Money, Power and Wall Street, Part One (full documentary) | FRONTLINE

>> Tonight on FRONTLINE Episode One of a special
four-hour investigation. >> You created the mess we're in and now you're
saying sorry? >> Inside the financial crisis… >> Wall Street got bailed out and Main Street
didn't. >> How did we get here? >> Other banks were taking these ideas and
applying them in ways that they'd never expected. >> Once the seed was planted there wasn't
any stopping it. >> We never imagined they were just taking
the risk and it came right back like a boomerang it turned into a Frankenstein monster. >> Money, Power and Wall Street: Episode One. Tonight on FRONTLINE. >> Every day, tens of thousands of workers
make their way to Wall Street. They work for banks, brokerages, hedge funds,
insurance companies and mortgage lenders.

It is the largest single sector of the American
economy, an industry that is almost double the size of America's manufacturing sector,
a business with enormous power and global reach. It is the industry that led America and the
world into its worst economic crisis since the Great Depression. The banks say they exist to create wealth,
holding in trust our collective worth, promising to invest the trillions of dollars that stream
in from businesses, pension funds and savings accounts that belong to all of us. One morning in the fall of 2011, bankers arriving
in Lower Manhattan were caught by surprise. >> This is what democracy looks like! We got sold out, banks got bailed out! >> On the sidewalk! You must go on the sidewalk! >> The recession had destroyed $11 trillion
of Americans' net worth.

A recovery seemed far off. Occupy Wall Street wanted bankers held responsible. >> Most Americans think, and with good reason,
that Wall Street got bailed out and Main Street didn't. We have very high unemployment. We lost 8.5 million jobs in the recession. People's houses aren't worth what they paid
for them. A lot of them don't have jobs. Their kids are graduating from college and
are moving back in. >> This is what democracy looks like! >> It is pretty clear, actually, that there
was massive illegality going on. And if somebody with subpoena power was intent
on prosecuting that, I don't think there's really much doubt that they would be quite
successful in criminal prosecutions.

>> We are the 99 percent! We are the 99 percent! >> In a matter of weeks, Occupy demonstrations
spread to scores of cities across America and the world, calling for radical changes
in the banking system. Bankers responded by saying that the answer
is to move on and get back to business. >> Some of our companies made a series of
bad mistakes, and— and— and— and we all paid for them, including— and— and—
and it lead to the economic crisis. >> But what makes people upset is that — I
mean, what— you know, a lot of the people that are on the streets demonstrating, Occupy
Wall Street — is that the economy hasn't recovered but banks have.

>> If you want a strong economy, you have
to have financial services companies that are safe and sound and able to lend and able
to finance their— their customers. Now, if you want to have a recession, then
go ahead and— and— and hammer the banks, and you know, make sure that they're— that
they fail because then you'll have another recession.

>> Do you understand why they're angry? Do you have any comment? Mr. Blankfein, can we ask you a question,
sir? Can you give the American people an accounting
of how you spent their money? And do you understand why it is they're are
angry at bankers? Do you have any regrets about the way you
spent the taxpayers' money? >> Since the meltdown of 2008, there have
been dozens of hearings. >> —and we regret that people have lost
money. And whatever we did, whatever the standards
of the time were, it didn't work out well. >> I would like to ask your opinion of the
role that over-the-counter derivatives played— >> Many questions have been asked— >> —in contributing to the financial crisis. >> —but there have been few satisfying

>> What goes on at Wall Street and exactly
what caused the crisis and how did we get where we are— it's difficult to understand
even for professionals. >> I'm not sure I understand that point. Maybe you could elaborate. >> Well, I think that it's— in many ways,
is very simple. I think our regulators and the industry have
to focus on complexity. >> But at the end of the day, people usually
have a pretty good ability to tell when something's wrong. >> Somehow, we just missed, you know, that
home prices don't go up forever.

>> What is a synthetic CDO? >> A CDO is a pool of assets— >> I think finance may have gotten too complicated
for anyone to understand— >> —that are pooled together and then can
be sliced. In a synthetic, you pool reference securities
that are indexed to specific more pools of mortgage. >> —and that the managers of these large
financial institutions in some ways have been given an impossible task, that they won't
be able to comprehend what it is their institutions are doing. And that is really, really scary. >> You created the mess we're in, and now
you're saying, "Sorry. Trust us." You created CDOs. You created credit default swaps that never
existed a few years ago. Who was the brilliant person who came and
said, "Let's do credit default swaps?" Find him! Fire him! >> It's hard to pinpoint the origins of America's
financial crisis, but one weekend at this resort in Boca Raton, Florida, is a good place
to start.

Assembled here in June 1994 were a group of
young bankers from JP Morgan. At the time, it all seemed innocent enough. >> Boca Raton was a gathering of people that
were part of the Global Derivative Group at JP Morgan, in part as a celebration, in part
as an opportunity to relax, but perhaps much more importantly, as an opportunity to get
creative, innovative people together in a room to discuss a whole variety of different

..And since they were young, mostly in their
20s, and since there was plenty of money floating around and they were full of high spirits,
they did what any young bunch of kids would do and they got drunk. They had parties. They threw each other in pools. You know, this is the normal stuff that happens
at conferences. >> Yes, I went into the pool fully clothed,
as did— as did my boss.

Some people drank, some people didn't. And I'm happy to say that, like, most people
stayed reasonably sober. >> They played hard. But they also worked hard. They were striving to address an age-old problem
in banking, how to reduce risk. The first journalist to tell the full story
was Gillian Tett. >> They began to look for ways to enable
financial institutions to pass risk between them. One way to do that was to sell loans. Another way, though, was to separate out the
risk of a loan going bad from the loan itself. And out of that came this drive to develop
credit default swaps.

>> Credit default swaps, a kind of derivative
that insures a loan against default. Traditionally, derivatives were a way to bet
on the future value of something. For hundreds of years, farmers have traded
derivatives to protect themselves against fluctuating crop prices. It is this type of derivative that has been
traded on the Commodities Exchange in Chicago, along with the futures of fuels, currencies
and precious metals. In Boca Raton, the JP Morgan team realized
that they could use credit derivatives to trade their loan risks. >> Bankers borrowed one set of ideas that
had been developed in the commodities market and applied it to loans for the first time. This idea was essentially created under the
banner of making the financial system safer. >> The first big credit default swap was engineered
by Blythe Masters and involved Exxon. >> Exxon was the client at the bank, and
we had credit exposure associated with that relationship. >> The Exxon Valdez spewed almost 11 million
gallons of oil into Prince William Sound. >> In the wake of the Exxon Valdez oil spill
and a rash of lawsuits, Exxon took out a multi-billion dollar letter of credit with JP Morgan.

>> A letter of credit creates credit risk. If Exxon were to fail on their obligations,
then JP Morgan would have to step in and make good on those obligations on their behalf. There was a large amount of exposure, and
there was a significant amount of risk associated with that. >> And that risk is a big drain on a bank. >> Every time a bank makes a loan, under banking
regulations, they're required to set aside certain reserves of capital for the loan. So JP Morgan, when they made the loan to Exxon,
would have had to set aside some capital. >> JP Morgan has to hold a certain capital
relative to the size of that loan in the event the loan is not paid off at 100 percent as
you expect.

Well, of course, if you don't have to do that
and you're a bank, you— you'd prefer not to do that. >> Because then you can finance more freely? You can take on more debt? >> Right. >> So Masters started looking at who could
take on their loan risk and free up JP Morgan's capital. She found a taker in London, the European
Bank for Reconstruction and Development, the EBRD.

>> EBRD would receive compensation from JP
Morgan for taking on or assuming credit risk, and felt that that was a good risk/reward
proposition. And so risk was essentially dispersed. And why did JP Morgan do that? Because we wanted to free up our capacity
to do more business. >> This was a major financial innovation. Credit derivatives made it possible for a
bank to skirt capital requirements. >> And that's what actually happened, is the
amount of capital that banks had to hold got less. And so banks became able to create more and
more credit.

They could make more loans. >> The Exxon deal was just the beginning,
demonstrating that risk could be off-loaded and capital freed up. JP Morgan had struck gold. In 1998, they decided to ramp up their credit
derivatives operation. That year, another young banker joined the
team, Terri Duhon. >> Part of my job was to come in as a trader
and to build a credit derivative trading book, including all the risk management around the
more exotic products. That was what I was brought in to do. >> Previously JP Morgan had written credit
swaps on single companies like Exxon. Duhon was asked to write swaps on bundles
of debt. >> The idea was, "Let's put together a portfolio
of credit risk, a portfolio of names." >> Her first trade was a credit default swap
on 306 corporate names on JP Morgan's books. >> And that list of 306 entities, they were
very highly rated.

They had very low credit risk. >> And the credit default swap was ensuring
JP Morgan against default by those 306 entities— >> That's correct. >> —many of them Fortune 500 companies or
other— >> It would have been— it would have been
your— some of your most well known household names. And so we were giving investors an opportunity
to, in effect, invest in our loan portfolio. >> JP Morgan did a lot of work, did a lot
of due diligence to assemble this portfolio of loans. And you can get it in one easy bite-sized
piece. >> And the bank facilitated this by slicing
up the portfolio into different risk levels, or tranches.

Investors could choose how much risk they
were willing to take. >> Different investors wanted different levels
of risk. There were some investors that wanted to earn
a big return on really risky stuff, and there were some investors that wanted to earn a
little return on stuff that wasn't risky at all. >> From there, the bank looked to expand their
business even further. >> So along comes this idea. What if we could create a market where people
were able to buy and sell freely, independently of the companies themselves, the risk associated
with lending to those companies? >> And so they began selling derivatives
that were simply bets on any and all portfolios, whether the bank owned them or not. These products came to be known as synthetic
collateralized debt obligations, synthetic CDOs.

>> There were investors who were able to invest
in some entities that they had not had access to before. >> By buying a credit default swap. >> By investing in a credit default swap because
it was a name that they hadn't previously had access to. So there was a lot of— a lot of very positive
reinforcement of the market. And it just grew. It grew very naturally. Once the seed was planted, there wasn't any
stopping it. >> It was the beginning of an unfettered brave
new world of banking. >> This was pretty new stuff. >> This was— [laughs] This was incredibly
new stuff. It was amazing. It was clearly a product that was in need. We had identified a need.

>> Most of the members of the global derivatives
group at JP Morgan were in their 20s, including Masters and Duhon. But with the creation of the credit default
swap market, they had made banking history. >> What in the long run this all meant was
that credit, which is a vital part of the lifeblood of any economy, the global economy,
became a more readily available asset. And the thinking was that that would be an
unambiguously positive thing. Credit helps drive growth, helps companies
deploy capital, helps employment, et cetera.

It wasn't any longer just an idea in a room
in Florida, it was the creation of an entire marketplace. >> Risk could now be easily traded. It fueled a worldwide credit boom. Soon other banks got excited about the money
to be made writing credit derivatives. Paul LeBlanc was a derivative salesman at
Morgan Stanley who remembers the pressure to get more deals done. >> The volume of transactions was just exploding. I mean, I used to know all the statistics
because they used to talk about it every meeting, how this is a growing market and you have
to get your customers involved. They can make money. We can make money. It was a massively important sector for us
to focus on, derivatives. >> And importantly, it was a private market,
unregulated, and out of view.

>> —the Dow up just about two and three
quarters of— >> See, unlike an exchange-traded market where
all the banks can see all the positions, there's no public market for these derivatives. You can't look in the newspaper and get a
price for them. These are all private off-exchange markets. And nobody else in the market knows what's
going on. >> And because this market was opaque, the
spreads — the difference between what banks could charge for derivatives and what it cost
to provide them — could be huge.

>> How much were these things making for the
bankers that were selling them? >> The spreads on derivatives are several
times larger than on comparable cash securities, just as a general rule. And that's why the banks trade them. >> Cash securities being those that are—
>> Equities, bonds— >> Well, paint some picture of that and the
kind of money that people were making. >> The best reference that you could give
is that if you look at, say, the spread that a bank might earn doing an IPO for FaceBook,
they're going to maybe make 1 percent to bring out that IPO, a very hot IPO.

If you were doing the same size deal in a
derivative security, you might make 10 times the fee. >> And the basic business that they created
was immensely profitable. But there's a problem with all of this. Most people in finance assume risk can be
eliminated, but all you can do is to move it around from one party to another party. >> There was growing concern in Washington. >> We are moving towards greater risk. We must do something to address the regulation
of hedge funds and especially derivatives in this country, $33 trillion, a substantial
amount of it held by the 25 largest banks in this country, a substantial amount being
traded in proprietary accounts of those banks. That kind of risk overhanging the financial
institutions of this country one day, with a thud, will wake everyone up. >> Proposals circulated to rein in the banks
and to regulate derivatives. >> What are you trying to protect? >> We're trying to protect the money of the
American public, which is at risk in these markets.

>> The head of the Commodity Futures Trading
Commission, Brooksley Born, led the charge. >> Certainly, we are the regulator which has
been given the authority to oversee the major derivatives markets—
>> Brooksley Born was absolutely right because what she said is if you don't have transparency
and regulation of derivatives, the risk is going to build up and they're going to lead
to a financial crisis that's going to cause massive taxpayer bailouts. >> The banks lobbied hard for no derivative
regulation. >> The banks didn't want anyone to know how
much risk they were taking on. They didn't want to have to quantify it on
their balance sheet. They wanted to be able to push it off and
hide it. And that was why they lobbied so hard to make
sure that swaps and derivatives would be treated differently from other kinds of financial
products. >> Others wanted them to be regulated like
insurance. >> One of the most heavily regulated products
in the country are insurance products, for all the obvious reasons. If you're going to— if you're going to write
insurance, you have to have enough money to pay off that insurance.

>> But if you write a credit default swap,
you don't have to have that same amount of money on hand. >> Or anything else, including, importantly,
no disclosure. >> So you're saying it's a kind of under-the-table
insurance agreement that avoids regulation. >> It's an insurance product designed not
to be regulated as an insurance product and designed to avoid regulation at all. And one thing we do know is that when a product
of any type is designed with minimal regulation, capital and activity moves into that area
and it expands dramatically. >> Regulation of derivatives transactions
that are privately negotiated by professionals is unnecessary.

>> The chairman of the Fed, Alan Greenspan,
sided with the banks. >> Alan Greenspan was coming from a very libertarian
tradition. Keep your hands off everything. The markets will sort themselves out. And if there's a problem, then we'll clean
up afterwards. And now that— that really was the way the
Federal Reserve operated under— under his leadership for almost 20 years. >> On Capitol Hill, supporters of bank deregulation
made urgent, stark pleas. >> The future of America's dominance as the
financial center of the world is at stake. >> Before them was legislation to lift restrictions
on how banks could do business. >> If we didn't pass this bill, we could find
London or Frankfurt or Shanghai becoming the financial capital of the world. >> This bill is going to make America more
competitive on the world market, and that's important. >> And legislation to prevent oversight of
credit derivatives.

>> —high-paying jobs not just on Wall Street
in New York City, but it affects every business in America and it benefits every consumer
in America. And we do it by repealing Glass-Steagall. >> It's the most important example of our
efforts here in Washington to maximize the possibilities of the new information age global
economy. >> In the end, banks would get larger and
derivatives would remain in the shadows. >> The derivatives market went into darkness,
almost no transparency and no regulation. And what you see is this explosion in the
growth of derivatives in the United States and throughout the world. >> The banks had won the day. Credit default swaps would now be introduced
to new markets. >> The next application of this same technology
was to portfolios of consumer credit risk, and in particular. mortgage-related credit risk. >> And the higher the risk, the better. >> What everyone is trying to create is something
that has a high rating and a high yield. That's the holy grail, that's the goal, is
to mix together assets in some way so that you come out with a AAA, and a big return.

>> And so Wall Street discovered the rewards
of funding the American dream. Just as they had bundled corporate loans,
bankers now bundled mortgages. >> You would buy these big pools of mortgages,
and these credit default swaps enabled you to bundle all this stuff together, bring it
in-house, in order to get it ready to put through the sausage-making machine and create
these securities. >> Bankers spread their investing dollars
across the country, but especially in states seeing historic levels of population growth,
places like Florida, Nevada, California, and here, in Georgia. >> Well, Atlanta was one of the hottest markets
in the country, the Atlanta region. >> Roy Barnes is the former governor of Georgia. >> Georgia was the fourth fastest growing
state at the turn of this last century, and the fastest growing state east of the Mississippi. So it was a hot market to start with. >> Elected in 1998, Barnes is renowned for
having taken on Wall Street over subprime lending, a market the
Street had traditionally avoided. >> And in the ‘80s, there was no place for

Nobody wanted it. The banks wouldn't buy it because there was
a higher risk. >> What really changed the appetite for subprime
mortgages was you could securitize them. And you could sell it on Wall Street. They do it in tranches, and then they wrap
it up so they could be packaged together and have an overall higher yield. >> Nearly half of all new single-family home
construction is in the South, now more than 50,000 a month.

>> And of course, Moody's says AAA. So it was just a feeding frenzy. I mean, it was just an absolute feeding frenzy
for subprime mortgages. >> With the economy strong, home buyers are
willing and able to spend double what they did just two decades ago. >> And you could just about drive by a bank,
and they'd throw a loan paper in your car as you passed by. It became very loose. Became very loose. >> But what big banks on Wall Street did not
or would not see was what was happening on the ground around the U.S., a wave of lending

>> The Wild West experience in home mortgages
was well under way. >> Forty one year old Hessiemay Hector, mother
of three, agreed to a second mortgage at 27.5 percent. >> We were creating mortgages that we had
never seen before. And they were being created faster and faster. >> The interest rate on these loans was as
high as 42 percent. >> We saw borrowers given loans that were
greater than the value of their home. Home buyers were getting loans that had no
income. >> When you have a high interest rate, then
you have high points. Then you have pre-payment penalties, when
you have balloon payments, when you have adjustable-rate mortgages and when you layer those bad practices
on top of a high interest rate, it becomes predatory. >> Housing advocates around the country took
on predatory lenders. But one of the fiercest fights was here in
Georgia, over what was called the Georgia Fair Lending Act. >> It's up right now on the House floor, a
governor's bill to crack down on— >> The mortgage lenders and the banks struck
back. >> None of these people have a clue of what's
going on! Nobody here understands the business, and
they didn't let us speak! >> You would have thought I had recommended
that we repeal the plan of Salvation.

Why were they so opposed to it? Money. Money.
>> This bill will cripple the mortgage business! It's going to cripple real estate sales! It's going to absolutely devastate the home
market in Georgia, I can guarantee you! >> There were threats that the residents in
Georgia wouldn't be able to get mortgages anymore because investors would not buy the
mortgages in Georgia. And if that were true, no bank would create
a mortgage in Georgia. >> Georgia now has the toughest predatory
lending law in the nation— >> Despite the efforts of the mortgage lobby,
the bill passed.

pexels photo 5257547

Fearing similar bills in other states, the
lobby helped to unseat Barnes, and rescind the law. >> Right after the Governor Barnes's defeat
in November, one of the top legislative priorities for the new governor and the new legislature
was to gut the Georgia Fair Lending Act. I think it was about two weeks into the new
legislative session, and it was gutted. >> No let-up in the housing boom, which is
good for the economy. Homes were selling last month at a record
clip, the main reason, low mortgage rates— >> The big banks continued to package and
sell more mortgage portfolios. And more and more of these CDOs contained
high-risk subprime debt. To keep the rating agencies on board, more
credit default swaps were sold.

>> Let's say I have a pool of mortgages. I have a thousand mortgages from California,
and I want to package these up. But I decide, "Well, some of these mortgages
may be subprime, and I want to buy a little bit of credit default insurance." >> And by doing that, you improve the profile-
>> In theory, yes. >> —of your CDO-
>> That's right. >> —so that you can sell it better. >> And I can go get a rating for it, too. I could go to Moody's and say, "Look, I have
laid off 2 percent of the risk on this portfolio. Shouldn't I get a better rating than if I
just sold the pool as it was?" >> So you take a lot of crap-
>> That's right.

>> —a lot of mortgages that are-
>> Hideous crap. [laughs] >> —people are not going to pay— right. OK. But you insure it, and the credit agency says,
"Hey, that's a good idea." >> Yes. Yes. >> New home sales jumped 13 percent over a
year ago, while existing home sales rose 4.5 percent, setting a new record—
>> The team at JP Morgan was also dabbling in mortgage debt, but they weren't sure it
made good sense.

>> We traded mortgages. We had some mortgages on our books. We certainly understood the mortgage-backed
security market. But we had a lot of trouble getting comfortable
with that risk. The big hang-up for us was data. We had years and years of historical data
about how corporates performed during business cycles. But we didn't have that much data about how
retail mortgages performed during different business cycles. >> We knew how much money people said they
were making. We saw that UBS and Merrill Lynch had securitized
products earnings that were growing faster than ours. And we asked ourselves the question, "What
are we doing wrong? What are we missing? Have we not figured out how to lay off some
of this risk?" And honestly, we couldn't figure it out.

What we never imagined was that those other
firms weren't doing anything at all. They were just taking the risk and sitting
with it. >> Sales of new single family homes shot up—
>> The first wave of JP Morgan bankers who had developed these original ideas in the
1990s, when they saw what was starting to happen — essentially, other banks were taking
these ideas and applying them in ways that they had never expected — some of them began
to get very worried. >> We were just about to say done on a transaction. We had a global phone call, and we were discussing
the risk that we were about to do, and we had discussed it over and over and over. And finally, someone on that phone call said,
"I'm nervous." >> Twice as many home buyers are getting adjustable
mortgages— >> —a huge increase in new home sales—
>> We almost had stopped thinking and stopped reassessing the risk as we went along.

And suddenly, we found ourselves with a product
that was vastly different from where we started. And every little tweak along the way, we had
all said, "Oh, that's OK. That's OK. That's OK," until suddenly, we all looked
up and said, "Hang on, it's not OK." >> The world is still living with a lot of
big unresolved problems— >> Other banks were not so cautious. >> —storm clouds on the horizon—
>> They aggressively sold subprime CDOs to customers all over the world.

London became a second beachhead for their
trading and sales operations. >> The stock market's on the rise and economic
statistics— >> The City of London actually did yeomen's
service in creating some of the nastier structures. They did this offshore. These were not SEC-registered deals. These were all private placements. So they were going through the legal loopholes. >> A group of state-run banks in Germany known
as Landesbanks were among the biggest customers. Desiree Fixler, who worked at JP Morgan, says
she was amazed by these banks' appetite for subprime mortgages. >> You knew that a core group of banks in
Germany would buy anything. We strongly believed they were very naive. We were amazed that they would buy this. It was— I mean, every single person, every
sales person, was envious of that particular sales person that was able to cover the Landesbanks
and IKB because you were in one of the hottest seats globally.

You were going to generate tremendous profit
margin. They were big buyers. >> IKB was very convinced that they were one
of the strongest banks in that area. They were running around, telling people how
good they are in investing. >> Multinational Deutsche Bank did several
deals with IKB. >> Did you think, at the time, that your products
were helping IKB, that these were good things for them to buy? >> Yeah, absolutely. Otherwise, we wouldn't have manufactured these
products and sold it to them. >> So you were bullish on subprime mortgages
in the U.S. >> We were bullish on the mortgage market
in general, and subprime, which was an element of it, we were not overly aggressive, but
we were a part of that market.

Absolutely. >> Americans are buying real estate in record
numbers. That demand has given—
>> By the end 2005, the total outstanding value of credit default swaps around the world
was measured in trillions of dollars and was doubling every year. >> Existing home sales rose 4.5 percent, setting
a new record. >> Did top management at JP Morgan understand
credit derivatives? >> Yes, they did. Absolutely, they did. >> Did they at other banks? >> No, not all other banks.

Certainly not. >> Did the regulators understand them? >> I don't think the regulators understood. I don't think the credit ratings agencies,
the bankers or the regulators fully understood all of the kinds of credit instruments that
we're talking about. >> In other words, some big banks simply didn't
know what they had in terms of risk. >> Certainly, they didn't— they didn't know
some of the forms of risk that they had. That's exactly right. >> Sales were higher than most regions, up
more than 40 percent in the West and Northeast— >> Housing prices continued to soar. >> The average price of a new home grew slightly—
>> Banks packaged more and more CDOs.

Theoretically, there was no limit. An investor didn't need to own any actual
mortgages. So-called synthetic CDOs allowed investors
to bet many times over on someone else's portfolio of debt.
>> It allowed participants— either buying or selling, so on either side of the market
— to take their positions without being constrained by the size of the underlying
market. >> In synthetic CDOs, all you had to do was
make a side bet based on what would happen to this group of mortgages and have that be
the basis of the CDO. The fact that someone had done it one time
wouldn't stop you from doing it again and again and again. >> So how is that different than betting on
the outcome of the Super Bowl? >> Or a horse race or a craps table.

There's no different at all. It's just a pure bet by somebody who has no
economic interest in what they're betting on. >> We're pretty confident that the housing
market's not going to down at all. It's just going to go up. >> Within a decade, you have the most phenomenal
machine anybody's ever seen. >> New homes are selling at the second highest
rate on record— >> We are in a housing boom. It's strong right now. >> Profits soared 93 percent. >> —expected to dole out $36 million in
bonuses this year. >> Everyone was high-fiving. It seemed to be brilliant. The combination of free markets, innovation
and globalization appeared to have delivered this incredibly heady cocktail of tremendous
growth. >> Top executives will earn as much as $20
million to $50 million— >> Between 2003 and 2006, Dick Kovacevich,
CEO of Wells Fargo, remembers attending meetings with bankers and regulators.

>> Oftentimes, what would happen at these
meetings is— regulators would be there, like Chairman Bernanke, and there might be,
I don't know, 30, 40 bankers. And they would often go around the room and
say, "Well, what are you guys seeing out there?" You know, "What's working? Are you concerned about housing," you know,
trying to get input. And when they came to me, I would say, "This
is toxic waste. We're building a bubble. We're not going to like the outcome. >> What did your fellow bankers say to you
when you told them that you thought this stuff was toxic? >> Well, the ones that were in it said I was
wrong and everything's fine. "We don't see any losses occurring in this." >> But we saw risk all over the place.

>> There's a great set of adages on Wall Street
about where risk will flow. And if you ask people, they're basically split
between two camps. One says that risk will flow to the smartest
person, the person who best understands it. And the other says that risk will flow to
the dumbest person, the person who least understands it. And at least based on my experience and my
understanding of what has been happening in the derivatives market, it's the latter. >> I was amazed at the interest on the part
of investors to invest in a product that was highly complex and very risky on top of it.

>> So let me get this straight. You were— you were first to the party. You developed this tranching of stuff—
>> That's right. >> —and writing credit default swaps on
it. But now everybody else has jumped into the
game. >> Everybody wants to do it. >> But your team decided to stop. Why did so many others keep going, marching
towards the cliff? >> The— I mean, there— I— look, very
simply, there are certainly some— some investors, some banks, some borrowers who are a bit greedier
than they should be. >> Goldman Sachs Lloyd Blankfein will take
home $53 million. >> No one wanted the party to end. >> —pocket an estimated $40 million—
>> Most banks believed housing prices would never go down, let alone crash.

>> To imagine losses of that severity required
very significant assumptions about the path of the economy which were just not in people's
mind. So it required things like assuming that house
prices in the United States fell by 25 percent. People weren't thinking that way. And as long as house prices never fell, then
these risks would never come home to roost. And that ultimately was obviously very flawed
logic. >> As interest rates rose early this year,
home sales slowed. And after years of record appreciation—
>> —businesses and individuals do, as well, and the cost of borrowing is going up. >> The unraveling began in late 2006. >> Big trouble for millions of American home
owners— >> When housing prices started to drop, only
a very few bankers could see the bubble they were trapped in.

>> The housing market has turned some mortgages
into time bombs. >> By 2007, 2008, all the smart money knew
the game had ended, and all the banks tried to effectively repackage what they were stuck
with as quickly as possible and get it off their books. But there was second parallel movement which
was going on, which was all about, "How can we take advantage of it?" >> The Dow-Jones average seemed in freefall,
ending the day down— >> One of the Wall Street banks that took
advantage of a declining market was Goldman Sachs. According to a congressional investigation,
the bank created a series of CDOs containing toxic subprime and then sold them to customers—
>> We at Goldman Sachs distinguish ourselves by our ability to get things done on behalf
of our clients— >> —while Goldman Sachs, using credit default
swaps, bet against them.

>> They bet against their own clients, so
when the clients lost money, Goldman was making money. Goldman has a little slogan that the clients
come first. No, they didn't. Not in these transactions. Goldman came first, second and third. They were really, I think, the only major
bank which made money when the housing bubble burst. >> In a settlement with the SEC, Goldman admitted
that some of their marketing materials did not disclose important information, but Goldman
claimed that their investors were highly sophisticated institutions. >> Thirty-four subprime mortgage companies
have gone bus— >> One customer was that German Landesbank,

>> Analysts say anyone associated with the
subprime market is going to pay the price. >> Even when there was a downturn in the markets,
they were still buying. I mean, the market is telling them. It's on the screen. There are headlines everywhere, "Danger." But they still wanted to go ahead. >> Did you feel there was an obligation on
your part to tell them that, "Look, wake up, the markets are going down.

Maybe you should stop buying this crap?" >> Those discussions— the word "crap" wasn't
used, but I mean, those discussions definitely happened. But they felt that this was just a temporary
glitch in an overall bull market. "It will recover. It has to recover." >> In July 2007, the German bank, IKB, stuffed
with subprime, was the first bank to fail. >> —hundreds of thousands of home owners
are defaulting on their loans— >> It was only a matter of time before the
crisis came back to Wall Street. >> —and that could hurt the value of homes
nationwide by— >> We knew that the housing bubble had burst. But we'd been reassured that the problem had
been contained.

But by the beginning of 2008, it was becoming
clear that this was a much, much bigger problem than anybody anticipated. >> There was a broad misperception of the
risk in housing prices. The widespread view that we could have a regional
decline in housing prices, but never a national decline in housing prices, proved to be horribly
wrong. >> Last week was a difficult time in the mortgage
business. There was talk about problems in funds—
>> This was the most actively traded stock by far—
>> In New York, banks were trying to unload what they could. But there was confusion. At CitiGroup, they were running in circles. >> One of the incredible things about CitiGroup,
we now know, was although it was tossing these risks off its balance sheet, those risks came
right back, almost like a boomerang.

Without knowing it, they had set up one business
to offload risk, and then completely reversed that business, taking those risks back onto
its balance sheet. >> It was quite clear to me that a number
of really quite large financial institutions had not had the kind of management information
systems which allowed them even to know what all their risks were. >> That was astounding to you. >> It was astounding to me. >> The sort of origination of these subprime
loans, the creation of the CDOs— that business is gone. >> And the reason why is all those credit
default swaps— >> It would all come down to those credit
default swaps. Would they pay off as they were designed to
do? >> We have known for generations that banks
are susceptible to runs.

Banks can't function if everybody comes and
wants their money at the same moment. >> —Merrill Lynch, devastated by losses—
>> The failure of Lehman Brothers and the fire sale of Merrill lynch—
>> —starting to take a closer look at AIG. The world's largest insurance company—
>> This time, it would be a run on an insurance company. AIG was on the hook for $440 billion worth
of credit default swaps. >> —credit default swaps—
>> Remember, an insurance contract is only as good as the credit quality of the insurer. They have to pay you. And if they can't pay you for whatever reason,
then this whole process of risk transfer breaks down.

>> We need to stabilize this industry. It can spread throughout the economy. It could be a very, very dangerous—
>> September 18th of 2008, when I have a conference of my CEOs, and CEOs traditionally don't read
their Blackberries during meetings. But I kept looking around and noticing that
a number of them were. And so I turned to one.

We recessed. And I said, "You looked like the world was
ended." And he said, "I think it has." >> —the enormity of the situation, like
a financial nuclear holocaust. Some $400-odd billion of credit default swaps—
>> —another government bailout, AIG securing an $85 billion—
>> AIG could not conceivably have paid off all of those credit derivatives because it
had misunderstood the risks and did not have what we'd call a balanced book or nearly enough
capital to back their losses. >> Didn't everybody know that AIG was holding
a lot of CDSs? >> No. There was no disclosure.

That's the whole point They haven't reported
this to anyone else. The other dealers have no idea what's going
on. The other banks don't know. Nobody knows. The banks turned this market into their own
private game. >> It was, in fact, a financial shell game
where we were manipulating banking results by moving the risk out through one door, but
bringing it back into the banking system by another door.

The risk was not leaving the banking system,
and everybody in the world was connected to these chains of risk. And if any part of that chain breaks down
because they can't honor the contract, the entire system implodes. >> The idea dreamed up by a group of young
JP Morgan bankers at a weekend retreat many years ago was supposed to reduce risk.

>> Their original idea had been taken and
it turned into a Frankenstein monster, which they never dreamt would become so big and
spin out of control to that degree. >> It was a very scary time. We were in totally new territory. And the notion that Lehman Brothers could
be filing for bankruptcy and AIG could be at risk of the same fate was absolutely unprecedented. And the implications— thinking through the
implications of that for the health not just of the U.S. economy but the world were—
I mean, it wasn't— it wasn't really conceivable to do that. I couldn't get my mind around it. I know others couldn't. >> We never saw it coming. We never saw that coming. And I was disappointed, hugely disappointed. I mean, I was part of a market that I believed
was doing the right thing. And maybe I was idealistic, maybe I was young,
maybe I— I didn't fully appreciate where we were going, but there was a whole system
going on all the way from the borrower of the mortgage, all
the way through to the investor.

There's a whole system of people who maybe
were turning a blind eye, maybe were, you know, just— I don't know. It's— it's frustrating to see, certainly. >> It shouldn't have happened. Most of our financial crisis in the past is
due to some macroeconomic event— an oil disruption, war. This was caused by a few institutions, about
20, who, in my opinion, lost all credibility relative to managing their risk. And the sad thing is it should never have
happened. The management should have stopped it before
it got big.

And people are suffering for something that
should never have happened. >> Today, the fallout is felt mostly in places
that had seen the highest growth, like Georgia. Ground zero of the subprime crisis— local
neighborhoods, city streets. >> Cities throughout the United States are
seeing a rise in vacant and abandoned properties. And that's where the neighbors feel it. As neighbors, we're concerned not so much
with the complexities of the subprime mortgage market and derivatives. These things we will hardly ever understand. What we feel on the street is the fact that
the house next to us is vacant, abandoned, partially burned. And we wonder how long it's going to be there,
how long we pay the price for that abandonment. A neighborhood cannot survive long when it
has a growing inventory of vacant, abandoned properties. >> Sometimes, no one even knows who owns the
properties. >> It's hard to know who owns it because it's
been sliced and diced so many ways by investors that it could be somebody in Ireland who owns
it. You have these securitized pools, where investors
own pieces of it.

The investors are around the world, literally,
and so it's just in no-person's land. It's a vacant property, mostly vandalized,
and it just sits here and we can't do anything with it. And the reality is that that plays out across
this neighborhood hundreds of times. >> That house has a loan that
is somewhere lost in a huge financial vehicle put together by some young Turks on Wall Street.

It's lost in that billion-dollar package because
there's nobody assigned to look after it. And there are whole subdivisions like this,
by the way, that are just lost in this great
morass. And so it affects Main Street because Wall
Street was too greedy. The greed of Wall Street broke Main Street..

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