TUESDAY 4 DECEMBER 2007

MR E GERALD CORRIGAN, LORD CHARLES ALDINGTON, MR JEREMY PALMER AND MR WILLIAM MILLS

  Q1200  Mr Love: Mr Palmer, are there any consequences for financial stability from the losses suffered by the larger institutions?

  Mr Palmer: So far, despite the losses suffered by some major institutions the overall consequences have been fairly well contained. Of course, the process is never finished. We have seen the larger institutions which have taken losses adapt and modify. We have seen changes of management as they take responsibility and efforts to adjust and improve risk management systems which are clearly very important as we move from this backward-looking way of thinking which in the past has driven risk analysis to a much more forward-looking stress analysis-type situation. From what we have seen so far all of those things mean that the institutions that are adapting reasonably well up to this point.

  Q1201  Mr Love: Why is it that a lot of the banks have failed to quantify the exact losses?

  Mr Palmer: I think that is a matter of opinion. At any one time the banks must assess, first, what their exposures are, second, the likely losses and, third, respond to their legal requirements in terms of what they can and cannot say at any one time. As we move into next year and see the audited full year results coming from a lot of the bigger institutions that are involved we will have a much clearer picture of exactly what has happened.

  Q1202  Mr Love: Mr Mills, one investment banking institution assumed that its exposures were now worth 63¢ on the dollar while other suggested 90¢ on the dollar. Why is there such a huge variation in the quantification of the losses being suffered?

  Mr Mills: What occurred in August and September was the fact that these markets stopped functioning and so there was no visible trading taking place. Typically, investment banks set their prices on their inventory and their positions based on the visibility of other trades that are taking place in the marketplace.So, for a period of time—roughly two or three weeks—investment and commercial banks had to come up with a different methodology for establishing values on their portfolios and fundamentally had to deconstruct these complex securities, look at the underlying collateral and come up with a valuation. So, there was a period of time when there were significant differences between institutions as it relates to that. I think that most of those have converged at this point. I believe that given the level of disclosure that has been forthcoming through the month October that those price distortions should not be as great as they were in September.

  Q1203  Mr Love: The 63¢ that I quoted would be considered pessimistic by some. Mr Palmer, how does UBS come to that conclusion?

  Mr Palmer: First, the fact is that every institution has different types of exposure; they are not always strictly analogous. Second, everyone has to make his own estimate of what he thinks the future impact of the economic environment will be and so there is bound to be an element of subjectivity in these things. Unfortunately, it is very hard to arrive at a common number. The nature of every organisation is different, not just by degree but in terms of the details of the actual exposure.

  Q1204  Mr Love: If you look at your competitors, would you assume there are any decisions taken to admit only to a small amount of loss but to drip feed it over a period rather than be more realistic in the valuations they make? Is there any assumption that that is happening in the marketplace at the present time?

  Mr Palmer: I can speak only for my own firm. Obviously, we are driven by the natural principles of transparency. Frankly, I think it is in everybody's interests to drive towards transparency as soon as possible. Of course, the rules determine what we can say and when we can say it.

  Q1205  Mr Love: Lord Aldington, how long before we overcome this problem?

  Lord Aldington: The key to that lies in the answer to the question you posed earlier: people retaining confidence in the value of what is on their books. That is the most important thing that must happen. Markets have to be confident in the values that are there.

  Q1206  Mr Love: I understand that, but how long will it take—three months, six months, a year?

  Lord Aldington: I would say we have made a very good beginning. One can always be a little optimistic, but the start of a new year has its own effect. I hope that we see things settling down in the first half of next year.

  Q1207  Mr Love: Mr Corrigan, companies report quarterly in the States. In this country that does not happen yet. Everyone tells us that all should be open and transparent about what the losses are. Why is no one doing that?

  Mr Corrigan: With all due respect, I am not sure I agree with that characterisation. On the whole, what we have seen so far, certainly compared with earlier experiences, suggests that loss recognition at individual institutions has been pretty good. Another observation directly germane to your line of questioning is that one of the single most important things we should look for in major financial institutions is the true independence within those organisations of the people who are responsible for price verification. That is usually found in something like the controller's division. How it is labelled across individual institutions probably varies, but when inevitably there are differences of judgment as, for example, a sales person and a controller's person about the best possible valuation of a particular trade or item in inventory naturally there should be discussions, but at the end of the day the controller's judgment should prevail. That independence as the basic principle of corporate governance is the single most important thing we can do to help ensure the best possible job is being done in response to the question you phrased. In the international supervisory community, certainly including the FSA in the UK, a renewed and aggressive effort is being directed at that issue.

  Q1208  Chairman: Mr Palmer, my colleague asked you about the figure of 63¢ on the dollar. Given that the market for many credit instruments has frozen up, thereby making it impossible for the banks to mark their assets to either model or market, are these figures not largely pie in the sky?

  Mr Palmer: Obviously, the biggest problem is that there is no visible benchmark in the market which is normally from where you start. When that does not exist you have to use your best efforts through statistical analysis.

  Q1209  Chairman: It is a guesstimate?

  Mr Palmer: The modelling process is very complex and must take into account an estimate of what is likely to happen in the economy. There is always an element of judgment in it. How fast will the US economy decline? How bad will delinquencies be on mortgages? These kinds of things are very difficult to assess.

  Q1210  Chairman: Mr Mills, do you agree that these figures are pie in the sky in light of the frozen market?

  Mr Mills: No Mr Chairman, I would not characterise them as pie in the sky but as a fairly sophisticated effort to try to determine the value of the underlying collateral.

  Q1211  Chairman: Just explain to us in simple language how, if it is impossible for banks to mark their assets to either model or market, there can be an accurate assessment.

  Mr Mills: I think you can come up with a range of values. As we mentioned, if there is a lack of a marketplace and there is no visible price benchmarks that you can look to, you have to look at the underlying collateral and look at the underlying cash flows of that collateral, because they are performing, and determine through different statistical analyses.

  Q1212  Chairman: On a scale of one to 10 how accurate do you think they are?

  Mr Mills: Mr Chairman, what I can benchmark for you is when we announced our earnings warning we gave a range. We said that the losses we would incur would be in a range of $8 billion to $11 billion.

  Q1213  Chairman: I am a simple chairman looking for a range.

  Mr Mills: I would say it is 80% to 90% accurate.

  Q1214  Chairman: Lord Aldington, what do you say?

  Lord Aldington: A valuation is a valuation and I think to say that it is only 90% accurate is always a difficult thing to say.

  Q1215  Chairman: You say it is nine?

  Lord Aldington: We arrive at our valuations and attach huge importance to what Mr Corrigan has said, what our IPV (independent price verification) people say and then there are the accountants.

  Q1216  Chairman: What valuation do you give?

  Lord Aldington: We stand by the valuations that we have on our books.

  Q1217  Chairman: To go back to my question, Mr Mills has given eight in the range of one to 10. What do you give?

  Lord Aldington: I can only repeat what I have said. We stand by the valuations we have on our books.

  Q1218  Chairman: Therefore, you do not give any range at all?

  Lord Aldington: A valuation is a valuation, and it has to be supported by the accountants.

  Q1219  Chairman: Mr Corrigan, what do you say?

  Mr Corrigan: Let me respond at two levels. First, I make it my own personal business to review in great detail the procedures and policies that we as a firm follow in the area of price verification. I have spent a lot of time kicking the tyres, if I may put it that way, to try to satisfy myself as best I can that what we come up with in terms of valuations is state of the art. To answer your question, on a scale of zero to 10 I would say it is 9¾ based on my experience and the amount of time and effort I have put into the task.