By James G. Neuger, Joshua Gallu and Simone Meier
Dec. 1 (Bloomberg) -- An isolated European country with an economy geared toward finance and winter sports is no longer a monetary bastion as credit evaporates around the globe. Banks teeter, the once-impregnable currency depreciates and a proudly independent people question whether a centuries-old go-it-alone strategy can survive.
Even Switzerland is wondering if it’s immune to the forces ravaging Iceland.
The drama playing out in the Nordic nation, whose economy the International Monetary Fund says may shrink about 10 percent next year, offers a cautionary tale for the no less fiercely independent Swiss. While they are in far better shape, their status as custodians of the world’s wealth is under threat by a global economic upheaval they can’t control and miscues by the banks that made them great.
“The Swiss model of isolationism is not an advantage” in the current environment, says Michael Baer, 46, the great- grandson of Julius Baer, founder of Switzerland’s largest independent wealth manager. “Switzerland is absolutely not immune to global developments, especially not as regards the financial crisis and the economy.”
Baer -- scion of a legendary family in one of the world’s oldest financial centers -- has moved his own business to one of the youngest: In 2006, he set up Baer Capital Partners in Dubai to tap Middle Eastern wealth.
For the 7.6 million Swiss, signs of stress are evident amid a cataclysm in world markets that has besieged them with reasons to doubt a splendid isolation dating back to medieval times.
Europe’s Biggest Losses
While the Swiss Market Index has outperformed the Nasdaq Composite Index this year, it has still lost 31 percent of its value. Zurich-based UBS AG, Switzerland’s flagship bank, amassed Europe’s biggest losses in the credit crunch, forcing the government and central bank to offer a $59 billion helping hand. The franc has tumbled against the dollar. And the banking secrecy that attracts offshore wealth is drawing more fire than ever.
Slowly, the pain on Zurich’s Bahnhofstrasse -- the boutique- and bank-lined promenade through Switzerland’s largest city -- is trickling through to main streets countrywide.
Switzerland’s economy will shrink 0.2 percent next year after expanding 1.9 percent in 2008, the Organization for Economic Cooperation and Development said on Nov.25. While the 2.6 percent jobless rate is low by global standards, unemployment rose for the first time in five years in September and is heading higher. UBS and Zurich-based Credit Suisse Group AG, the No. 2 bank -- whose combined balance sheets equal seven times the Swiss gross domestic product -- were once a calling card for Swiss economic power; now, they are hurting.
Reeling
UBS has seen its shares dive 67 percent this year. Credit Suisse, reeling from a 1.3 billion-franc ($1.1 billion) loss in the third quarter, opted out of Swiss government aid, raising 10 billion francs from investors including Qatar Holding LLC and Tel Aviv-based Koor Industries Ltd., adding to concerns that control of the country’s banks is moving out of Swiss hands.
“I think we will see a move to more protectionism,” says Baer. “If the crisis lasts longer and the real economy cools further, we will soon see social problems, strikes, unrest.”
A grass-roots backlash is already under way. Protesters barricaded UBS’s private-banking branch in Zurich in October, demanding that executives pay back bonuses. A banner at another demonstration labeled the bank “United Bandits of Switzerland.”
The greatest menace may be a series of probes in the U.S. that puts the nation’s tradition of banking secrecy at risk. Former UBS banker Bradley Birkenfeld in June admitted scheming to help American clients hide $20 billion and dodge taxes. On Nov. 6, a grand jury in Fort Lauderdale, Florida, indicted Raoul Weil, 49, chairman of global wealth management at UBS in Zurich, on a charge of conspiring to help 20,000 wealthy Americans stash assets out of sight of the Internal Revenue Service. Weil, who the bank is replacing on an interim basis, denies the charges.
Blacklist
Meanwhile, German Finance Minister Peer Steinbrueck is pressing for Switzerland to be added to a blacklist of tax havens being prepared by the Paris-based OECD.
Switzerland’s hush-hush tradition “may well break down under pressure from the rest of the world,” says Edwin Truman, a former head of the Federal Reserve’s international-finance division. “There’s less and less mileage for being different.”
The Swiss franc, long seen as a safe haven in the world’s financial riptides, is increasingly being swept up in them. “From a relative-value perspective, the Swiss franc is still among the top performers,” says Paresh Upadhyaya, who helps manage $50 billion at Putnam Investments in Boston: Since July, the franc has advanced against 12 of 16 major currencies, including a 4.5 percent rise against the euro.
Running Out of Ammunition
Still, the currency, which reached 0.9638 per dollar on March 17 -- the strongest since at least 1971 -- has since fallen to 1.2140, and it won’t recover through 2009, according to the median of 48 analyst forecasts compiled by Bloomberg. And the Swiss National Bank is running out of ammunition to buoy currency and the economy.
The central bank has cut its main interest rate three times since early October to 1 percent, and lowered the one-week repurchase rate to as low as 0.1 percent. Since Oct. 20, the bank has been forced to team with the European Central Bank to supply francs to borrowers outside Switzerland in an effort to bring three-month rates in line with its target.
The franc is “likely to remain weaker” as investors keep selling overseas holdings in favor of dollar-based assets, according to UBS. “The safe-haven status has shifted away from the Swiss,” says Matthew Strauss, a senior foreign-exchange strategist at RBC Capital Markets in Toronto.
Two Pathways
As pressures grow, two pathways lie open for the 26-canton federation that traces its origins to 1291 and has officially styled itself neutral for some 500 years. One is to turn inward -- an ages-old temptation in a country that wouldn’t even join the United Nations until 2002. The other is to embrace the wider world by becoming a member of the European Union.
“We can’t afford to stay outside the EU any longer,” says Hans-Juerg Fehr, 60, a Social Democratic lawmaker and former chief of the country’s second-biggest political party. The assault on the banks, he says, “wouldn’t be as great if Switzerland had the EU covering its back.”
With a GDP of around $420 billion, Switzerland is on a par with Belgium and Sweden, two middle-ranking economies in the 27- nation EU. Exports account for more than half of GDP, and sales to the EU -- facilitated by trade pacts dating back to a 1967 accord on cheese tariffs and a 1974 deal on clocks and watches - - make up more than 60 percent of exports, intertwining Switzerland’s and Europe’s economic fates.
Web of Agreements
Undetected by many Swiss, a web of agreements on everything from goods inspections to air transport has already saddled Switzerland with the bulk of the EU’s business rules. Yet the Swiss don’t have a seat at the table when EU officials gather in Brussels to set the regulations.
The Swiss are “stuck with that,” says Clive Church, a retired professor of Swiss and European politics at the University of Kent in the U.K. “All the pressures are going to put them further into alignment with Europe.”
The next step, backed by Swiss voters in 2005, comes on Dec. 12 when the landlocked stronghold opens its frontiers to travelers from the 24 countries in the EU’s passport-free zone. The disappearance of border-control officers will bind Switzerland more closely to the EU than even Britain and Ireland, two EU countries that maintain passport checks.
Still, the question of outright EU membership -- rejected by Swiss voters in 1992 -- is far enough off the agenda that the Bern-based GfS research institute hasn’t asked the question since 2005. A survey then found 54 percent against, 37 percent in favor and 9 percent undecided.
Aiding Eastern Europe
Pro-EU campaigners who seize on current economic woes as a reason to join have to reckon with a vast, far from silent majority that fears the costs and loss of sovereignty. The Swiss got a glimpse of the price tag in 2006, when the government was cajoled into making a 1 billion-franc payment over 10 years to aid the eastern European countries that entered the EU in 2004.
“We’d have to pay a lot,” says Bernadette Bachmann, 50, a mother of one from the Zurich region. “I don’t think we’d be better off in the EU. You can reach a deal with someone without getting married.”
Looming in the mists of the North Atlantic is the worst- case scenario of Iceland, which emulated Switzerland by hitching its fortunes to the financial industry. Unlike Switzerland, Iceland had little else to fall back on when its top three banks crashed and a $4.6 billion rescue loan made it a ward of the IMF.
“The good news is that Switzerland isn’t Iceland,” says Truman, the former Fed official who is now a senior fellow at the Peterson Institute for International Economics in Washington. “The problem is: What does Switzerland do? The crisis is truly global. No country can hide from it. As a small, open economy --even if it’s high-income, highly industrialized - - it’s going to have problems.”
To contact the reporters on this story: Simone Meier in Frankfurt at smeier@bloomberg.net; Joshua Gallu in Zurich at jgallu@bloomberg.net; James G. Neuger in Brussels at jneuger@bloomberg.net
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