At the height of the financial meltdown, Paul Moore rose to prominence when he was dubbed the “HBOS Whistleblower“. As head of Group Regulatory Risk at that bank, in 2005 Paul warned the board of the dangers of its sales culture – and he was sacked. Half a decade on from the subsequent financial collapse – and the regulatory counter-reaction – does Paul think banks are now safe places to put our money, whether as savers or investors? And what’s the story behind Assetz Capital, the peer-to-peer lender where he’s now the non-executive chairman?

The following is an unedited transcript of this Fool podcast:

Owain:

Hello, and welcome to Money Talk, the investing podcast from The Motley Fool.  I’m Owain Bennallack, and my guest today is Paul Moore, the non-executive chairman of Assetz Capital. Paul shot to fame in 2009 as the HBOS whistleblower.  As head of Group Regulatory Risk at that bank, in 2005 he warned the board of the danger of its sales culture, and was promptly sacked.  We all know now that the kind of risk-taking Paul was warning about was endemic in banking at the time, and we know what happened next.  Paul, welcome to Money Talk.

Paul:

Hi there.

Owain:

Paul, you’re one of the few people who can legitimately claim to truly have foreseen at least some of the problems with the culture of big banking that ultimately led to the financial crisis, that every year more people claim they saw coming.  It reminds me a bit of those bands, famous bands that everyone seems to have been at their first gig.

Paul:

Yes.

Owain:

You must get everyone, when you go to a cocktail party or whatnot, these cocktail parties that people attend in interview land, where they always accuse other people of going to cocktail parties; when you go to a cocktail party, you must have people coming up to you all the time, who say, I saw that coming as well, Paul.

Paul:

Well yeah.  I’m not entirely sure I totally agree with you.  I do think actually a lot of people knew it was coming, but I think very very few people, and that’s where the difference is, were courageous enough to say so.  The system did not allow people to speak up. Even ordinary people you spoke to in the street knew things were kind of a bit too good to be true, don’t you think so?

Owain:

Well, I think, in contrast, I agree that there was a certain kind of culture where people in general thought there was too much debt around and whatnot, but I think people maybe were doing some shonky maths, that people routinely don’t count assets, for example, so they’ll say, Britain or the US is a couple of trillion in debt, but they don’t count the seven trillion in assets.  I think people have those innate qualms about big finance, but I do remember that bankers were granted these incredible powers of foresight and credibility by the highest levels of government.

Paul:

Well, the government weren’t overseeing them, and the regulators were being told, particularly in this country, to lay off, and the accountants don’t do proper auditing, and the control functions reported to the executive, and the non-executives were all members of the same club as each other, so nobody, or hardly anybody, was actually checking out what they were doing.  You didn’t need to do much analysis.

Owain:

I think where I’m slightly disagreeing with your view, that people saw it coming, was that I think that that culture that you’ve described, with that system of non-checks and balances, kind of came about because there was an underlying assumption, perhaps you could go right back to the end of the Cold War, that capitalism had won, the free market had won, and the best thing you could do was leave them to get on with making money.

Paul:

Well, in my view, the banking crisis is just another example of humanity operating as it does.  We all know expressions like the emperor’s new clothes, pride comes before a fall, lemmings and pied pipers, and that is what the banking crisis was an example of.  It was terribly simple, if you did a forensic investigation, and you asked people what was going on, to know that people cared much more about selling and building the balance sheet than they ever cared about the checks and balances, or the control systems.  So it was coming, and it’s just another example of human history.

Owain:

I actually completely agree with you on that.  Our only disagreement is, how many people foresaw the crisis, but that’s because I don’t like people claiming credit for things.

Paul:

The thing about hubris, this word that means kind of blind, excessive pride, is that we’ve written about it for centuries and centuries, and the trouble was (and I said this quite clearly in my evidence to the Treasury Select Committee) that there was inadequate ability, inadequate separation of balance of power in the boardroom.  Of course the chief executive thought he was perfect.  Of course all the traders thought they were perfect.  But actually, it didn’t take much of an analysis at all to work out that what was being done was highly risky.

Owain:

So we’ve sort of seen a glimpse there of how banking conducted itself before the financial crisis.  Do you think the financial landscape in general in 2013, just generally, how would you say the years prior to the financial crisis were different from today, then? – because it sounds a little like you and I disagree a bit, in that I think that there was this position of widespread complacency, whereas you say perhaps the ordinary man of the street knew something was up.

Paul:

Well, I fundamentally think it was about the ability of people to speak truth to power.  In other words, the people who did the control functions with the risk, the compliance, the internal audit, were they able to speak up? – and they weren’t able to speak up for a whole range of reasons.  But have things changed, has the landscape changed? – the answer is, yes – of course it’s changed in one way, but in many other ways, it hasn’t changed.  The fundamental drive of capitalism, the fundamental duties of directors, are to drive profit.  Now, at the moment they’re being watched very, very carefully, and very, very closely.  As time progresses, unless we get the oversight and the checks and balances, and the separation of power and the cultures right, we’ll have exactly the same thing happen again. It always has.

Owain:

So we saw what did happen last time – the meltdown ultimately caused a widespread economic slump, and many industries were hit for six.  But as we perhaps push through the end of this kind of on-off recessionary period, what do you think were the lasting consequences of the crisis for ordinary savers and borrowers? – because the Austrian school view that you’ve explained there, where you think boom and bust sounds like it’s going to be endemic unless we clamp down on it, would suggest that nothing much has really changed. We’ll have to get ready, put a note in our diary for 2030, and the next crisis coming around.

Paul:

The biggest problem for ordinary investors, as I see it, is trying to find somewhere where they can get a sensible yield out of what they’re investing in. You look at the problems that people who were investing for pensions have in terms of obtaining a rate of return, when you have had to pump, do so much quantitative easing, that the interest rates are terribly low, and the bond rates, and there’s been a race from bonds into equities.  So you’ve got a slightly, some people would say that that kind of manipulates the markets.  Now, I would do exactly the same thing, that when something like that happens, I would invest in equities.  Actually, I do invest my entire SIPP in equities.  I think the landscape is, where do you get a proper yield?  I don’t think we are completely through this whole affair yet.  There’s been a huge amount of rush from the euro to apparently safer currencies like the pound.  Property prices in London are an example of that.  I think it’s very, very difficult for ordinary investors to work things out.  We were sort of talking about this earlier – I worry about accounting a lot, and the way accounting and auditing actually provides investors with a proper and sensible view of what a company is actually worth, and what its performance is, and has been.  At the moment, I don’t think ordinary investors can get to the bottom of that.

Owain:

OK, well perhaps we’ll get onto that, because that is an interesting point.  You’ve already made one interesting point in there, which is this chase for yield, and it is an irony, isn’t it, that we have a financial crisis which is fundamentally driven by excessive risk-taking, and even if it was the best response, we could have a whole other podcast where we debate whether that’s true or not, ultimately the response has been to encourage people to enter assets that are more risky, thereby bringing down the interest rates on ordinary cash, government bonds.

Paul:

Yeah, it’s a long question, isn’t it?  Are asset-backed investments less or more risky than non-asset-backed investments?  The answer is, I think in the long run, they’re probably not, so long as you have a good balance in your portfolio. Obviously, if you’re a stock picker, then you recognise that you’ve got a concentration risk in relation to the stock that you pick, but if you do asset allocation properly, obviously to me asset-backed investments, over the longer term, properly selected, are going to be better than non-asset-backed investments.

Owain:

We’d completely agree at the Motley Fool, and the historical data tells the same.  But still, I think there is an element of irony, that people who would have been happily sitting in cash a few years ago have bought corporate bonds.  Some of the people who would have bought corporate bonds have maybe bought dividend-paying shares. In general, people are exposing themselves to more volatile and more day-to-day risky investments.

Paul:

That’s true. 

Owain:

As a response to a crisis of this token.

Paul:

And I know we’ll talk about peer-to-peer lending later, but that is a route to yield. I’ve been the keynote speaker at the Institutional Investors’ Institute for the UK and Ireland, and the reality is that all they talked about, when managing, I think it was, a trillion-and-a-half pounds’ worth of assets, is where are they going to find yield?  It’s a very big problem. We’re in interesting times, and I just don’t know where we are, to be honest.

Owain:

Well, let’s think about where we are with regulation.  We’ve heard a lot from politicians, from other people in authority, some of the central bankers and whatnot. Even the bankers themselves have been coming out and saying, the industry has been reformed, and we now risk over-regulation of the banking sector, potentially bankers even being criminalised for just innocently going about the daily business of banking.  Do you think the changes to oversight here in the UK, Paul – greater capital requirements, the various other legislative changes – do you think they’ve gone far enough?

Paul:

I’ve got lots to say about this, but you can calculate capital until the cows come home, but it never saves a bank, or any other institution, from a conduct of business failure caused by a dysfunctional and greedy and unethical culture.  So all this nonsense of sitting in a room, a smoke-filled room, working out whether it should be 6%, 8% …

Owain:

It wouldn’t be smoke-filled any more, Paul.

Paul:

Exactly, but it doesn’t work.  Capital is not the answer to this question.  It’s much more about culture.  Now, there were easily adequate powers in the previous regulatory regime to deal with this crisis.  By the way, you could have added up the wholesale funding of these banks on the back of a fag packet, if you were a regulator, in about ten minutes, and you only needed to do the simplest stress test on that to say, well, what would happen if there was a drying up of the wholesale markets?  We’d have wholesale insolvencies, which effectively is what happened.  Yes, there have been some changes.  There’s been a lot of noise, and there have been some good changes in the regulatory environment.  In particular, the Parliamentary Commission on Banking Standards’ recommendations, in my view, are really game-changing.

Owain:

What would you say is the key change there?

Paul:

Well, I think there’s a number of key changes.  The first is, and you’d expect me to say this, is that control functions, ie, those who advise on risk, compliance and internal audit, effectively will no longer report to the executive.  That means that they are freed up to speak up.  The other thing is, they cannot be dismissed now without a full meeting of the non-executive directors.  These are recommendations I made throughout.  If I at HBOS had been reporting to the non-executive, I would not have been fired.  In fact, I have written evidence saying what a brilliant job I was doing, but because the executive had too much power, we didn’t have a balance of power in the boardroom.  This is something that investors should really care about, and it doesn’t just apply to banks – it applies to any organisation.  Effectively, when Adam Smith wrote “Wealth of Nations”, and when people invented the separation of limited liability, nobody believed that companies would have balance sheets the size of sovereign governments, and more power than most of them.  So they didn’t think about a governance system that truly created a separation and balance of power between the executive on the one hand, and all the constituents supposed to be keeping them under control.  The Parliamentary Commission on Banking has a done a lot of that.  It has also made the chairman himself personally accountable for any detriment to people who speak up, in other words, what they call whistleblowers.  I don’t like that expression, but that’s what they call them. So some things have been done, but the fundamental state of the system is the same.  The monetary system is the same; the drive for short-term profit is the same, and so we’ve done some things, but we haven’t done everything we need to do.

Owain:

I feel that we could take this podcast in several directions, and be here for hours.  I think that’s a very interesting point about the wholesale funding requirements. Sometimes I feel that the most cautious of the critics of the banks effectively are asking for a new capitalist financing system.  You were always going to get a situation where a bank that’s lending money can face a run on its assets.  You’re always going to face systemic events, almost whatever your regulatory framework is.

Paul:

Well, unless you change to a monetary system which is full reserve banking, and I don’t know if you or your readers know anything about this, but I strongly recommend they start to inform themselves about it.

Owain:

But isn’t the argument there that that would then constrain the creation of capital, it would choke business?

Paul:

Not at all, because the total percentage of outstanding credit in the marketplace, of the total amount, only somewhere between 11 and 13% is directed toward the productive economy, through banks.  The rest of it is residential and commercial mortgages, and financial intermediation.  So we don’t actually have a banking system that actually drives productive growth.  Yes, of course, banks do lend to large companies, but they don’t lend to SMEs. So the system is, at its heart, not working properly.  If you are encouraged to lend to the property market, which we’ve just seen with the latest political intervention in the property market, you are bound to create a bubble. When you create bubbles, bubbles always ultimately deflate, or burst.

Owain:

Yeah, I couldn’t agree more, Paul. I think we can book you in for a podcast in 2017, because this whole help-to-buy thing is insanity.  But let’s leave that to one side, and let’s turn to the banks again, and whether they individually, and we’ll talk about one or two of the specific ones in a moment, but whether their part in the system, we’ve seen perhaps politicians have wised up, regulators have got more tough – have the banks done enough to change their spots?  We’ve heard about all sorts of scandals, rogue trading, LIBOR fixing, PPI-mis-selling scandal, but potentially those were in the past. We’ve seen big director changes at the top of Lloyds, Barclays, and the other big banks. Does that speak of a cultural shift that’s going to roll through the banking sector?

Paul:

I don’t want to be discourteous to Sir David Walker, the Chairman of Barclays, and I don’t want to be discourteous to Hector Sants, the new global Head of Compliance, but in reality they are from the past, with the past way of thinking.  Do I think that has changed the culture or approach of Barclays? – no, I don’t.  You may or may not recall, but I offered myself to be the interim chairman of Barclays after the LIBOR scandal. I don’t think the leadership has changed fundamentally from what it was.  I think the paradigms are the same.  I’ve always thought of HSBC as a different sort of bank, because they have a different sort of culture.  I’m not in any way saying that what they did with the money-laundering in Mexico was a good idea, but nevertheless I think they’re slightly different. I have heard on the grapevine that there’s a big effort at Royal Bank of Scotland to change the culture.   Whether it comes to anything, when fundamentally the directors’ fiduciary duty is to drive short-term profit of the same, I doubt.  At the moment, they’re under the very close scrutiny of everybody, but as time goes on, will we go back?  I started in this business in 1984, and year after year after year, because the primary measuring stick was profit, and by the way, who measures it? – the accountants, which is another thing we ought to talk about; ultimately, profit came before sensibleness.  Short-term profit came before sensibleness.  By the way, I believe that you can do and be good, and generate a very substantial amount of profit, so I’m not a socialist at all; I’m against socialism, but I don’t think we’ve got the balance right in capitalism yet.

Owain:

What about one bank that you didn’t mention there, which was, of course, the bank that picked up those basically ruinous assets, in some cases, from HBOS, which was Lloyds.  We’ve had a guy come over from Spain to run Lloyds.

Paul:

Is he Portuguese?

Owain:

He’s from Santander, but he has not brought a different culture, do you think?

Paul:

I have personal experience of dealing in relation to some matters with senior people at Lloyds, and I have direct personal evidence that they have not changed the way they think.  There’s a lot of fancy words, but when you try to connect the fancy words to the actions on the ground, and I can’t disclose exactly my evidence, but I can indeed prove it, I don’t believe there has been a change.  I don’t believe there’s been a fundamental change and focus on customers, and focus on prudence.  Banks, retail banks and corporate banks, should essentially be prudent places which generate a reasonable rate of return, but not a huge rate of return.  I think there’s still a view in the investing community that banks should be able to return to half or two-thirds of where they were before – no.  That’s why I personally wouldn’t directly invest in banks, because I don’t think their rates of return … yes, they should be in a portfolio, at the right level, at the right price and at the right return.  The other thing I want to say is this: proprietary trading, which is where so much of the money is made, isn’t banking business, and actually it’s a manipulation of the market by a dominant position in information, mathematics and computer science, which has a victim, and the victims are your readers.  Ordinary investors that are trying to find the right assets are having their marketplace manipulated by the proprietary trading.  What’s it got to do with banking? – nothing. 

Owain:

You can certainly raise questions about some of the investment banks that have reported long strings of weeks and weeks without a down day, and wonder where they’re getting their kind of edge, and argue that they’re seeing one side of the book, and trading on the other side. 

Paul:

Go and sit with a day trader who invests their capital with their information streams, their limited information streams, and they will show you exactly where the big boys are manipulating the marketplace on any given day.

Owain:

So, I take it then from what you’ve said, that none of the UK-listed banks pass the Paul Moore sniff test at the moment for a potential investment, not even HSBC?

Paul:

Well, let me be clear and straightforward about this.  I invest my entire self-invested personal pension plan through a fund manager, because I haven’t got time to do it myself, and they will have banks in their portfolio, I’m absolutely sure of that (I haven’t checked that).  But I personally wouldn’t invest directly in a bank, because I think these banks have got a lot more to go through, and let me say this: as disintermediation, such as peer-to-peer lending, and equity-based crowd funding, gets more and more of a hold on the marketplace, then it makes no sense to invest in a bank, because over time those banks will ultimately lose market share.  I was talking to a very senior executive in risk management in one of the world’s largest banks, and he told me they are having real trouble finding ways to make money. Guess where they used to make their money? – creditor insurance, the mis-sell of PPI, creditor is PPI.  When I arrived at HBOS, they were making 12% of groupwide profits from creditor.  Lloyds was even larger. So how are they going to get a way, particularly retail distribution review and all the rest of it, they were making their money more from their insurance and investment businesses than they were ever making from the banking business, and they were often selling loans that had no decent credit quality, simply because they could then sell a PPI along with it.

Owain:

Well, you could also argue that they’re about to lose their greatest asset, which is their installed base of savers, because is it next month that these new rules come in? – where you’ve got to be allowed to transfer a bank within five days, and all standing orders have to move over.  So effectively, they’re not going to be able to just keep their customers, like the kind of sheep to be farmed.

Paul:

That’s absolutely right, so I’m cautious of banks.  I’m not against banking.  I don’t like the fact that it’s the banks that control our money supply.  97% of the money in circulation in this country is created by banks when they issue credit.  They don’t have to have money there to lend.  People don’t seem to realise that.  That means that 80 to 85% of our money supply is controlled by about 25 executive directors, and guess where they lend it? – not to the productive economy; elsewhere. So we haven’t got this system right; proprietary trading’s wrong.  Accounting is very wrong, and auditing doesn’t work properly, and needs to be completely overhauled, so I’m very cautious about banks; yes, as a utility, making a reasonable rate of return, a good dividend.  I like the fact that Lloyds have said they’re going to pay quite a lot of their dividends out.

Owain:

OK, well you’ve mentioned peer-to-peer lending, and of course Assetz Capital, that’s the business model of Assetz.  So some people have touted that as, if not the future of banking, then a piece of the future.  Is that why you decided to join it?

Paul:

I am a huge believer in this business of connecting people directly to what it is that they’re buying, without having necessarily to have an institution in between them.  So the basic idea of it makes sense, but what really drove me was that I had been writing and writing to the Treasury Select Committee and other places, trying to get proper policy reform in relation to banking.  I felt that actually, this was a way of replacing positively disgusting finance with what I call positively disruptive finance.  So I love the idea of taking on the banks at their own game, and I think it creates a fairer deal for borrowers. In fact, many of the borrowers that Assetz lend to, SME, small and medium-sized enterprises, wouldn’t be able to get those loans from anybody, even though they’re quite low-risk loans, a better rate of return for the lender.

Owain:

We should quickly outline here how it works.  What actually is the offering?

Paul:

Assetz Capital lends to small and medium-sized enterprises, and to property developers and constructors.  We source the loans.  We underwrite the loans with a highly-experienced team of credit risk management professionals. We then put a full detailed amount of information relating to those loans on our website.  We create security over every single loan, which is different to other players in this marketplace, so you always have security, and then we market them to lenders, and lenders come into the website, the technology platform, and they buy, or take on, a part or all of a loan, but mainly a part of a loan.

Owain:

And the security is the asset, I take it?

Paul:

Yes.  All the loans in our book will be secured primarily by assets, and not personal guarantees.

Owain:

And is Assetz mainly targeting large investors, sort of sophisticated, high net worth individuals?  Or do you think your business has a role for savers of more modest means?

Paul:

We had a loan, this happened to be a buy-to-let mortgage, 55% loan-to-value ratio, 6% return.  I’d recommend my mother, who’s 87, to take on that, because she couldn’t even get an annuity hardly at that rate at that age.  So what we’ve got is a lot of good-quality credit out there that the banks ignore, where there’s plenty of security.  So I believe that, at the moment, what we’ve got in the marketplace is pioneers – people like yourself, or other people who are looking and more sophisticated, but I’m absolutely convinced that, over time, this will become a perfectly sensible place for ordinary investors to invest, so long as there’s proper protection of the money flow, so there can’t be a Ponzi scheme – an operator can’t act like a Ponzi scheme; and secondly, that there is complete disclosure of everything relating to the loan.  In fact, it’s a lot easier to see the security and the risk in relation to our loans than it often is in relation to a share in a company.

Owain:

But wouldn’t some people, Paul, say that whereas the risks of traditional banking were hidden or ignored by investors and regulators, the risks of peer-to-peer lending are just hiding in plain sight. That’s the question of where the average person, with the best will in the world, can assess even the most transparent information.  Even the most simple case like the buy-to-let loan you’ve outlined, is the genuinely average person in the street, 50% of whom will have got a less-than-average grade at maths, I guess you could argue, according to the bell curve, are they going to be able to go up to your service, and really assess those risks?

Paul:

It’s a very, very important question, but it’s an important question in relation to the entire financial market. The lack of understanding of ordinary people, about what basic financial instruments are and what they can do, has been one of the reasons why there’s been such massive mis-selling.  This is a challenge for all of us, but it’s not terribly complicated for me to explain to my mother what a first legal charge on a buy-to-let mortgage is, and it’s not very difficult for me to explain to somebody that, if we’ve got a first legal charge over all of the creditors of a company, and we’re only borrowing 50% of that, and the previous history of credit default has been good, that that is a very low-risk loan.  So I believe it is perfectly possible to run this business in a way that does not lead to a scandal of mis-selling to people, and this is why regulation becomes terribly important of this industry, and it will be regulated by next year.  Protection over client money, and proper disclosure, and proper credit risk management – we are going to do the best credit risk management.  I’m not suggesting the other firms that are operating in this market aren’t doing or trying hard to do that, but we have got people who will give us a lead on that.  We’ve also got to find a way of agreeing how you make a simple assessment of low-risk, medium-risk, high-risk, a bit like share funds do.

Owain:

Yeah, I think mis-selling is a very good word, because one of the things that people do have to learn, as you’ve mentioned, and part of this financial education that we’d love to see more people get, is that some things will go wrong. Some of your loans will go wrong, but the important thing is that people weren’t mis-sold them, that they understood what was happening.

Paul:

Yeah, I mean, if you wouldn’t mind me saying, you might be more likely to take a risk by taking advice from a bank advisor than you might of actually having a look at the simple information that we put onto the website in relation to a loan. It might be easier for you to understand it.

Owain:

So where do you think, just to include, we’re headed with financial services and their relationship with banks, and other financial firms?  I personally think that we kind of get the financial services that we deserve.

Paul:

Hear, hear!

Owain:

As long as we’re not interested, as long as even the Prime Minister will say, no more boom and bust, encouraging complacency, things will never change.

Paul:

Well, I liken peer-to-peer lending to the eBay or the Amazoning of the retail market, and actually, if you think about it, peer-to-peer lending is probably what happened before banks ever existed.  So I think it’s just taking us back to where we need to be, and I think disintermediating, in other words, taking out of the scenario of the institution of the bank, creates much greater transparency, and therefore in many ways lower risk.

Owain:

I think that’s a brilliant place to end it, so thanks very much for coming in today, Paul, and best of luck with all that.

Paul:

Thanks a lot, Owain.

Owain:

Oh, and we’ll see you in 2017, after the housing crash.

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