UBS $15bn deal with Blackrock looks absurd

Why would you sell an asset at a big discount and then make a loan to fund that same acquisition putting risk back on your own balance sheet? Welcome to the crazy world of hedge funds and banks. For this is exactly what UBS has just done in selling $22 billion of toxic assets to Blackrock for $15 billion, while providing 75 per cent of the funding.

Hedge fund Blackrock therefore acquires a $15 billion loan portfolio for an equity payment of $3.75 billion. But the risk of this massive leverage is largely borne by the seller UBS through a loan to fund the acquisition.

Now as the Chinese found when their investment in the Blackrock IPO fell by 25 per cent in value, hedge funds are not without risk. Indeed, the only way they achieve their high performance is by gambling with huge amounts of money lent to them by bankers who ought to know better.

Unregulated hedge funds have somehow managed to convince investors that allowing them to borrow money to bet on risky asset classes is good business. It certainly is for them. If it works they claim success fees. If it does not work the investor and banks take the full hit and they pay nothing.

Now UBS is the largest Wealth Management firm in the world. If this is how the firm manages its own loan book it seems only a fair question to ask about how they are handling the assets of their clients.

Of course, this may just work out fine. Blackrock could well make its profit and go on to bigger and bigger deals. Or its highly leveraged portfolio of transactions could land the firm in big trouble if financial markets take another lurch down and another shoe or two drops.

Then any bank with exposure to Blackrock would have a major problem. So is UBS really saying that $3.75 billion in cash is sufficient payment for $22 billion in distressed assets? Now that is what marking to market might really mean in the current environment.

But is this not symbolic of everything that is wrong with the highly leveraged and unregulated financial world that we live in? Hedge funds are assuming far too much risk on assets that can not support it, and passing that risk on to the banks through leverage.

Why do the banks lend to hedge funds? Why are hedge funds allowed to assume levels of risk that the banks would not take with everyday clients?

I suppose the assumption is that the experts who run hedge funds are so clever that they know much better than ordinary investors? But what if that proves to be a sham and they are not all endowed with the ability of a George Soros? Then we really do have a problem.