Money, Power & Wall Street

Part One
PRODUCED BY CO-PRODUCERS WRITTEN BY
Martin Smith Linda Hirsch Martin Smith
Marcela Gaviria Ben Gold Marcela Gaviria

NARRATOR: 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 Americas 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.
OCCUPY WALL STREET DEMONSTRATORS: This is what democracy looks like! We got sold out,
banks got bailed out!
POLICE OFFICER: On the sidewalk! You must go on the sidewalk!
NARRATOR: The recession had destroyed $11 trillion of Americans net worth. A recovery seemed far off.
Occupy Wall Street wanted bankers held responsible.
DAVID WESSEL, The Wall Street Journal: Most Americans think, and with good reason, that Wall Street
got bailed out and Main Street didnt. We have very high unemployment. We lost 8.5 million jobs in the
recession. Peoples houses arent worth what they paid for them. A lot of them dont have jobs. Their kids are
graduating from college and are moving back in.
DEMONSTRATORS: This is what democracy looks like!
NARRATOR: Some protesters were calling for bankers to be prosecuted.
DENNIS KELLEHER, Financial Reform Advocate: It is pretty clear, actually, that there was massive
illegality going on. And if somebody with subpoena power was intent on prosecuting that, I dont think theres
really much doubt that they would be quite successful in criminal prosecutions.
DEMONSTRATORS: We are the 99 percent! We are the 99 percent!
[Twitter #frontline]
NARRATOR: 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.
STEVE BARTLETT, Financial Services Roundtable: 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.
MARTIN SMITH, Correspondent: 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 hasnt recovered but
banks have.
STEVE BARTLETT: 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 theyre that they
fail because then youll have another recession.
REPORTER: [to bankers] Do you understand why theyre 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 theyre are angry at bankers? Do you have any regrets about the way
you spent the taxpayers money?
NARRATOR: Since the meltdown of 2008, there have been dozens of hearings.
LLOYD BLANKFEIN, Goldman Sachs CEO & Chairman: and we regret that people have lost money.
And whatever we did, whatever the standards of the time were, it didnt work out well.
BROOKSLEY BORN, Financial Crisis Inquiry Commission: I would like to ask your opinion of the role
that over-the-counter derivatives played
NARRATOR: Many questions have been asked
BROOKSLEY BORN: in contributing to the financial crisis.
NARRATOR: but there have been few satisfying answers.
DENNIS KELLEHER: What goes on at Wall Street and exactly what caused the crisis and how did we get
where we are its difficult to understand even for professionals.
BYRON GEORGIOU, Financial Crisis Inquiry Commission: Im not sure I understand that point. Maybe
you could elaborate.
JOHN MACK, Morgan Stanley CEO and Chairman: Well, I think that its in many ways, is very simple.
I think our regulators and the industry have to focus on complexity.
DENNIS KELLEHER: But at the end of the day, people usually have a pretty good ability to tell when
somethings wrong.
JAMIE DIMON, JP Morgan Chairman, Pres. & CEO: Somehow, we just missed, you know, that home
prices dont go up forever.
Sen. JOHN McCAIN (R-AZ), Permanent Subcommittee on Investigations: What is a synthetic CDO?
LLOYD BLANKFEIN: A CDO is a pool of assets
FRANK PARTNOY, Morgan Stanley, 1994-95: I think finance may have gotten too complicated for anyone
to understand
LLOYD BLANKFEIN: 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.
FRANK PARTNOY: and that the managers of these large financial institutions in some ways have been
given an impossible task, that they wont be able to comprehend what it is their institutions are doing. And that
is really, really scary.
Rep. MICHAEL CAPUANO (D-MA), Financial Services Committee: You created the mess were in, and
now youre 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, Lets do credit default swaps? Find him! Fire
him!
NARRATOR: Its hard to pinpoint the origins of Americas 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.
BLYTHE MASTERS, JP Morgan, 1991-Present: 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 topics.
GILLIAN TETT, Author, Fools Gold: 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.
BILL WINTERS, JP Morgan, 1983-09: Yes, I went into the pool fully clothed, as did as did my boss.
Some people drank, some people didnt. And Im happy to say that, like, most people stayed reasonably sober.
NARRATOR: They played hard. But they also worked hard. They were striving to address an age-old problem
in banking, how to reduce risk.
BILL WINTERS: The defining problem was that banks were unable to adequately deal with their own credit
risks.
MARK BRICKELL, JP Morgan, 1976-01: Were thinking about how to manage risk. We were thoughtful
and deliberate and careful. We had a responsibility not just to make a profit for the shareholders, but to look
after the financial system as a whole.
NARRATOR: Over two days of meetings, they looked at whether they could find a way to make their loans
less risky. The first journalist to tell the full story was Gillian Tett.
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.
NARRATOR: Credit default swaps, a kind of derivative that insures a loan against default.
This was a very new concept. 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.
GILLIAN TETT: 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.
NARRATOR: The first big credit default swap was engineered by Blythe Masters and involved Exxon.
BLYTHE MASTERS: Exxon was the client at the bank, and we had credit exposure associated with that
relationship.
NEWSCASTER: The Exxon Valdez spewed almost 11 million gallons of oil into Prince William Sound.
NARRATOR: 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.
BLYTHE MASTERS: 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.
NARRATOR: And that risk is a big drain on a bank.
SATYAJIT DAS, Fmr. Derivatives Trader: Every time a bank makes a loan, under banking regulations,
theyre 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.
DENNIS KELLEHER: 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 dont have to do that and youre a bank,
you youd prefer not to do that.
MARTIN SMITH: Because then you can finance more freely? You can take on more debt?
DENNIS KELLEHER: Right.
NARRATOR: So Masters started looking at who could take on their loan risk and free up JP Morgans capital.
She found a taker in London, the European Bank for Reconstruction and Development, the EBRD.
BLYTHE MASTERS: 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.
NARRATOR: This was a major financial innovation. Credit derivatives made it possible for a bank to skirt
capital requirements.
SATYAJIT DAS: And thats 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.
MARK BRICKELL: The innovative element of swaps is that they allow companies, financial institutions,
governments, to shed the risks that they dont want to take and take on other risks that they would prefer to be
exposed to.
NARRATOR: 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.
TERRI DUHON, JP Morgan, 1994-02: 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.
NARRATOR: Previously JP Morgan had written credit swaps on single companies like Exxon. Duhon was
asked to write swaps on bundles of debt.
TERRI DUHON: The idea was, Lets put together a portfolio of credit risk, a portfolio of names.
NARRATOR: Her first trade was a credit default swap on 306 corporate names on JP Morgans books.
TERRI DUHON: And that list of 306 entities, they were very highly rated. They had very low credit risk.
MARTIN SMITH: And the credit default swap was ensuring JP Morgan against default by those 306
entities
TERRI DUHON: Thats correct.
MARTIN SMITH: many of them Fortune 500 companies or other
TERRI DUHON: 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.
BILL WINTERS: 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.
NARRATOR: 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.
BILL WINTERS: 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 wasnt risky at all.
NARRATOR: From there, the bank looked to expand their business even further.
BLYTHE MASTERS: 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?
NARRATOR: 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.
TERRI DUHON: There were investors who were able to invest in some entities that they had not had access to
before.
MARTIN SMITH: By buying a credit default swap.
TERRI DUHON: By investing in a credit default swap because it was a name that they hadnt 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 wasnt any stopping it.
NARRATOR: It was the beginning of an unfettered brave new world of banking.
MARTIN SMITH: This was pretty new stuff.
TERRI DUHON: 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.
NARRATOR: 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.
BLYTHE MASTERS: 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 wasnt any longer just an idea in a room in Florida, it was the creation of an entire
marketplace.
[www.pbs.org: More from Duhon and Masters]
NARRATOR: 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.
PAUL LeBLANC, Morgan Stanley, 1983-04: 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.
NARRATOR: And importantly, it was a private market, unregulated, and out of view.
NEWSCASTER: the Dow up just about two and three quarters of
CHRISTOPHER WHALEN, Investment Banker: See, unlike an exchange-traded market where all the banks
can see all the positions, theres no public market for these derivatives. You cant look in the newspaper and get
a price for them. These are all private off-exchange markets. And nobody else in the market knows whats
going on.
NARRATOR: 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.
MARTIN SMITH: How much were these things making for the bankers that were selling them?
CHRIS WHALEN: The spreads on derivatives are several times larger than on comparable cash securities, just
as a general rule. And thats why the banks trade them.
MARTIN SMITH: Cash securities being those that are
CHRIS WHALEN: Equities, bonds
MARTIN SMITH: Well, paint some picture of that and the kind of money that people were making.
CHRIS WHALEN: 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, theyre 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.
SATYAJIT DAS: And the basic business that they created was immensely profitable. But theres 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.
NARRATOR: There was growing concern in Washington.
Sen. BYRON DORGAN (D-ND), 1981-11: [1999] 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.
NARRATOR: Proposals circulated to rein in the banks and to regulate derivatives.
Rep. SPENCER BACHUS (R-AL), Financial Services Committee: What are you trying to protect?
BROOKSLEY BORN, Commodity Futures Trading Commission Chair, 1996-99: Were trying to protect
the money of the American public, which is at risk in these markets.
NARRATOR: The head of the Commodity Futures Trading Commission, Brooksley Born, led the charge.
BROOKSLEY BORN: Certainly, we are the regulator which has been given the authority to oversee the major
derivatives markets
DENNIS KELLEHER, Chief Counsel, Sen. Dorgan, 2006-10: Brooksley Born was absolutely right because
what she said is if you dont have transparency and regulation of derivatives, the risk is going to build up and
theyre going to lead to a financial crisis thats going to cause massive taxpayer bailouts.
NARRATOR: The banks lobbied hard for no derivative regulation.
FRANK PARTNOY, Author, Infectious Greed: The banks didnt want anyone to know how much risk they
were taking on. They didnt 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.
NARRATOR: Others wanted them to be regulated like insurance.
DENNIS KELLEHER: One of the most heavily regulated products in the country are insurance products, for
all the obvious reasons. If youre going to if youre going to write insurance, you have to have enough money
to pay off that insurance.
MARTIN SMITH: But if you write a credit default swap, you dont have to have that same amount of money
on hand.
DENNIS KELLEHER: Or anything else, including, importantly, no disclosure.
MARTIN SMITH: So youre saying its a kind of under-the-table insurance agreement that avoids regulation.
DENNIS KELLEHER: Its 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.
ALAN GREENSPAN, Federal Reserve Chairman, 1987-2006: Regulation of derivatives transactions that
are privately negotiated by professionals is unnecessary.
NARRATOR: The chairman of the Fed, Alan Greenspan, sided with the banks.
SIMON JOHNSON, Economist, MIT: Alan Greenspan was coming from a very libertarian tradition. Keep
your hands off everything. The markets will sort themselves out. And if theres a problem, then well clean up
afterwards. And now that that really was the way the Federal Reserve operated under under his leadership
for almost 20 years.
NARRATOR: On Capitol Hill, supporters of bank deregulation made urgent, stark pleas.
Sen. CHARLES SCHUMER (D), New York: [1999] The future of Americas dominance as the financial
center of the world is at stake.
NARRATOR: Before them was legislation to lift restrictions on how banks could do business.
Sen. CHARLES SCHUMER: If we didnt pass this bill, we could find London or Frankfurt or Shanghai
becoming the financial capital of the world.
Sen. PHIL GRAMM (R), Texas: This bill is going to make America more competitive on the world market,
and thats important.
NARRATOR: And legislation to prevent oversight of credit derivatives.
Sen. PHIL GRAMM: 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.
NARRATOR: The campaign to roll back Glass-Steagall, a Depression-era set of reforms was led by the
countrys biggest bank, CitiCorp.
SIMON JOHNSON: They felt it was in their way and persuaded lawmakers, both Democratic and Republican,
that Glass-Steagall should be repealed. It also symbolized when everything really started to go wrong.
[www.pbs.org: CitiGroup & repeal of Glass-Steagall]
Pres. BILL CLINTON: Its the most important example of our efforts here in Washington to maximize the
possibilities of the new information age global economy.
NARRATOR: In the end, banks would get larger and derivatives would remain in the shadows.
DENNIS KELLEHER: 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.
NARRATOR: The banks had won the day. Credit default swaps would now be introduced to new markets.
BLYTHE MASTERS: The next application of this same technology was to portfolios of consumer credit risk,
and in particular. mortgage-related credit risk.
NARRATOR: And the higher the risk, the better.
FRANK PARTNOY: What everyone is trying to create is something that has a high rating and a high yield.
Thats the holy grail, thats the goal, is to mix together assets in some way so that you come out with a AAA,
and a big return.
NARRATOR: And so Wall Street discovered the rewards of funding the American dream. Just as they had
bundled corporate loans, bankers now bundled mortgages.
PAUL LeBLANC: 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.
NARRATOR: 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.
ROY BARNES, (D) Governor of Georgia, 1999-03: Well, Atlanta was one of the hottest markets in the
country, the Atlanta region.
NARRATOR: Roy Barnes is the former governor of Georgia.
ROY BARNES: 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.
WOMAN: I put my house on the market on a Tuesday, and it was gone Thursday.
[www.pbs.org: More on the housing bubble]
NARRATOR: Elected in 1998, Barnes is renowned for having taken on Wall Street over subprime lending, a
market the Street had traditionally avoided.
VINCENT FORT, State Senator, Georgia: Subprime lending has been around for a long time and is
supposed to be lending done to people whose credit is inferior.
ROY BARNES: And in the 80s, there was no place for subprime. Nobody wanted it. The banks wouldnt buy
it because there was a higher risk.
[television commercial]
City Mortgage. May I help you?
Ive been having trouble with my credit.
Thats no problem. Well give you the best rate possible.
ANNOUNCER: 688-CITY.
FRANK ALEXANDER, Emory Univ. Law School: The subprime market was originally a niche market.
Originally, it was not the major banks, it was the mortgage brokers who were specialists in this market.
NEWSCASTER: Subprime loans in Atlanta jumped by more than 500 percent during a five-year period.
ROY BARNES: 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.
NEWSCASTER: Nearly half of all new single-family home construction is in the South, now more than
50,000 a month.
ROY BARNES: And of course, Moodys says AAA. So it was just a feeding frenzy. I mean, it was just an
absolute feeding frenzy for subprime mortgages.
NEWSCASTER: With the economy strong, home buyers are willing and able to spend double what they did
just two decades ago.
ROY BARNES: And you could just about drive by a bank, and theyd throw a loan paper in your car as you
passed by. It became very loose. Became very loose.
NARRATOR: 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 abuses.
NEWSCASTER: Its a phrase youre likely to hear in the future
NEWSCASTER: predatory lending
1st WOMAN: We trusted mortgage companies
2nd WOMAN: We say that we were swindled.
3rd WOMAN: The situation have caused me to go into the state of bankruptcy.
4th WOMAN: This is what you call robbing somebody without a gun!
FRANK ALEXANDER: The Wild West experience in home mortgages was well under way.
NEWSCASTER: Forty one year old Hessiemay Hector, mother of three, agreed to a second mortgage at 27.5
percent.
FRANK ALEXANDER: We were creating mortgages that we had never seen before. And they were being
created faster and faster.
MAN: The interest rate on these loans was as high as 42 percent.
FRANK ALEXANDER: We saw borrowers given loans that were greater than the value of their home. Home
buyers were getting loans that had no income. The borrower, particularly the elderly or the low income, had no
clue as to what they signed. There was a tremendous growth of mortgages that we knew made no sense
financially.
VINCENT FORT: 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.
NEWSCASTER: Black home owners in Atlanta have become such frequent targets of unscrupulous lenders
that councillors regularly hold community meetings to issue warnings.
WOMAN: monthly payments that you cant afford.
VINCENT FORT: And why did they sell them to people that they were not good for? They did it because they
could.
WOMAN AT COMMUNITY MEETING: Weve got to fight, fight, fight, fight!
NARRATOR: 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.
VINCENT FORT: But we dont need rhetoric, we need
NARRATOR: The bill was sponsored by State Senator Vincent Fort
VINCENT FORT: we need action now!
Gov. ROY BARNES: People are tricked into owing more money than they could ever dream
NARRATOR: and backed by Governor Roy Barnes.
Gov. ROY BARNES: talked into believing theres a way out.
NEWSCASTER : Governor Barnes and others are making a last ditch effort
NARRATOR: The bill targeted high-cost loans and predatory lenders with a series of rules and prohibitions.
NEWSCASTER: Its up right now on the House floor, a governors bill to crack down on
NARRATOR: The mortgage lenders and the banks struck back.
MORTGAGE LENDER: None of these people have a clue of whats going on! Nobody here understands the
business, and they didnt let us speak!
ROY BARNES: You would have thought I had recommended that we repeal the plan of Salvation. Why were
they so opposed to it? Money. Money.
MORTGAGE LENDER: This bill will cripple the mortgage business! Its going to cripple real estate sales!
Its going to absolutely devastate the home market in Georgia, I can guarantee you!
FRANK ALEXANDER (Prof. of Law, Emory University): There were threats that the residents in Georgia
wouldnt 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.
NARRATOR: Despite the efforts of the mortgage lobby, Barnes and Fort got the bill passed in April 2002.
NEWSCASTER: Georgia now has the toughest predatory lending law in the nation
NARRATOR: The mortgage lobby feared that similar legislation could pass in other markets, like California.
They opposed Barness reelection, they funded his challenger, and lobbied to rescind the law.
FRANK ALEXANDER: Right after the Governor Barness 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.
NARRATOR: But for a seven-month period, predatory lending in Georgia declined. It may have been the last
chance to slow the housing boom.
ROY BARNES: I would like to sit up here and tell you that I was like Nostradamus, that I saw that the world
was going to come to an end because of all this. But I could never have foreseen the difficulty that existed,
never have could I have foreseen that.
FRANK ALEXANDER: I think we still would have seen an unrealistic bubble, but it wouldnt have gone up
as fast and it wouldnt have collapsed as fast. We would not have been in as deep a hole today as we are if we
hadnt had these funny mortgage products.
NEWSCASTER: 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
NARRATOR: 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.
CHRIS WHALEN, Tangent Capital Partners: Lets 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.
MARTIN SMITH, Correspondent: And by doing that, you improve the profile-
CHRIS WHALEN: In theory, yes.
MARTIN SMITH: of your CDO-
CHRIS WHALEN: Thats right.
MARTIN SMITH: so that you can sell it better.
CHRIS WHALEN: And I can go get a rating for it, too. I could go to Moodys and say, Look, I have laid off
2 percent of the risk on this portfolio. Shouldnt I get a better rating than if I just sold the pool as it was?
MARTIN SMITH: So you take a lot of crap-
CHRIS WHALEN: Thats right.
MARTIN SMITH: a lot of mortgages that are-
CHRIS WHALEN: Hideous crap. [laughs]
MARTIN SMITH: people are not going to pay right. OK. But you insure it, and the credit agency says,
Hey, thats a good idea.
CHRIS WHALEN: Yes. Yes.
GILLIAN TETT, Financial Times: And it seems that in the housing market, many investors actually began to
take more risks precisely because they thought that they had bought protection with credit default swaps.
[www.pbs.org: Watch on line]
NEWSCASTER: New home sales jumped 13 percent over a year ago, while existing home sales rose 4.5
percent, setting a new record
NARRATOR: The team at JP Morgan was also dabbling in mortgage debt, but they werent sure it made good
sense.
TERRI DUHON, JP Morgan, 1994-02: 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 didnt have that much data about how retail mortgages performed during
different business cycles.
BILL WINTERS, Co-CEO, JP Morgan Investment Bank, 2004-09: 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 couldnt figure it out. What we never imagined was that those other firms werent doing
anything at all. They were just taking the risk and sitting with it.
NEWSCASTER: Sales of new single family homes shot up
GILLIAN TETT: 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.
TERRI DUHON: 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, Im nervous.
NEWSCASTER: Twice as many home buyers are getting adjustable mortgages
NEWSCASTER: a huge increase in new home sales
TERRI DUHON: 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, thats OK. Thats OK. Thats OK, until suddenly, we all looked up
and said, Hang on, its not OK.
NEWSCASTER: The world is still living with a lot of big unresolved problems
NARRATOR: Other banks were not so cautious.
NEWSCASTER: storm clouds on the horizon
NARRATOR: They aggressively sold subprime CDOs to customers all over the world. London became a
second beachhead for their trading and sales operations.
NEWSCASTER: The stock markets on the rise and economic statistics
CHRIS WHALEN: The City of London actually did yeomens 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.
NARRATOR: 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.
DESIREE FIXLER, JP Morgan, 2001-04: 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.
JOSEF ACKERMANN, CEO, Deutsche Bank: 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.
NARRATOR: Multinational Deutsche Bank did several deals with IKB.
MARTIN SMITH: Did you think, at the time, that your products were helping IKB, that these were good
things for them to buy?
JOSEF ACKERMANN: Yeah, absolutely. Otherwise, we wouldnt have manufactured these products and
sold it to them.
MARTIN SMITH: So you were bullish on subprime mortgages in the U.S.
JOSEF ACKERMAN: 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.
NEWSCASTER: Americans are buying real estate in record numbers. That demand has given
NARRATOR: 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.
NEWSCASTER: Existing home sales rose 4.5 percent, setting a new record.
MARTIN SMITH: Did top management at JP Morgan understand credit derivatives?
TERRI DUHON: Yes, they did. Absolutely, they did.
MARTIN SMITH: Did they at other banks?
TERRI DUHON: No, not all other banks. Certainly not.
MARTIN SMITH: Did the regulators understand them?
DANIEL K. TARULLO, Federal Reserve Board Governor: I dont think the regulators understood. I dont
think the credit ratings agencies, the bankers or the regulators fully understood all of the kinds of credit
instruments that were talking about.
MARTIN SMITH: In other words, some big banks simply didnt know what they had in terms of risk.
DANIEL K. TARULLO: Certainly, they didnt they didnt know some of the forms of risk that they had.
Thats exactly right.
NEWSCASTER: Sales were higher than most regions, up more than 40 percent in the West and Northeast
NARRATOR: Housing prices continued to soar.
NEWSCASTER: The average price of a new home grew slightly
NARRATOR: Banks packaged more and more CDOs. Theoretically, there was no limit. An investor didnt
need to own any actual mortgages. So-called synthetic CDOs allowed investors to bet many times over on
someone elses portfolio of debt.
BILL WINTERS: 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.
[www.pbs.org: More on synthetic CDOs]
Prof. FRANK PARTNOY, Univ. of San Diego School of Law: 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 wouldnt stop you from doing it again and again and again.
MARTIN SMITH: So how is that different than betting on the outcome of the Super Bowl?
DENNIS KELLEHER, Better Markets, Inc.: Or a horse race or a craps table. Theres no different at all. Its
just a pure bet by somebody who has no economic interest in what theyre betting on. Youre going to bet on
the outcome of the Super Bowl, youre going to bet on the outcome of a horse race, or youre at the craps table
or youre betting on which way the dice are going to go.
MAN: Were pretty confident that the housing markets not going to down at all. Its just going to go up.
CHRISTOPHER WHALEN: Within a decade, you have the most phenomenal machine anybodys ever seen.
NEWSCASTER: New homes are selling at the second highest rate on record
MAN: We are in a housing boom. Its strong right now.
NEWSCASTER: Profits soared 93 percent.
NEWSCASTER: expected to dole out $36 million in bonuses this year.
GILLIAN TETT, _Financial Times: 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.
NEWSCASTER: Top executives will earn as much as $20 million to $50 million
NARRATOR: Between 2003 and 2006, Dick Kovacevich, CEO of Wells Fargo, remembers attending
meetings with bankers and regulators.
DICK KOVACEVICH, CEO, Wells Fargo, 1998-07: Oftentimes, what would happen at these meetings is
regulators would be there, like Chairman Bernanke, and there might be, I dont know, 30, 40 bankers. And they
would often go around the room and say, Well, what are you guys seeing out there? You know, Whats
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. Were building a bubble. Were not going to like
the outcome.
MARTIN SMITH: What did your fellow bankers say to you when you told them that you thought this stuff
was toxic?
DICK KOVACEVICH: Well, the ones that were in it said I was wrong and everythings fine. We dont see
any losses occurring in this.
MARTIN SMITH: But you saw risk all over the place.
DICK KOVACEVICH: We didnt even participate in the exotic subprime side of the mortgage because we
knew that this was absolutely wrong for our customers, if we would have done it, and would have been wrong
for us because we think this thing was going to blow up.
FRANK PARTNOY: Theres a great set of adages on Wall Street about where risk will flow. And if you ask
people, theyre 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, its the latter.
TERRI DUHON, B&B Structured Finance, 2004-Present: 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.
MARTIN SMITH: So let me get this straight. You were you were first to the party. You developed this
tranching of stuff
TERRI DUHON: Thats right.
MARTIN SMITH: and writing credit default swaps on it. But now everybody else has jumped into the
game.
TERRI DUHON: Everybody wants to do it.
MARTIN SMITH: But your team decided to stop. Why did so many others keep going, marching towards the
cliff?
TERRI DUHON: 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.
NEWSCASTER: Goldman Sachs Lloyd Blankfein will take home $53 million.
NARRATOR: No one wanted the party to end.
NEWSCASTER: pocket an estimated $40 million
NARRATOR: Most banks believed housing prices would never go down, let alone crash.
BLYTHE MASTERS, Head of Global Commodities, JP Morgan: To imagine losses of that severity
required very significant assumptions about the path of the economy which were just not in peoples mind. So it
required things like assuming that house prices in the United States fell by 25 percent.
People werent 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.
NEWSCASTER: As interest rates rose early this year, home sales slowed. And after years of record
appreciation
NEWSCASTER: businesses and individuals do, as well, and the cost of borrowing is going up.
NARRATOR: The unraveling began in late 2006.
NEWSCASTER: Big trouble for millions of American home owners
NARRATOR: When housing prices started to drop, only a very few bankers could see the bubble they were
trapped in.
NEWSCASTER: The housing market has turned some mortgages into time bombs.
SATYAJIT DAS, Author, Traders, Guns and Money: 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?
NEWSCASTER: The Dow-Jones average seemed in freefall, ending the day down
NARRATOR: 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
LLOYD BLANKFEIN: [television commercial] We at Goldman Sachs distinguish ourselves by our ability to
get things done on behalf of our clients
NARRATOR: while Goldman Sachs, using credit default swaps, bet against them.
Sen. CARL LEVIN (D-MI), Permanent Subcommittee on Investigations: 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 didnt. 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.
NARRATOR: 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.
NEWSCASTER: Thirty-four subprime mortgage companies have gone bus
NARRATOR: One customer was that German Landesbank, IKB.
NEWSCASTER: Analysts say anyone associated with the subprime market is going to pay the price.
DESIREE FIXLER, Ariya Capital, 2008-Present: Even when there was a downturn in the markets, they
were still buying. I mean, the market is telling them. Its on the screen. There are headlines everywhere,
Danger. But they still wanted to go ahead.
MARTIN SMITH: 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?
DESIREE FIXLER: Those discussions the word crap wasnt 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.
NARRATOR: In July 2007, the German bank, IKB, stuffed with subprime, was the first bank to fail.
NEWSCASTER: hundreds of thousands of home owners are defaulting on their loans
NARRATOR: It was only a matter of time before the crisis came back to Wall Street.
NEWSCASTER: and that could hurt the value of homes nationwide by
DAVID WESSEL, The Wall Street Journal: We knew that the housing bubble had burst. But wed 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.
DANIEL K. TARULLO, Federal Reserve Board Governor, 2009-Present: 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.
NEWSCASTER: Last week was a difficult time in the mortgage business. There was talk about problems in
funds
NEWSCASTER: This was the most actively traded stock by far
NARRATOR: In New York, banks were trying to unload what they could. But there was confusion. At
CitiGroup, they were running in circles.
FRANK PARTNOY, Author, Infectious Greed: 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.
DANIEL K. TARULLO: 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.
MARTIN SMITH: that was astounding to you.
DANIEL K. TARULLO: It was astounding to me.
NEWSCASTER: The sort of origination of these subprime loans, the creation of the CDOs that business is
gone.
NEWSCASTER: And the reason why is all those credit default swaps
NARRATOR: It would all come down to those credit default swaps. Would they pay off as they were designed
to do?
DAVID WESSEL: We have known for generations that banks are susceptible to runs. Banks cant function if
everybody comes and wants their money at the same moment.
NEWSCASTER: Merrill Lynch, devastated by losses
NEWSCASTER: The failure of Lehman Brothers and the fire sale of Merrill lynch
NEWSCASTER: starting to take a closer look at AIG. The worlds largest insurance company
NARRATOR: This time, it would be a run on an insurance company. AIG was on the hook for $440 billion
worth of credit default swaps.
NEWSCASTER: credit default swaps
SATYAJIT DAS: Remember, an insurance contract is only as good as the credit quality of the insurer. They
have to pay you. And if they cant pay you for whatever reason, then this whole process of risk transfer breaks
down.
NEWSCASTER: We need to stabilize this industry. It can spread throughout the economy. It could be a very,
very dangerous
STEVE BARTLETT, Pres., Financial Services Roundtable: September 18th of 2008, when I have a
conference of my CEOs, and CEOs traditionally dont 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.
NEWSCASTER: the enormity of the situation, like a financial nuclear holocaust. Some $400-odd billion of
credit default swaps
NEWSCASTER: another government bailout, AIG securing an $85 billion
DANIEL K. TARULLO: AIG could not conceivably have paid off all of those credit derivatives because it
had misunderstood the risks and did not have what wed call a balanced book or nearly enough capital to back
their losses.
MARTIN SMITH: Didnt everybody know that AIG was holding a lot of CDSs?
CHRISTOPHER WHELAN: No. There was no disclosure. Thats the whole point They havent reported this
to anyone else. The other dealers have no idea whats going on. The other banks dont know. Nobody knows.
The banks turned this market into their own private game.
SATYAJIT DAS: 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 cant honor the contract, the entire system implodes.
NARRATOR: The idea dreamed up by a group of young JP Morgan bankers at a weekend retreat many years
ago was supposed to reduce risk.
GILLIAN TETT: 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.
BLYTHE MASTERS: 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 wasnt it wasnt really conceivable to do that. I couldnt get my mind around it. I
know others couldnt.
TERRI DUHON: 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 didnt 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. Theres a
whole system of people who maybe were turning a blind eye, maybe were, you know, just I dont know.
Its its frustrating to see, certainly.
DICK KOVACEVICH, Chairman, Wells Fargo, 2005-09: It shouldnt 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.
NARRATOR: 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.
Prof. FRANK ALEXANDER, Emory Univ. Law School: Cities throughout the United States are seeing a
rise in vacant and abandoned properties. And thats where the neighbors feel it. As neighbors, were 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 its 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.
NARRATOR: Sometimes, no one even knows who owns the properties.
MTAMANIKA YOUNGBLOOD, Atlanta Housing Activist: Its hard to know who owns it because its 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 its just in no-persons land. Its a vacant property, mostly vandalized, and it just sits here and we cant
do anything with it. And the reality is that that plays out across this neighborhood hundreds of times.
ROY BARNES, (D) Governor of Georgia, 1999-03: That house has a loan that is somewhere lost in a huge
financial vehicle put together by some young Turks on Wall Street. Its lost in that billion-dollar package
because theres 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.