risk takers overlooked risk, its risk controllers miscalculated it. Probing questions could and should have revealed the scale of the risks that UBS was taking. Concerns were raised at various times in 2006 and 2007. The bank's top executives were sufficiently attuned to the deterioration in the American housing market to have raised it in September 2006. But the report says that they were fobbed off by assurances from executives at the investment bank that all was well. The investment bank's bosses only realised the depth of the hole they were in by late July by which time it was too late to do much about it.

There is no suggestion that anything untoward was going on. Assurances that risks were being properly managed were given in good faith, says Rupert Jolley, who led the investigation. But there was also a clear incentive to set aside any doubts so long as revenues were rising.

The report only deals with write-downs up to the end of last year. Nonetheless it asks some awkward questions of the bank now. If the culture of the bank was at fault, then can an insider such as Peter Kurer, plucked from the position of general counsel to replace Marcel Ospel, the former chairman, fix it? One large shareholder describes the combination of Mr Kurer and Marcel Rohner, the chief executive, as “terrifyingly weak”.

The report also notes that the issue of subprime exposures jostled unsuccessfully with several other items on the agenda of group-level meetings (leveraged finance got plenty of attention, by contrast): that will reinforce the doubts of those who think that the bank has become too complicated to manage. Perhaps most worrying of all for battered shareholders is the implication of the investigation's findings for UBS's sizeable remaining exposures to the American housing market, including $16 billion-worth of Alt-A positions that were still on the balance sheet at the end of March. There is scant reason to assume that these positions were researched or hedged more effectively than their subprime sisters.

The rest of the industry can hardly rest easy either. UBS got more things wrong than most but the traps it fell into will be familiar to its peers. Lots of other investment banks measure their status via league tables and seek to bulk up where they are weakest. Compensation and funding structures that fail to distinguish “alpha”, or skill, from simple carry trades are widespread. The flaws in measuring risk, and the emphasis on net rather than notional exposures, are also known hazards. The investigation found no evidence to suggest that regulators criticised the way UBS managed its risks. The banking commission sits in judgement now; it might usefully have done so earlier.