MR JON MOULTON

13 MAY 2008

  Q125 Chairman: Mr Moulton, good morning and welcome to this session on financial stability and transparency. Your invitation to come here resulted from our report which highlighted the complexity of financial products and posed the question of whether those providing the products and those buying them understand what they are selling and what they are buying. There was a huge question mark over that. We are delighted that you have come along to give us this presentation to explore that further. We will have a few questions on the back of your presentation. Could you identify yourself for the shorthand-writer and then it will be over to you.

Mr Moulton: Jon Moulton, Managing Partner at Alchemy. Thank you for the opportunity to speak to you. You asked for a presentation[1] and I found it quite difficult to do. The document that this Committee has produced is actually a pretty damn good summary of everything that is out there. I am conscious that I do not really want to repeat things you already know. I have allowed myself a few thoughts to take you through it. There is an ongoing post-mortem into what has happened in the financial world and everybody pretty well knows it. In summary, we had strong economies and people arrived with this new wall of highly structured products that had not been seen before. They provided very, very large quantities of very cheap debt. The only way you can make any money out of cheap debt is to buy assets with it that yield more than the debt. People got very rich finding the assets that would provide enough return and that was sub-prime mortgages, that was leveraged loans in the buyout industry, it was credit card debt, it was consumer debt, it was every kind of debt you can imagine, but, of course, there is a problem; eventually supply runs out and when the good assets ran out people started to buy worse assets. So instead of going at three times salary and 70% loan to value, it was four times salary and 90% loan to value and then that did not work because there was not enough value or enough income, so you stopped checking income, you stopped checking valuations and you stopped worrying about the legals. So integrity went out of the market to try and maintain the flow of assets. At the same time, everybody got more and more complicated scrabbling for the last pennies of return in the business. That was the boom. But, of course, if you buy rubbish eventually the rubbish cannot pay the interest and whether it is US sub-prime or whether it is a company that is overloaded, eventually they cannot pay the interest and things went bust. That is actually the core of everything that has been going on. There are a lot of things around it. This slide is possibly a little odd to you but it might illustrate what happened. This is a Google earth picture. You might wonder what a Google earth picture had to do with financial stability. This was actually the method used by some of the sub-prime valuers to value houses. They would pick off one of these houses on here, take its Zip Code and then arrive at a value. There is, however, one technical issue which you must give them time for. These pictures were taken at about four in the afternoon. The reason for that is that they could tell from the shadow how many storeys the houses had. That is how silly it all got. That is when the integrity went out of the market. That is valuation. Then you have all the supporting players. You have seen these people, you have interviewed them and in some cases ascertained what it is they have been doing wrong and how they have contributed. There are the rating agencies with this bizarre attitude of, "You don't have to rely on our ratings. They really don't matter. People shouldn't use them to lend money." It is an extraordinary position and one which obviously has its defects because they were central to the whole game. Without the ratings very little of this structured product was even possible. They are a big cause and they are quite difficult to deal with. Then you had the banks. The banks made quite a bit out of this, their profits went up, but actually when the music stopped they were holding so much unsaleable rubbish that they lost an enormous multiple of the profits they had made. We have seen massive erosion of the capital bases of the banks driven by this huge difference between the profits they made and the credit they lost. In the case of Citibank it is something like a factor of ten to one. Then you should look at the bankers. The individual bankers made a lot but they lost little, with big bonuses, huge salaries and big equity packages. This was an extraordinary period of happiness for senior bankers around the world. Then we had the regulators and, as you have found, they were not equipped to deal with the structures that were in front of them and certainly in the UK their organisation was less than perfect. There is still quite substantial disagreement as to what would represent a good organisation. Let me start putting some simple ideas together. What is financial stability? We need to have trustworthy banks. It would be a huge benefit to the UK if the rest of the world believed that our banks were better than others. At bare minimum we would like them to be as trustworthy as others. It would be a lot better if they were better. The same applies to insurance companies: they really do matter to financial stability. The same is true for asset management and pensions. These are the things that are central. If these work we have financial stability, mostly. We are less concerned about the people that play elsewhere in the jungle. If people want to bet and hazard and try and be very clever in all kinds of exotic things then that is fine, it is good, it is innovative, it makes things liquid, but do we really need them? If the hedge funds were to vanish tomorrow I do not think the UK's financial stability would be that much affected. You could certainly take the view that they do not need control and regulation in the way the other things do. The Governor made this point gently to you but it is an observable fact: bonuses and payments for failing bankers have been at all time peaks. It is quite remarkable how few bankers have left after losing their institutions billions of dollars. It is no coincidence this, it is the real world: people who are given very large incentives to do things will do them; they will do all kinds of things. All that does is it means that the bloke is interested in the current quarter's earnings. He will hazard his institution's money because it is in his interest to do it short term. It is the transaction that matters and not the quality of the investment. The method of payment is absolutely wrong from the viewpoint of ending up with the right economic answer over time. I believe that this ought to be something the regulators should take a lot of interest in because a bank that pays its people 1,000% bonuses on short-term profits is massively more risky than one that pays people out on the basis of five-year performance or of share price performance over a medium term; they generate completely different behavioural patterns. I cannot find much evidence that the regulators take any notice of remuneration schemes when they are assessing the risk of organisations and this is probably the mechanism which actually would drive bonuses and payments for failure back into line, making them a risk factor. If people had to hold more capital because they have got a risky remuneration system it would not be long before they changed their remuneration systems. Let me look at bank capital. Basel 2 is hideously complicated and it is the result of a lot of compromises. It drives in the wrong way; it drives off history and predicts the future. As you get a declining level of failure and default the Basel 2 mechanism drives the capital of the banks down. As things get better the bank needs less capital. It is not a very sensible direction to head in because when things do eventually flip they are left with the least possible amount of capital. That is just the general problem. The more basic point is it is too complicated. It is based on piles of models, all of which have got spurious accuracy attached to them. Many of them have no underlying basis. The complexity of Basel II is a big problem. Northern Rock was fine under Basel II. In the middle of last year they said, "We can increase our dividend and do a share buy back." Basel II does not work properly, it is not perfect and, despite its almost mystical air, it needs working to make it a lot easier. I cannot understand why the banks are still paying dividends. Many of them are increasing their dividends after announcing diabolical results. The banks clearly need more capital yet somehow they are being allowed, either by the markets or by the regulators, to increase their dividends at the same time. I do not understand that. I think it would be a very good idea to put a simple floor under the bank capital rather than spending some years trying to come up with a Basel III, which I think the Governor was of the opinion would be beyond his lifetime. If we were to say that banks had to have 6% shareholders' funds or some similar statement we would actually give a great deal of confidence to the banking world by putting a floor under it. So you would have to have the greater of the basic floor or the Basel II calculation, that kind of thing. The base rate—another fairly random point but it is a very, very obvious point—is no longer controlling our economy. The bank rate, the LIBOR rate is today 5.8% for 12 months and the base rate is 5%, but gilts for 12 months are 4.3% or so as of this morning. Base rate does not really work very well any more and that has been obvious over recent months. The base rate moves, mortgages do not move, LIBOR does not move. Something needs to be done here and I am certainly not qualified to say what. The principal economic tool that has been used to run the economy is no longer very effective and that is very important towards financial stability. Let me give you some of the things to go wrong that are to come and add a bit of thunder and lightning to give it a background! A lot more can still happen. Things have become terribly interconnected. This is just an example of one horribly complicated game. Let us say you would like to set up a nice new sub-prime CLO or CDO, some horrible little vehicle that is going to lend to very poor credit in poor housing areas in some country or other. Let us call it "Vagrant Loan" just to give the right flavour of the nature of the business. What is the easiest way to get your AAA rating? Of course, you want to get AAA rating on your debt. It was very easy in those days. You would get a bullet proof AAA insurer, a monoline insurer to insure your debt and you are immediately AAA. This became quite routine. This could be done in a matter of a few weeks last year. The CLO could be rapidly raised. This is what you ended up with: a monoline insurer, AAA guarantees the debt of Vagrant Loan. Vagrant Loan itself might be quite a ropey credit but it does not matter because anybody who is buying one of the bonds of Vagrant Loan is relying on the insurance, not on Vagrant Loan. The insurance companies, the pension funds and the rest buy the debt off Vagrant Loan in the belief it is AAA. If this was Northern Rock debt it would have been sold last summer at six one-hundredths of a per cent over Euribor; that was the return for the risk in the deal. Why is Monoline AAA? It sounds like a very simple question. It has got a very simple answer. Because a rating agency says it is, it is a simple as that. Then the problem comes up, how can a monoline insurer underwrite one hundred times its own net worth? Some of them did. I am told that the worst Monoline did 232 times its own net worth. You do not have to have to be of a particularly doubting nature to worry about an insurance company that is covering more than 100 times its assets. What did we come up with? Pass the parcel! Let us introduce a large AAA rated insurance company and let us call it BIG to avoid lawsuits! It sells reinsurance, which is basically a credit default swap. A credit default swap is a piece of paper which says that if the borrower does not pay we will. The mechanics are a bit more complicated than that but that is all it amounts to. It says that if Vagrant Loan is getting into trouble and cannot pay we will pay instead of Vagrant Loan. So the monoline is now bulletproof because it has got a AAA guarantee of itself. Here is how you start to build the kinds of cycles and circles that make this world impossible to handle. You have got guarantees everywhere here. Just look at that for a second. BIG is basically guaranteeing the monoline. Vagrant Loan, which it has got a sort of dotted line relationship to on that credit default swap, is actually going to pay its debt. The insurance company at the bottom is relying on the monoline, which is relying on BIG. The rating agencies have conveniently labelled everything in this circle AAA with a couple of interesting exceptions. Vagrant Loan itself, which has never any kind of rating and, perhaps more importantly, the actual source of the asset here, which is the "shack owners" as I call them, the people with the sub-prime mortgages. Look at what happens when the people do not pay. The word "guarantee" becomes "liability". Liabilities are quite different to guarantees, they hurt. You have to take them through your profit and loss account and write your assets off. So as the mortgages start to go down the CDS, which was just a very large guarantee, becomes a liability and BIG starts to incur very big losses. Its net worth subsides and here is what happens, you lose a bit of rating. Now you have lost a bit of rating. In Monoline, which was an insurance company, it relied on the rating of BIG for itself. What happens next? The Monoline loses a better rating. Think about the people who are in the loans at the bottom. It is no use looking to the sub-prime people, Vagrant Loan has got nothing in it, and you are relying on the Monoline. So what happens to the loan? Those loans are all over America. Every insurance company and pension fund you can imagine will own them and they will just suddenly have suffered a loss in value of the loans because the rating has gone down, and it gets worse. Because the CDS now starts to trade at a terrible price because people realise Vagrant Loans are a real problem you have got more losses, BIG loses more and Monoline loses more. That is the kind of spiral that exists in the market now. These are everywhere. This is the CDS death spiral and there are huge numbers in this game. I am not really here to sell you the pain of this one. There are other problems in the CDS market. There are some remarkable pieces of arithmetic. AIG, which is the biggest writer of these things, has just announced its results. It has got a net worth of about $80 billion. It has got a CDS portfolio called "Super Senior", which is a very reassuring name until you discover that their definition of super senior is that there was no expected loss at inception, which I think means pretty well every asset I have ever possessed as I would not expect to have a loss at inception. Quite worryingly they talk about their super senior CDS portfolio of $475 billion, which makes me look with some fear for the other portfolio. They have written $21 billion off this risk-free portfolio so far, $9 billion of it in the last quarter. What do they do? They raise their dividend and they introduce an improved pay structure for the guys who are operating in the unit that has just lost the $21 billion. It is interesting times. Then they put out a note which says that the loss is more likely to be $2 billion and not $21 billion but they have had to put $21 billion and, by the way, there is another study which shows it should be $30 billion. These things are not easily dealt with. The next stuff you could not invent. This is the method they use to value their write-offs on CDSs. They use a model called the BET model. To reinforce the feeling of playing in a casino they use a Monte Carlo simulation to add to the refinement of the calculations. In reality none of us knows whether that write-off should be $2 billion, $20 billion or $40 billion. Part of the CDS portfolio—remember, AIG has a net worth of $80 billion—is $192 billion which is used to replace regulatory capital in banks. So a remarkable financial feat seems to have occurred here where $80 billion is guaranteeing $192 billion of bank capital. I do not know how that works. I cannot improve on giving you an idea of the fairyland we are in over just showing you the words out of AIG's own press release. This is about transparency and disclosure. I will read it aloud because it deserves it: "AIG present its operations in the way it believes will be most meaningful and useful, as well as most transparent, to the investing public and others who use AIG's financial information in evaluating the performance of AIG. That presentation includes the use of certain non-GAAP measures. In addition to the GAAP presentations, in some cases, revenues, net income, operating income and related rates of performance, and out of period adjustments are shown exclusive of realized capital gains (losses)"—so they are excluding either something they add or subtract, we are not really sure—"the effect of FIN 46(R)"—which I am sure I do not need to explain to this audience—"the effect of EITF 04-5, the effect of FAS 133, the effect of trading account losses"—profits before losses are always larger—"the effect of remediation activities, the effect of change in actuarial estimate, the effect of expenses of industry wide reviews and the effect of catastrophe-related losses." You would not like to think about things like hurricanes and earthquakes affecting the resource of an insurance company. All I am trying to do here is demonstrate to you the incredible complexity of what is going on here. You would not believe that this stuff is out there but it is out there, it is in the fine print and the mountains of paper that these industries produce. Here is what we have got, we have got an interconnected, mind-blowingly complicated market where losses are not just limited to actual economic losses, there are economic losses arising because of the amplifying effects of the inter-connectedness, the loss of confidence and fear. It is very hard indeed to estimate what a $5 billion loss in sub-prime really means to the financial markets. It might be $50 billion of losses, the complexity has no limit. However, there is no doubt that both the regulators' and directors' skills in these entities are limited. You have interviewed people who did not know what a CDO was and you have interviewed people who do not understand how this lot fits together at all. I do not think you are ever going to get to a situation where boards of directors and regulators can handle this level of complexity in an effective way. Transparency does not do it. If you look at an HSBC set of accounts, famously 400 and something pages last year and the Royal Mail would not carry it for health and safety reasons, they are unreadable. Northern Rock was a master of disclosure. Everything about Northern Rock is available on its website still. You can find all the details, their off-balance sheets, their guarantees, but how you are supposed to interpret a 400 page document on one of the guarantees, with 11 layers of debt, interest rate swops, currency swops done in three currencies, I do not know. Transparency will not do it. Disclosure does not get you to the answer because nobody understands it or follows it. People piled into the Northern Rock paper at tiny margins. Next we have some ways ahead and some simple ideas. I think if you want to have a UK bank that is worth having you have got to do something which is against pretty well every instinct I have and that means you have got to stop them doing things that are not capable of being regulated. Do not let them go into synthetic CLO squared. We have lost a lot of money in the UK on those and there is not one bank director in ten that could give you a coherent account of one. If you want to have confidence in banking you cannot allow them to play with plague like vehicles and some of these things are. I think that is a really big step but I think it is the right way to go. Limit the banks to that which is realistically capable of being regulated. That will give enormous confidence in the banks. Increasing the banks' capital as the economy recovers is absolutely something that has to happen. There is not enough capital there on any reasonable calculation. They should not be dissipating it in dividends, they should be hoarding it at the moment and building some real capital back up and reducing the risk by getting out of these ludicrous activities that they have lurched into and lost a lot of money at. A clearer capital setup is important. The language of Basel 2 about pillars, levels, layers and models is too complicated. Something much simpler is needed and it may be simple arbitrary percentage floors would be a marked improvement over the apparent sophistication of the current setup. Regulation did not work well in the UK. The multi-headed model simply did not work last year. Each of the heads has a different view on how it should be sorted out. Organisations all have different views. It seems to me very simple: it would be nice to have somebody clearly in charge, a single soul, somebody who could act across the lot. Why do we need three entities to do it? I do not know. I really cannot understand why we need three entities. It was pathetic that they did not work very well. It was bizarre to read the Governor's evidence to you that it was not helpful to have people on each other's boards, but that would be very straightforward. The FSA deserves a bit of applause for saying it got things wrong. There are things that can be done to sort it out. It is unrealistic to imagine that the FSA can ever handle the complexity of some of these models and markets; they will never do it. Then you have got to have a better bail-out system which is being rushed through at the moment and it needs a little bit of care in the process. If you try and rush through a comprehensive package it will fail. It might be better to live with just extending the emergency powers and doing it properly because they are not going to be needed very often, one hopes. You need to do something similar for insurers. I think that the risks in the insurance industry are something that have been discussed only a little yet, but there are some of the similar risks and some of the same instruments dotted around the insurance world. Finally, you have to allow failure for most non-banking organisations, to make it clear that you would allow that to happen. That is the end of my presentation. Thank you.

  Q126  Chairman: Thank you for that fascinating presentation. I remember the words of Josef Ackerman of Deutsche Bank when he said, "I no longer believe in the self-healing power of the market." Who is to do these things? Is it nasty politicians and regulators that have got to do something that interferes with a fantastically mobile free market? Are we up against our prejudices here?

  Mr Moulton: I think you have to have some level of regulation. I do not think there is a requirement for politicians to be nasty, but they do need to be firm and they need to work out what it is they are trying to achieve. I think the basic thing you are after is setting up a stable financial structure. Central to that is having banks that are trusted and trust each other. As of this morning, it is a 1.5% risk premium between taking a piece of paper from a bank for 12 months and a piece of paper linked to gilts. That is the level of distrust there still in the marketplace. People think banks can fail. You need to get the banks in order and that will not happen without some level of regulation. It never has anyway. Yes, you have got to intervene. I would urge you to intervene to the extent of making sure the banks are trustworthy and capable of being understood.

  Q127  Peter Viggers: Before we recover from where we are we have got to work out just how bad the situation is. Mr Moulton, you did not follow your chilling and very accurate analysis of the banking situation through to its natural conclusion by looking at the housing corporations in the United States and the implied guarantee by the United States Government of the housing umbrella structures. Perhaps you could tell us something about this. I think I am right in saying that there are national housing bodies which give implied guarantees and everyone assumes that the United States Government stands behind those. The chairman of one of the leading housing bodies, when asked about six months ago what would happen if housing prices fell by about 20%, said, "I don't even want to go there." I think we should go there. How bad could it get in terms of the United States' credibility?

  Mr Moulton: The very strong probability is that US housing prices will descend 20%. I think they will survive the experience. There will be further losses in mortgage banks in the United States. Mortgage vehicles will cease to operate, as they have been doing fairly steadily over the last few months. I do not think that the US Government is threatened by it. They will have to inject liquidity repeatedly into those guaranteeing organisations and those injections will be inflationary in nature, that is the risk they have to take, but that is what will happen. They cannot allow them to go bust. Fannie Mae and Sallie Mae cannot be allowed to cease functioning, so they will pump money into them somehow.

  Q128  Peter Viggers: And you did not go on to the even more chilling thought that the United States' credibility as a financial entity is threatened by this?

  Mr Moulton: It is threatened by it. It is threatened now. The dollar has had a terrible time recently. People are much less confident about it. It has been fished out by foreign money and by very energetic efforts in the capital markets. It is a very unstable world. There is as much likelihood of things getting worse as better in the credit markets over the months ahead.

  Q129  Mr Todd: How has it affected your business?

  Mr Moulton: I have two businesses with completely different activities in this. We have a distressed debt business which is quite enjoying the current days and a private equity business with a rather larger portfolio which is finding the effects on the businesses quite painful. There is no debt available for the larger buyouts anymore, so I think the activities that you were investigating a year ago have gone away for quite a while. I met a man from one of the larger funds on his way to the office this morning and he said, "Good morning. I don't know why I'm going to the office!" That gives you an idea of the state we are in. There is no large debt available and so it has stopped large buyouts. The further effects are the real ones that are starting to hurt us, retail, house building, construction materials, high end home purchases and anything that is a financial product to the consumer which is finding it very hard to be financed.

  Q130  Mr Todd: There were two forms of model for private equity: one was leveraged buyout in which you just made your return on the very low debt servicing you carried and the other was injecting proper management skills into a previously rather poorly run sideline business. Presumably the latter model is equally applicable now, is it, if not more so?

  Mr Moulton: You can either play financial games or you can play operational games. Most private equity firms have fundamentally played both over the years. At the moment there is no financial gain. The financial side of life is a problem. There is a lot more focus on the operations of the companies than there was. The resources have had to divert themselves to it.

  Q131  Mr Todd: Is this going to produce a shift in this sector with some fallout? There are certainly some businesses which have loaded themselves with debt which presumably is going to come back to haunt them in this exercise.

  Mr Moulton: For companies that got very heavily laden with debt, particularly over the 18 months to the middle of last year, there will be failures amongst them. I do not know how many failures and I do not know the scale of the failures. Some of those companies are laden with debt at levels that they cannot handle properly. There will be adverse effects on the business; that is happening. There are probably 20 or 30 substantial UK companies that would be in that category. Yes, there is more pain there. Going forward, it is probably quite healthy for private equity because it is going to force people to become managers if they were not so before. The people that are working in the firms are gradually changing towards managers and away from bankers.

  Q132  Mr Todd: The Government is currently giving some thought to the balance between debt and equity in taxation terms. Is that an area where more could be done? To some extent your previous answer indicates that it is not an issue which will trouble us greatly in the immediate future.

  Mr Moulton: In the current market the availability of abusive levels of debt is nil; the horse has gone.

  Q133  John Thurso: I am finding your analysis fascinating, not least because of its strong focus on the banks, which chimes very much with where my own thoughts were going and your way ahead of strong banks. Don Cruickshank, in his famous report ten years ago, I think made the point that banks in good times make excessive profits and in the bad times get protected by the State and the remedy is for them to be one animal or the other. In other words, they are either like a utility, regulated, not very high risk, not very high profit but absolutely trustworthy or we design a regulatory system which protects depositors but allows any and every bank to fail. Is that a reasonable analysis? Do you feel pulled in either direction?

  Mr Moulton: It is a reasonable analysis. The arguments between the various approaches are quite divided. I think it is really quite desirable that banks have a low probability of failure for any party that deals with them, not just depositors. There is a very clear and obvious danger in making banks guaranteed entities. I think shareholders should be able to lose money and I think people who provide subordinated capital to banks should be able to lose money as otherwise things will just work like the US S&Ls did in the bad days. You have got to end up with a balance where there is risk. It may be that the kind of situation you want is if a bank gets in trouble typically the government or some fund will bail out the depositors and then the banks should be put into a bankruptcy situation. That would be absolutely right in most circumstances and it would not lead to an erosion of confidence if it was something which happens every 20 years and it is handled properly and quickly.

  Q134  John Thurso: So your preferred approach, if possible, which I would share, is to ensure strong protection for the depositors, everybody knows where they are, but to say to the banks, and it does not matter how big they are, "If you play fast and lose and you cannot learn to say no then you will go under"?

  Mr Moulton: Fundamentally, if you make them government guaranteed entities the abuse of that guarantee would undoubtedly occur on a very large scale and you will end up with an absolutely monstrous bailout requirement at some point.

  Q135  John Thurso: You were talking about the impact on what the Governor called when he was in before us the real economy as opposed to the financial economy. I know that an instruction has been given to the head of RBS business managers in Scotland anyway that they are to get 1% more on every loan coming up for renewal irrespective of whether it is a loaded company. That means that a huge number of businesses which are either family owned or small businesses, which are a big engine of our economy, are all having 1% stuck on their financing costs to pay the bonuses of millions to the Board of RBS basically, which seems to me an incredibly shocking indictment of banking mores as they are at the moment.

  Mr Moulton: I think there is considerable merit in what you are saying.

  Q136  Chairman: The issue behind the Financial Services Compensation Scheme is tied to this, that is, we will let the banks go bust. I saw a story at the weekend that said it has got £4 billion at most. That will not cover it at all. We have got the BBA coming in this morning and they are going to say to us, "What you have recommended in your report, a pre-funded scheme, is going to destroy the banks. We do not want that." At the end of the day, if we do not do anything about that it will be all the taxpayers picking up the bill.

  Mr Moulton: Absolutely. I have noticed that the banks are welcoming the abolition of any risk sharing. If people have got 90% of their retail deposits covered that helps, just the fact that it is 90 and not 100. You cannot have a situation where the Government is an absolute guarantee of these things. People will abuse it, they always do. There will be a concern that there will be loss, but if you make depositors roughly the equivalent of football creditors in the bankruptcy of a football club, where they get out first, then you would probably solve the problem every time. I do not know if you are familiar with how it works, but in a football club basically the footballers get paid out of any money there is swilling around before anybody else gets paid. If you did the same with banks then that would, in one fell swoop, pretty much guarantee depositors had very little risk ever.

  Q137  Mr Mudie: I have a lot of sympathy for what you said about banks being trustworthy, capable and understood. It is like Alistair Darling saying he would like old fashioned banking back! I think the consensus is to protect depositors in some way. Let us say that is done and we are in the present situation and we say we are only worried about depositors and we will deal with that. The bank has just $50 billion. Would you have done that? I am not asking you to pass a judgment on that act. Would you not intervene and just sit back and let them reap the rewards of their own greed? Is that what you are suggesting?

  Mr Moulton: To a large extent the old moral hazard argument is such a strong one here. There has to be a degree of suffering by the banks.

  Q138  Mr Mudie: I listened to that argument with the Governor, but I do not see the banks suffering. I see it as the poor sods that are not getting their mortgage extended and the little business that is suddenly getting its money withdrawn suffering. The banks just seem to me to be able to sit it out, recoup slowly and keep paying themselves their salaries.

  Mr Moulton: It is remarkable how the distribution of the payment has been done. I am a good old fashioned capitalist. To see increases in pay, increases in dividends and a diminution of funds available for small businesses and mortgages is not a particularly graceful sight and that is how it has been worked out.

  Q139  Mr Mudie: I understand. Nobody in the room would defend the payment of dividends, the payment of bonuses or even some people keeping their jobs. In terms of a politician looking at the general economy and being responsible for the standards of living of people out there, do we not have to intervene to keep this thing intact?

  Mr Moulton: Yes, you do, there is no alternative, but some central regulation and control, whether it be the very old fashioned fatherly figures of the Bank of England 20 or 30 years ago with a tap on the shoulder and the "Really, you hadn't ought to be doing this" speech, which worked—