Examination of Witnesses (Questions 140-153)
MR JON
MOULTON
13 MAY 2008
Q140 Mr Mudie: The Governor says
he does that. He showed us some obscure speeches he had made in
Bristol and Cardiff and places where he says he warned them.
Mr Moulton: I am sure the good
bankers of Cardiff were listening to him!
Q141 Mr Mudie: I wonder if you place
too much responsibility on the regulators in this respect. Ferguson
and the Arsenal manager never blame their players, it is always
the referee. Their players can kick the hell out of someone and
they will say, "Why didn't you control it?" The banks
can behave badly and it is the poor FSA who cop it, they will
say, "Why didn't you stop them?" Why did they do it?
Mr Moulton: There is nothing at
all that I can disagree with you on. It is the way things are.
It can be stopped.
Q142 Mr Mudie: As politicians we
can put heavy pressure and abuse on the regulators, but what on
earth will stop the City continuing with the greed and bad behaviour?
Mr Moulton: I would put up one
clear suggestion and it is a mechanic, which is that the way people
are paid should be part of the way that they are assessed for
risk. You put people on 1,000% bonuses and they will do all kinds
of things. You can restrict this stuff. Short term they will say,
"No, you can't do that, you will restrict innovation."
We do not want widely innovative major banks.
Q143 Mr Mudie: You are suggesting
in effect that if you pull it out of the emotional role the regulators
should set salaries and bonuses.
Mr Moulton: No, I do not think
they should do that. Salaries can be very high. It is the incentive
payments and so on that really do the damage and it is the structure
of the way people are paid which is always a tremendously difficult
judgment, but I do not think anybody would say that things had
not swung far too far.
Q144 Mr Mudie: You would then be
advocating that a regulator would interfere with the internal
affairs—and I am not criticising it, it is a very interesting
thought—of an institution in setting—
Mr Moulton: No. What you say is
that if you operate with bonuses of no more than 100% as salaries
or compensation schemes based on five-year targets that will be
fine and you will get the standard capital allocation. If, on
the other hand, they want to have 20% of their total remuneration
paid out in monstrous bonuses to a small group of people we will
add 1% to their capital requirement because we think they have
got a lot more risk and then the market will sort it out.
Q145 Chairman: George's point is
a very valid one because we can write the script and the script
would be that you are going to chase good bankers away to other
countries and the UK is going to be a pariah. We have seen it
before. Angela Knight said in a speech, after Mervyn King made
his comments here, "It is not healthy to argue about the
executive compensation in the public eye. This is a financial
services industry in which a lot of jobs are hanging." So
the minute the nasty politicians say, "We'd better clean
up the market, Jon Moulton and others have told us to clean up
the market," they are going to say, "But you're going
to chase every good executive away from here and the UK is going
to be on its own." How do we argue against that?
Mr Moulton: The answer is that
at the edges there will be a few. The lad who is determined to
get the maximum possible bonus will behave like a traditional
salesman does when he does not get a commission scheme he fancies,
he will move to a different sector of the market. He might move
to the hedge fund market or overseas. I am not talking about reducing
the total level of money or anything, I am talking about the way
it is paid. If you pay somebody for doing something terribly short
term in a business which is fundamentally medium and long term
you have a mismatch of rewards and the needs of the business and
the economy. I do not think you would lose very many if you just
changed the structure. Three- and five-year plans are much more
appropriate for banking than some guy who is paid a fortune for
selling a load of rubbish to somebody who does not understand.
Q146 Ms Keeble: You were quite critical
of the ratings agencies in the early part of your presentation
but you did not suggest any recommendations for them in the way
forward. I wonder if you have any.
Mr Moulton: I have got some. I
wish I had got a much clearer good one as then I would have put
it in my presentation. I think it is important that they give
better information than they do. At the moment they get away with
murder. What does AAA mean? Bulletproof is probably about as near
as most people imagine to what it is supposed to mean. They ought
to be saying it means that you will lose your money X number of
times and X shares. They ought to give a lot more information
about what losses, rates of loss and so on are associated with
their ratings historically. Being more open would be good. I think
it would be really quite good for them to be forced to show their
own performance, how their ratings are tied to what plays out
would be very useful information for the market and it would mean
that they would be less inclined to get over-enthusiastic, which
I think one would have to say they seem to have been last year
when AAA was handed out fairly freely.
Q147 Ms Keeble: You have said that
people cannot understand the products that they are investing
in and you also talked about the "pass the parcel" approach
to this as well. Are the people who invest in these not supposed
to undertake due diligence? Is that done and, if not, what should
happen about that?
Mr Moulton: The reality is that
in the early days of the growth of structured products probably
due diligence was quite well done, integrity was high in the market,
but integrity gets squeezed out as you move up the boom. By the
time you reached the end of the spring last year large numbers
of the people taking pieces of the debt in my market, in the buyout
world, were not even bothering to go to the data room to look
at the available information.
Q148 Ms Keeble: Could you give an
example of that so we know what it is?
Mr Moulton: Somebody at Goldman's
or CFSB might be syndicating a large loan. They might have 50
people going to participate in that loan. They would fill up either
an electronic or a physical, sometimes both, data room with lots
of information of variable quality. Half the participants in the
loan by the spring of last year would not have visited the data
room. That was the routine of what was going on. People had abandoned
due diligence. Quite often all they did rely on was a rating or
a so-called shadow rating and said, "It's a B something or
other and it is two point something over LIBOR, we will take it,
done."
Q149 Ms Keeble: Is there not an element
of culpability in that?
Mr Moulton: Yes, there is.
Q150 Ms Keeble: Why was it not dealt
with or should it have been dealt with? How should it have been
dealt with? Who should have done it?
Mr Moulton: It varies very much
by the segment you are dealing in as to what should have been
done or not done. There were boom times. You were rewarded for
taking as much as you could of the relevant product. That was
the way most people were rewarded. As a result of that they behaved
in the way that you would expect, they did stop checking. If you
went into the US sub-prime, income checking declined from virtually
100% to January last year when 56% of loans were done on what
amounted to self-certification to the call centre. That is what
happens in all booms because if you want to grab the asset you
are going to have to take poorer quality assets and do less due
diligence, it is the market forces. I can tell you now that on
deals being done in private equity the level of work being done
by the banks now is more than has been done for a decade.
Q151 Ms Keeble: You have also mentioned
that one of consequences of all of this is that interest rates,
which have been a very successful lever for managing the economy
here, particularly for innovation, does not work any more, which
really spreads the impact from this out to the wider economy into
everybody's pockets in a very catastrophic way. Would you say
whether you think the genie can be put back into the bottle there
or do you think that we then have to look at some other ways of
managing the wider economy?
Mr Moulton: You have probably
got to look at other ways. You cannot put it back in the bottle
as long as you have international capital markets and the diversity
of animals in those markets we now have. The base rate no longer
rules. It is a really difficult area because it has been a successful
tool for controlling the economy and it manifestly no longer works
very well.
Q152 Ms Keeble: Who do you think
should be looking at alternative tools and in what directions?
Mr Moulton: It should be the Bank
of England under the current structure.
Q153 Mr Brady: How big a problem
is it that the regulators struggle to recruit and retain the best
people because they cannot compete with the remuneration?
Mr Moulton: It must be quite serious.
When you move up to the serious end of complexity it is very complicated—structured
products interconnected between different entities sometimes literally
going round in a circle, that death spiral I showed you. The loan
from Vagrant Loan might have been owned by BIG, in which case
it really vanishes of its own in a rather unpleasant manner. I
think the regulators cannot reasonably hire the best people in
the marketplace because the best people in the marketplace will
not work in that kind of environment. They can hope to hire good
people and they can hope to train them well, but the very best
they cannot, which is why I think you have to limit what they
do so that they can reasonably be staffed to perform reliably.
Do not forget, one single contract of some of the natures we are
talking about here could bring an entire organisation over. You
would need to be a brave lad to spot it. I have some sympathy
with the regulator. I think the job is currently impossible no
matter how much money and people you throw at it.
Chairman: With your few clear thoughts
in this topsy-turvy world you have enhanced our lack of understanding
on this issue. It is a hugely important topic. We are going to
come back to this. The points you made this morning we are not
going to forget. We are going to be on this subject until the
autumn and we will have various people in front of us. As an efficient
market participant we take what you have to say very seriously
this morning. Thank you for the time you have put into your presentation.
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