>> tonight ofrontline, part two of a four-hour special investigation. >> the economy is melting, the bush administration is leaving. obama gets a real glimpse of the future. disaster is coming. >> the epic story of the globl meltdown continues. >> the american people are angry. >> those banks needed to be held accountable. >> inside the politics of the financial crisis... >> why do we not fire the ceo of some of these companies that got into terrible trouble? >> taking on banks "too big to fail." >> how can we not demand from the banks some conditions upon getting bailed out? >> there was almost two ces of obama. publicly he wanted to tell you that these were the fat cat bankers. privately he wanted to get them onboard. >> a global crisis... >> the bankers were fanning out across europe. investment banks such as goldman sachs were eager to lend to
risky places such as greece. >> even convents are being sold derivatives. >> and a culture of greed. >> it's actually known as "casino banking." >> one loophole after another. >> they came down here like sharks to raw meat in the water. >> have i got a deal for you. >> "money, power and wall street" part two, tonight on frontline. >> frontline is made possible by contributions to your pbs station from viewers like you. thank you. and by the corporation for public broadcasting. major funding is provided by the john d. and catherine t. macarthur foundation, committed to building a more just, verdant, and peaceful world. and by reva and david logan, committed to investigative journalism as the guardian of the public interest. additional funding is provided by the park foundation, dedicated to heightening public awareness of critical issues.
by tfrontline journalism fund, supporting investigative reporting and enterprise journalism. and the best exotic marigold hotel, in theaters this summer. >> so much for that election day euphoria... >> the economy has now lost 650,000 jobs just in the past three months... >> narrator: the inauguration was 76 days away. >> this was the most eventful and consequential presidential transition in american history. >> all eyes are now on barack obama to turn it around... >> narrator: in chicago, president-elect barack obama was watching the economy continue to collapse. >> this is like watching a train wreck in slow motion... >> the s&p 500 in an 11-year low... >> he had to start thinking
about this the day after he was elected. >> and the losses just snowballed... >> narrator: at the start of his presidential quest, obama had chosen a dream team of reform-minded economists. >> and that team, for the most part, gathers around barack obama as he rises. and who have you got? you've got robert reich, the liberal labor secretary under bill clinton. you've got joe stiglitz, who, of course, called the crisis earlier than anyone. and at the center of it all, you've got all 6'8" of him, paul volcker. >> narrator: they had been advising him for months-- warning, really. >> obama at that moment gets a real glimpse of the future: disaster is coming. >> narrator: and in those first weeks after the election, his entire economic team was stunned by the bad news. >> we were all worried about what we were seeing. we knew that the credit system was pretty quickly headed towards something that looked a lot like seizure. >> narrator: unemployment was
nearly 7% and climbing, the stock market was down more than 6,000 points. >> there was a growing sense of calamity. this could be the most climactic economic cris in all of american history, that we were that close to a complete meltdown. >> at the end of the conversation, there's basically no bright spots. and i say to the then-president- elect, "wow, that had to have been the worst economic briefing a new president's had in, you know, almost a century." and the president says, "that's not even my worst briefing this week." >> citigroup, which crumbled 26% today, was one of the biggest... >> narrator: just then, overleveraged and filled with toxic mortga assets, the megabank citigroup was failing. >> every option from a merger to a possible fail is on the table. citigroup stock fell 23%. >> it's a very dynamic situation, because the economy
is melting. the bush administration is left or rapidly leaving the stage-- "this is beyond our kin to manage. we're going to be out of here in january." meanwhile, there's no one really to manage it. >> the federal government plans to pump billions of dollars into citigroup. >> the government rescued citigroup from the brink. >> narrator: george w. bush's treasury secretary henry paulson had already spent $125 billion bailing out wall street's largest banks. and now during the transition he would spend another $20 billion to keep superbank citigroup afloat. but it wouldn't stem the unfolding disaster. >> that period, when we go back and look at the history books, i think is going to be one of those periods where you look and go, "what were they doing? why did nothing happen? why was there no political will to do anything?" and the reason was very simple: there was nobody in charge. there really was nobody in charge.
>> profits in the banking industry are plunging. >> there's news today of a federal bailout for a wall street investment firm... >> narrator: the economic meltdown had begun eight months before, in the middle of the election. >> are you fired up? are you ready to go? fired up! >> narrator: candidate barack obama had made the economy a key issue. >> we've got eight years of disastrous economic policies, that's what we're going to change when i'm president of the united states of america. >> obama very early realized that things were only going to get worse. and so, obama made this decision: "the thing i'm going to run on is that there is a problem in our economy, my opponent doesn't see it, and i can fix it." >> narrator: and early in the@i campaign, he had traved york to push for wall street to change its ways. >> i actually went down to the cooper union speech with him in his car. >> senator barack obama...
(applause) >> he was talking about the idea of making sure that the ethics of wall street was pure and that we were doing the business that we should be doing. >> thank you very much. thank you. we let the special interests put their thumbs on the economic scales. we've excused and even embraced an ethic of greed. >> the cooper union speech was essentially obama's effort to say to the democratic party and to the country that he believed that we had to rein in wall street, we had to resume more aggressive regulation of wall street. >> instead of establishing a 21st century regulatory framework, we simply dismantled the old one. in doing so we encouraged... >> narrator: in the audience, wall street's power brokers were paying close attention. >> he was sitting in the heart of the world financial center,
talking about regulation before we started talking about regulation. >> a free market was never meant to be a free license to take whatever you can get, however you can get it. >> i would say the reaction wasn't great from wall street. but to the president's credit, that didn't stop him from laying out what he thought was going to be necessary. (applause) >> thank you. thank you. thank you. >> narrator: but now, during the transition in chicago, president-elect obama faced a crucial decision about the economy: what team would he put together to carry out his agenda? >> the rumors were swirling. "so, who's going to be secretary of the treasury? who's going to be the head of the nec? who's going to be what?" >> narrator: the decision would be an early signal.
was the new president going to ally himself with those who wanted to reform wall street, or those who wanted to rebuild it? >> there's people on the left who are saying that obama should appoint someone who represents a tough-on-wall-street regulator, someone who's going to take wall street to the wood house on behalf of the treasury. >> paul volcker is extremely close to obama... >> narrator: their first choice was paul volcker. >> a kind of adviser in chief during this financial... >> narrator: feared on wall street, he was the reformers' guru, a former federal reserve chairman, a pro-regulation advocate, and an outspoken critic of the wall street banks. >> volcker was the main force for a historic change that has brought inflation rates down for 30 years now, and interest rates have been declining for 30 years. >> narrator: picking volcker would deliver on his campaign promises to reform the banks and get tough on wall street.
but inside his transition team, there was also a more moderate faction-- veterans of the clinton administration. they had their own candidate. >> you could not afford to have anybody but the best, most knowledgeable person on the job with their hand on the wheel. tim geithner was the perfect person. >> narrator: tim geithner, the president of the new york federal reserve. during the financial crisis, he had led the bush administration's response on wall street. >> he's 47 years old, he looks like he's about 32. >> extremely smart, extremely aware of the stuff, very discrete, controlled. >> narrator: geithner's career took off in the clinton administration, a protégé of treasury secretary robert rubin. >> i knew he was a protégé of bob rubin.
and i knew that he was, therefore, of and by and from wall street. he sees the economy as a practical matter, the way wall street sees the economy. and, therefore, tim geithner is going to reflect what wall street ultimately wants. >> narrator: and during the meltdown, he had engineered the bailout of bear stearns, had gone along with letting lehman go bankrupt. but then pushed for a more than $180 billion bailout of the insurance giant aig. >> tim geithner thought that if they did not do everything they had to do to save aig, as distasteful as it was, that they would be jeopardizing the global economy. >> he certainly talks now of having stared into the abyss after lehman and concluded that that was not going to happen again on his watch. >> narrator: for obama, adding geithner, a key player during the bush administration, would be an unusual choice.
but the two men had formed a personal connection the first time they met, just before the election. >> the meeting was secret because they didn't want things coming out about who might or might not be in the obama cabinet. >> people tell me it was like-- men tell me, who know about this-- "it was love at first sight." and i got this from both sides. people close to geithner said he was "smitten." >> narrator: they were almost exactly the same age, born just two weeks apart. >> geithner is an obama kind of guy. he's a no-drama guy himself. i mean, their personalities sort of meshed, to some extent. >> they had an almost immediate mind meld. they'd both grown up partly abroad. they both had a parent who worked for the ford foundation. and they had a similar worldview. >> narrator: according to geithner's official calendar,
the meeting lasted only one hour. by now the financial crisis that started on wall street was going global. >> on the trading floors, turmoil. >> the global financial meltdown comes to iceland. >> today's was the nightmare scenario. >> we had a contagion that operated almost around the globe. the panic from lehman spreads to aig, spreads to morgan stanley, spreads to goldman sachs. suddenly ireland is having problems. suddenly the bank of england is-is bailing out banks. suddenly iceland is bankrupt. the govern... the state of iceland, it's bankrupt. an entire country! suddenly china has gone from being one of the world's highest growth countries to almost a no-growth country in the flash of an eye.
that's contagion. >> wall street will once again be keeping a close eye on the incoming administration... >> narrator: back in chicago, obama had news he hoped would reassure the markets. >> timothy geithner... >> narrator: tim geithner would be his treasury secretary. >> this is the guy who's going to be the point man in leading us out of the worst economic period since the great depression. >> narrator: then, another insider-- former clinton treasury secretary larry summers-- would be the president's chief economic adviser. >> old hands from the clinton era. >> obama called him one of the great economic minds of our time. >> obama was always looking for establishment guys. he was looking for establishment input, even sort of establishment affirmation. he definitely was a guy for whom credibility with the establishment was something that he cared about. >> narrator: summers had been president of harvard and had made millions working at a hedge fund. >> well, he was told that
appointing this team would present a problem. people will see it as reflecting the interests of the banks. "you're bringing in the same plumber that caused the problem. why do we believe that they're going to be fixing it, at least fixing it in the interest of the american people and not the interests of the bank?" >> narrator: but to obama's team, the choice signaled they intended to hit the ground running. >> i think the president's view was, "i got to have some people who can come in and are going to know what they're doing right away because it's such a dangerous moment." >> narrator: two-and-half months after he was elected... >> it's the inauguration day of the nation's first african american president. >> hundreds of thousands of people already... >> narrator: the president and his economic team arrived at the white house. >> i, barack hussein obama, do solemnly swear... >> narrator: now the financial crisis was theirs. >> it's like you're moving into a new house and the roof's on
fire and the basement is flooded and there's gas in the kitchen, there's a dog in the back yard. the question is, how do you make this house livable? >> narrator: next door at the treasury department, tim geithner was also just moving in. he hadn't yet hired a staff. >> when you go to the website for treasury and you try and figure out who holds what position, and it says, "vacant, vacant, vacant, vacant, vacant." they're still learning, like, which keys go to which locks and how to get around the offices. and they're being asked to provide the plan that will save the world. >> narrator: one of geithner's top deputies, lee sachs, was there. >> our piece of it was, how do you stabilize the financial system? it was all about making sure that we stopped things from going off a cliff. you need a functioning banking system to have a functioning economy, and so we were charged
with coming up with the plans to deal with that problem. >> narrator: just a few months before, geithner had been in and out of these rooms when the bush administration was spending billions of dollars to save the banks. but it hadn't been enough and the obama white house was under pressure to do something immediately. >> the white house tells geithner, "look, we've got to tell the american people something, we've got to tell the financial markets something. you know, ready or not, you guys are going to have to take this show public." >> i know how much pressure the president was feeling to produce, to show action, to do as much as possible to get out there with some appreciation of the magnitude of the problem and some sense of-of direction. >> narrator: on february 9, the president tried to do just that. he promised geithnerould deliver a plan to rescue the financial system.
>> my secretary of the treasury, tim geithner, working with larry summers, my national economic adviser, and others, are coming up with the best possible plan... >> president obama set a high level of expectations. the impression from watching that press conference was, "tomorrow, secretary of treasury tim geithner is going to tell us what the plan is to save the world." >> and so, tomorrow my treasury secretary, tim geithner, will be announcing some very clear and specific plans for how we are going to start loosening up credit once again. >> the white house announces that tim geithner's got the plan to fix the banks, and he's going to present it. >> i'm trying to avoid preempting my secretary of the treasury. i want all of you to show up at his press conference as well. he's going to be terrific. >> the president said, "tim geithner is going to come with a plan and that plan is going to contain the magic bullet." >> narrator: but inse treasury, geithner wasn't ready. his speech was still not finished. and larry summers, the
president's chief economic adviser, was not satisfied. >> the moment of reckoning is coming, and they're sending copies to larry summers. and summers writes back, "well, this doesn't sound like language a treasury secretary would use. you know, it sounds, you know, it sounds a little amateurish. it doesn't quite have the gravitas. you know, i don't think this is going to inspire confidence when you deliver." so they-they get very nervous and they tear that draft up and they're frantically reworking it. secretary geithner's time was up. >> you have everything set up-- a vip audience, cameras, all the press. markets are expecting something big, and they're expecting details. so the secretary walks out and frankly looked nervous. and he comes to the podium and there are two teleprompters there. >> thanks to all of you for
coming here today. >> he starts his speech, but he's just not good athis yet. and so his head's turning from one teleprompter to the next, and he gave the whole speech going like this. >> our plan will help restart the flow of credit. it will help clean up and strengthen our banks. >> at that point, geithner had never given a national press conference. this was the country's first view of this guy who was, you know, put in place to rescue the country from this crisis. >> geithner was very inexperienced before, you know, the public eye. before he became treasury secretary, had never once appeared on television. >> geithner looked like he was about 12 years old. he is not a good public speaker, and he just seemed like he wasn't ready for prime time. >> first, we're going to require... >> narrator: geithner's plan centered on what he called a stress test... >> ...comprehensive stress test. this borrows the medical term. we want their balance sheets cleaner and stronger, and we are going to help this
process by providing a new program of capital support for those institutions that need it. >> narrator: under the stress test, the government would examine the health of the country's biggest banks, and if necessary bail out those that were in the most trouble.jx >> they're going to go through and get some hard data, make as much of it public as possible and it'll be a confidence- building exercise for the banks. >> narrator: to many watching, however, geithner's plan seemed inadequate. >> it's a pretty bad flop. every cable network is showing the dow just collapsing hundreds of points as he's speaking. >> thank you very ch. thank you for coming. (applause) >> he gives his speech, he turns and walks away. and you could tell, even the vips, ben bernanke and everyone else are, "okay, well, i guess
we leave now." there was a little bit of clapping, and it's over. >> the market responds by dropping almost 400 points the day he announces it. over 4% it drops that day. >> this is the guy who's going to be our secretary of the treasury... >> it did not go as well as anyone had hoped... >> narrator: in the wake of geithner's speech, the financial markets were near a ten-year low and still falling. >> this guy brings no credibility. >> maybe he doesn't understand it well enough to explain it to the rest of us. >> the markets reacted in a way that none of us would have hoped. expectations got way out of control. we shouldn't have let that happen, frankly. >> narrator: they'd been in office three weeks. already obama was being pressured to replace his young secretary of the treasury. >> there was instantly chatter in washington, "how long would he last? is he going to be the first one out the door? is obama going to have to find somebody else?"
>> people start saying that this guy is in over his head and is just not the right guy for the job. >> everybody's calling for blood, right? they want this sacrificial lamb, and it's going to be geithner. >> narrator: but in the oval office, geithner mounted a spirited defense. he stood by his strategy for stress tests. >> the guy people describe is a different guy than the one we all saw on tv. and he was very convinced that this was the way to go, and he was very resolute. >> he was unflappable. if you think about what was going on in the markets, what was going on in the economy, the pressure that you can imagine, he didn't miss a beat. >> narrator: geithner walked obama through the details. >> the stress test, which is ultimately geithner's solution to this problem, kind of grows out of that idea that if you can just convince the markets that these guys are going to be okay, that the hole isn't as bad as everyone's worst-case scenario suggests, then the panic will
subside, confidence will come back, prices of securities will rise, things will just level off. >> narrator: critics doubted the stress tests would be enough. but for now the president would stick with geithner. >> obama couldn't back off of tim geithner at this point. you're in the honeymoon stage of an administration, you can't dump one of your guys. so he stands by tim geithner. >> the president stuck with the secretary. and he was under tremendous pressure to change course. i've got to believe that this decision was one of the hardest decisions he had to make at that time. (shouting) >> firms gave out $18.4 billion in bonuses... >> narrator: for months there had been public anger at wall street.
>> the same year the dow jones... >> the sixth highest total on record... >> narrator: the focus was ceos like the chairman of lehman brothers, dick fuld. >> you belong in jail. >> you blame it on the people who want housing. >> you belong in jail. >> ...growing backlash against wall street... >> ...frustration with the economy... >> ...anger from the u.s. public... >> narrator: and in cities across the nation, protests erupted... >> banks got bailed out; we got sold out. >> narrator: in chicago, bank of america ceo ken lewis was seen as one of the villains. >> ...story the obama administration doesn't need... >> narrator: in washington, outrage at wall street and the bailouts pushed the anger to the edge. >> we're on the sidewalk. and now you're on the sidewalk too. (coughing)
>> other one. other one. >> narrator: and the anger was not just confined to the streets. on capitol hill, congress responded to the public anger. they summoned the heads of the nation's biggest banks. >> let me be frank, my constituents in illinois are angry and so am i. >> what did the banks do with the taxpayers' money? >> i cannot believe no one's prosecuted you on this. >> it was chilling to watch that. i mean, just to see them all lined up next each other. i think most americans, when they saw that, thought of the heads of tobacco. that's where we're at. we have an industry that's just vilified to that point and the frustration is so high. >> the whole thing, frankly, had a bit of political theater element to it, that particular hearing. there seemed to be a little bit of a contest to who could get these guys by the scruff of the neck and slap 'em around the most. >> as of matter of fact, bank of
america, you paid yourself $30 dollars in fees just to accept our tarp money. >> i don't know what you're talking about. >> narrator: bank of america's ceo ken lewis was in the spotlight. his bank had taken more than $45 billion in government bailouts. >> it was clear we were there to take a public whipping, you know, and we did. i just tried to think of it that way and think of it as, "this too will pass" and just get through it. >> there has been wide speculation that some of our larger banks around the nation may end up being nationalized. do you feel that your bank should be considered one of those banks at risk? >> are you talking to me. >> yeah. >> absolutely not. i don't know why you would ask the question. >> this was a grilling that lasted all day. >> bank of america has to explain this to congress... >> growing public anger aimed at banks... >> do the banks need to be held accountable for their part...
>> narrator: at the white house, the political team worried it was just a matter of time before the anger would be aimed at the president. they wanted to make an example of one of the ceos. >> david axelrod, obama's top political adviser, very much wanted some scalps. robert gibbs, who was the press secretary, but also very senior political aide, wanted scalps. and even larry summers thought there should be a scalp. and that was when the talk drifted toward, do you fire, you know, the ceo of the bank of america? >> narrator: summers and the political team thought that maybe it was time for a ceo like ken lewis to lose his job. it would send the banks and the public a message: those responsible for the financial crisis would pay a price. >> summers thought that maybe they needed to have a change in management, at least one bank, and that they needed to send a signal that, you know, poor
performance was going to lead to consequences. >> royal bank of scotland is almost twice as big as citigroup. you know what the british government did? they took it over and fired the ceo. guess what? when we had the problem with car dealers, car companies, we went out there, we fired the ceo. why do we not fire the ceos of some of these companies that have gotten into terrible trouble? >> narrator: it would have been a bold step for obama, but tim geithner warned the president against it. he wasn't going to participate in what he called "old testament justice." >> geithner didn't want to do it because it would kind of create this risk. it would create this conception that the government was going to come in and mess with these banks, and that would frighten off private investors. >> narrator: geithner believed the banking system was still fragile. >> this notion that the financial system was so fragile
that you couldn't do anything that might hurt confidence, it becomes very formative and very important to understanding geithner. he is very afraid to do anything to roil the market and to create fear. it becomes this very delicate, "let's tiptoe around the situation." >> narrator: he saw the banks as an ailing patient in critical condition. he had taken to invoking the first prinpal of medicine. >> the first rule is, to borrow from medicine, the hippocratic oath-- first, do no harm. and there were a lot of ideas out there, frankly, that some of us thought might do harm. >> narrator: geithner insisted now was not the time to reform wall street. but inside the white house he had a powerful opponent: larry summers. >> the hard part about larry summers is, (a) larry summers wanted to be treasury secretary, still acts in some cases,
depending on who you talk to, like he's treasury secretary. >> summers is very smart, very experienced and has very sharp elbows. >> narrator: summers, a highly regarded economist, believed wall street was fundamentally broken; aggressive reform was necessary. >> he thought that there was perhaps trillions of dollars in losses. and that, you know, you were going to need to do something really bold and aggressive to solve that problem. >> narrator: summers had a bold idea. >> he wants to restructure the major "too big to fail" banks. >> narrator: summers wanted to take on and break up at least one of the "too big to fail" banks. >> larry says, "what if we don't bail out these institutions? what if we restructure them? there's going to be blood on wall street, a lot of it. wall street won't exist the way it has existed up to now, it going to be restructured."
>> narrator: summers was concerned about "too big to fail" banks like citi, wells fargo, bank of america-- the new breed of superbanks. >> they bought and bought and bought. and they would buy one bank and then they'd buy another bank and get bigger and bigger and bigger. even if they got bought by someone else, they were the ones who ended up taking over the show. >> narrator: but in the crisis, the banks were so large and interconnected, the government felt it had to bail them out because their failure could bring down the entire economy. they are "too big to fail." >> the financial system is too dependent on them. and, therefore, the taxpayers, we have in effect decided that we will not allow them to fail. >> narrator: and summers now believed some of the "too big to fail" banks might be on the verge of collapse. the time was right to do something dramatic about it. >> his thought was, "well, we
need to take over, to shut down, to nationalize the weakest of the banks." and, (a), that would set a good example. you know, wall street would see thatf you gamble with your own fortunes, if you gamble with the country's fortunes, and you fail, you're going to get shut down, you're going to lose. that supposed to be one of the basic lessons of capitalism. >> narrator: and summers had a formidable ally-- christina romer, a berkeley economist who had been picked as one of obama's top advisers. >> larry summers and i were both on the side of we needed a more definitive cleanup of the financial system. and, the question was if somebody, you know, really wasn't solvent, do you need the government to put in capital, realize the losses, ean it up and then put it back into private hands? >> narrator: but geithner completely disagreed. he thought the banks were vulnerable, and that summers was playing with fire.
>> if you're going to take over one of these institutions, that's like pushing a boulder off a... down a hill. you have to make sure that you have enough firepower to stop that boulder from rolling all the way down. >> narrator: on march 15, they all gathered with the president. summers versus geithner-- a showdown. >> it was an extraordinary meeting. it was literally a six-hour murder board in which you had the president of the united states, sometimes aided by larry summers, really asking the hardest questions, raising every criticism that was being raised from the outside. >> narrator: summers and his allies argued that geithner's stress test plan was not aggressive enough.
>> the stress tests are a part of a confidence game. many people in the administration, and out of the administration, were worried that the stresses that the system would be put through were not real stresses. >> i was one who was critical of the stress tests and worried that the scale was going to be tilted in a way that you get the result you want. you know, it's not that hard to cook a stress test and make it look like you're in much better shape than you are. >> narrator: geithner would not back down. >> tim says the stress tests are enough. it's real action. summers says, "no, it's not. it's watchful waiting." tim is livid-- "it's not watchful waiting. it's not just waiting around. it's real." and larry said, you know, "what you're doing is not action that's needed. you need to pull off the band-aid." >> narrator: hour after hour, in front of the president of the united states, tim geithner stood up to larry summers. >> the secretary just kept methodically, but clearly,
making the case that the plan we had laid out had the best chance of success with the least downside risk. and he just, every time someone would raise another point, he would just, again, go through it. >> narrator: obama listened. should they take on a major bank? were geithner's stress tests the best way to go? for now, he'd keep his own counsel. >> for the economy, this is what free fall feels like... >> when will the recession end? >> narrator: two weeks later, the nation's top bankers were summoned to the white house. >> ...after leveling some very harsh words at bankers... >> narrator: the president wanted to talk to them. >> looking for accountability from the nation's banking leaders, today president obama... >> thirteen bankers were called into a room to meet with the president of the united states.
they were told they were going to be chastised, that this was going to be the opportunity for the president to vent the public's anger. >> narrator: the bankers feared they could be forced to accept dramatic reforms: a ban against "too big to fail," a limit on executive compensation, and a requirement that they refinance mortgages for underwater homeowners. >> walking into that meeting, these guys have not been this nervous since they were in nursery school. they're ultimately powerful, sovereign men, atop their institutions. but now they know that they really could get whacked. >> narrator: no one knew what to expect-- summers' "old testament justice" or geithner's cautious encouragement.
now they'd find out what he thought. >> obama comes in, and he's all business. >> narrator: there were few pleasantries exchanged. the president spoke first. >> the president made it pretty clear when he talked to us, you know, "we're between you and the pitchforks, guys, and you need to just acknowledge that." >> the bankers have essentially made a decision that they're prepared to go along with what needs to be done to resolve this problem, to get the public back on the side of corporate america. >> narrator: but as the meeting progressed, to their astonishment, it became clear the president was in no mood for confrontation. >> what's interesting is that the next statements and the rest of the meeting essentially is obama skinning back as fast as he can on that pitchforks punch. and he says, right after that,
"what we have, gentlemen, is a public relations disaster that's turning into a political disaster. and i'm here to help." >> i interpreted it as a kind of a watershed time. banks are the catalyst to get us out of this morass that we are in. you can talk so long about the past, but at some point you've got to look at the present and the future. and i felt that's what he was saying. >> i think the president sees himself as a pragmatist, and i do too. "let's get through this. let's be pragmatic. let's not shoot for the moon and miss. let's accomplish as much as we can, but let's do it with the certainty that we know we can produce by taking this a little more cautiously."la >> narrator: the president required no firm commitments from the bankers. >> i think it was clear it was an opportunity lost. he had a room full of very frightened ceos. he was in a position then to make demands and he didn't.
>> he didn't want to disturb the banks. he wanted them on their side so that things were as calm as possible. there would be basically business as usual. >> narrator: the president had decided-- geithner had prevailed. that day there would be no aggressive action to take on wall street. >> there was almost two faces of obama. publicly, he wanted to tell you that these were the fat cat bankers. but privately, when he was with the bankers, he wanted to get them on board. >> good afternoon. i'm john stumpf with wells fargo... >> narrator: the bankers made it clear the president had let them off. >> we had a wonderful meeting today with the president. the basic message is we're all in this thing together. >> we're quite pleased with the cooperation that's evidenced with the group and with the white house. >> i think the bankers came out
of that meeting realizing that they had dodged a bullet, and that was what was required of the was to go out, stand before the cameras and speak as though everyone were in harmony, that they and the president were on board, to make this great expression of confidence and reassurance. >> we, all of us, walked out of there knowing fully that we're all in it together. and we're all looking forward to promoting a recovery-- economic recovery. thank you. >> narrator: the bankers who left the meeting that day had already received more than $180 billion from the federal government with almost no conditions. >> no strings attached? i mean, everybody else-- homeowners, everybody else who's trying to get a loan, everybody on main street, small businesses-- not only are they not able to get loans, but if they get anything there are huge strings attached. how, in good conscience, in good faith, can we not ask the banks-- demand from the banks--
some conditions upon getting bailed out? that just seemed incredible. >> narrator: unknown at that time, many of these banks had been drawing on a vast reservoir of cash from the federal reserve in order to keep their daily operations from freezing up. it had started more than a year before, during the bush administration. >> now we know that these banks were not successful. these banks were on the brink of failure. what we found out was that the biggest banks in the united states borrowed a heck of a lot more money than anybody had imagined. >> narrator: the details of the loans became public only after bloomberg news took the case all the way to the supreme court. >> so what we found out, really, was that wall street was in much, much deeper problems, they were in much deeper trouble, than we ever imagined. on the peak day in 2008, it was
december 5, 2008, the banks had taken loans of $1.2 trillion. and that's one day. and out of that $1.2 trillion, not necessarily on the same day, morgan stanley alone took out $107 billion, had $107 billion in loans out in a single day. citigroup-- over $99 billion on a single day. bank of america-- $91 billion on a single day. royal bank of scotla, ubs, all the biggest banks in the world, had borrowed way more than we ever thought. >> narrator: the loans were part of an unprecedented intervention in the financial system. in all, the federal reserve made available more than $7.7 trilli in loans, commitments and guarantees to financial institutions around the world. >> the data shows the fed was lending not just to american banks, but to banks all over the
world, and in amounts that were really astonishing. >> another big bank is in the black... >> people starting to get comfortable that maybe these banks can earn through their problems... >> narrator: but in that spring of 2009, in new york, the public was hearing good news about the banks. >> bailed out banks reporting billions in first quarter profits... >> so should we be outraged or enthused? >> narrator: just in time for tim geithner's stress tests. >> they sent all these supervisors from the fed to kind of look up and down the banks and to see if they have enough capital. >> it was a three-month process. all the bank supervisors working together in an unprecedented fashion, digging into the books of each one of these banks. >> the government today officially announces the results of the financial stress tests... >> today was report card day... >> narrator: by may 7, the government was ready to reveal the results. >> today, we got the official findings...
>> these actions today are going to bring an unprecedented level of transparency and clarity to the health of the nation's banking system. they're going to replace... >> narrator: according to geithner's stress tests, the nation's 19 largest banks were fundamentally healthy, and soon they would repay their loans. >> replace the government's investments with private capital as soon as possible... >> none of the 19 banks are at risk of insolvency... >> tim geithner feels like he saved the financial system and that he did so at extraordinarily low cost. >> narrator: and geithner took a victory lap. >> when those stress test results come in and the news is quite good, he goes over to the white house and actually shows the president some of the reports, sort of his moment of, "you see, mr. president, i was right." >> narrator: the president and even some of geithner's white house critics seemed pleased. his position as secretary of treasury was secure. >> looking back, i actually think they were pretty effective. and if anything, the financial
sector is highly profitable again. i think the problem is that they're about the only ones that are highly profitable right now. and so, that leads to, i think, very justifiable anger at bailouts that didn't help the middle class enough. >> we're mad as hell and we're not going to take it any more. >> hundreds of rallies in all 50 states today... >> they came to vent their outrage in big gatherings and small groups... >> narrator: august 2009-- the wall street bailouts stoked new anger from a new movement: the tea party. >> runaway government spending... >> they want to send a message to bailed out companies... >> stop spending my kid's money. >> narrator: the anger was over health care, taxes and especially the bank bailouts. >> there was a lot of anger, a lot of incredible concern about what was going on. the american people were angry to a person. they were just angry. >> no! no! >> hardworking americans all across this country, you know, they have a right to be offended, to be frustrated by what they saw happen.
those banks needed to be held accountable. >> narrator: much of the anger was directed personally at president obama. >> ...at president obama's stimulus package and budget in particular... >> obama's a marxist, socialist... >> we are the people and we have finally awoken and we arnot going to stop until we take down this government. >> you work for us! you work for us! >> it was this new force in american politics. and the white house did not have a plan to counter this. it kind of caught them by surprise. and on the communications front, they were flatfooted. >> narrator: at the white house, chief of staff rahm emanuel had been worried about the growing public anger for months, telling the president he should act. >> rahm emanuel, he recognized that you cannot inject hundreds of billions of dollars into the banking system without reassuring the american people that this is not going to happen agai >> rahm emanuel is quite
forceful. now emanuel is usually a guy for favoring do no harm, favoring wall street, says, "now is the time, mr. president, for old testament justice." >> narrator: now the president decided to revive a central theme of his campaign: reforming wall street. >> president obama visits new york today to deliver a major address to wall street... >> one year to the day after the fall of lehman brothers... >> narrator: that september, on the one-year anniversary of the meltdown, the president headed to wall street to again make the case for reform. he would push for legislation to reform the banks. >> calling for immediate action to reform financial regulation... >> we've seen bailouts, stress tests, an alphabet soup of treasury and fed programs... >> he decides to have a meeting that's literally steps from wall street, right? i mean, federal hall is... you can walk down to the exchange floors. >> narrator: washington's power brokers were there-- congressional leaders, tim
geithner, even paul volcker. >> ladies and gentlemen, the president of the united states... >> narrator: but many of the titans of wall street didn't show up. >> essentially, none of the big figures from wall street show up to hear the speech. they all... they all just stay in their offices and do their work. >> they don't even show up to the speech. jamie dimon and lloyd blankfein... it wasn't like the speech was scheduled, you know, without notice. they just had better things to do that day. >> narrator: none of the bank ceos had been fired or prosecuted. >> that's why we need strong rules of the road to guard against the kind of systemic risks that we've seen. >> those who attend from wall street, you know, they're checking their watches. you know, they're talking about their summer vacations. somehow they have survived this disaster of their own making, and it is back to business as usual. >> if you go have a speech on wall street and people from wall
street don't even show up for your speech, and you're the president of the united states, what more public display can you make, to try and force these guys to come and participate? and they apparently just felt like they could just wash their hands and walk away. >> it's a very difficult day for barack obama. >> we will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. >> once everything's calmed down, once the banks have gotten what they want, once revenues have gone up again, once things seem stable... >> thank you very much, everybody. >> ...they just completely disengaged. and there was no way for the white house to force them to the table. there was nothing that the white house could do. (applause) >> 52% of the american people disapprove of president obama's
handling of the economy... >> rising doubt about his approach on domestic issues... >> narrator: back in washington, the president's efforts to reform the financial system were competing with another priority. >> it was clear from the start that there were two options that obama could choose, but he could only choose one of them, because they were both huge, huge accomplishments. he could either reform the entire financial system, or he could get health care through. and they chose health care. >> narrator: and the health care battle was all-consuming. >> between the economy and health care reform, the president's approval rating is tumbling. >> you're tied down in this disaster of a public fight over health care. all the energy of the political people in the white house are fighting this health care campaign. >> there was no interest, no incentive inside the white house, for doing structural reform to the banking system before health care was passed.
>> narrator: as the health care debate heated up, reforming wall street was left to congress. >> the problem was the timing. it was 2010. and by 2010, the banks had recovered. they were much more aggressive. they were no longer under the thumb of the government. and they-they could, you know, water down big parts of the bill, buy off senators, and have more of their way. >> narrator: armies of bank lobbyists descended on congress. >> what you had was a financial system, individual banks, that were really rescued by the u.s. government and the fed, then using some of that money to influence the u.s. government to make the rules less strict on them going forward. >> the vast majority of money that was spent for lobbying was being spent by wall street. and they're hiring the very, very best people to do it. >> the lobbying effort has just been incredible. the banks have thrown every
weapon they have on washington. and it's, you know, this is what we've gotten as a result. it's like one loophole after another. >> the one thing that's been demonstrated by this is, if you leave the smallest hole, the littlest hole, very, very smart people on wall street will figure out how to slip through that hole. >> narrator: key congressional proposals to break up those "too big to fail" banks were kept out of the bill by wall street lobbyists. >> almost two years after the entire banking system almost collapsed... >> it's designed to prevent another economic meltdown... >> today, president obama signed into law the wall street reform and consumer protection act... >> narrator: on july 21, 2010, president barack obama signed what became known as the dodd-frank bill. >> and finally, because of this law, the american people will never again be asked to foot the bill for wall street's mistakes. there will be no more tax-funded bailouts. period.
>> narrator: the bill included some rules against risk taking by banks, limited consumer protections, and new powers for regulators. but even some at the white house admitted the reforms may not be enough. >> i think the weakness is that in order to get it over legislative hurdles, there were so many is and ts left undotted and crossed that big decisions that are actually of great importance are still being made. and they're being made in a climate where they're not necessarily under public scrutiny, where the lobbyists have a chance to get in and sway things their way. i very much worry that we haven't learned the lessons that this crash should have taught us. in an era of this level of interconnectedness, yeah, i worry, i worry that we haven't learned the lessons. >> narrator: the president's
supporters say his greatest accomplishment has been to save the financial system from complete collapse. >> the problem for obama is the thrust of his case right now to the american public is it could have been worse, you know? and that's a hard bumper sticker-- "it could have been worse"-- on the back of your car. i think... that's not something that you run for esident on. >> that's an abstraction that can't be proven, that you prevented something that didn't happen. and it's a much harder sell to say to the american people, as he's doing in this election, "it could have been worse." it's true, but it's not a very good... a very strong political argument. >> narrator: and many worry the serious problems are still out there. >> what we have done, again, is institutionalize "too big to fail." and in many respects, one crisis sows the seeds of the next crisis, and i'm afraid the next one could be even larger.
>> three pieces that we really had to get right-- "too big to fail," risky investments, derivatives-- it isn't a matter of opinion, those three things are three things that we really haven't solved and therefore until those are solved, we haven't dealt with the problem. >>ere we are three years plus after and very little has changed. in many respects, the financial crisis never ended. it never ended. people seemed to think about this financial crisis as one in which there was a run up to september 2008, a bailout, and then the crisis passed. but, in fact, those clouds are still hanging over the global economy. and they're still filled with risk. this crisis really never ended.
>> coming up next, "money, por and wall street" continues. >> occupy everything! >> occupy everything! >> the anger of the 99%... >> nobody knows how the system works, but the occupiers know the result of the system is not working for them. that's enough. >> the culture of high finance... >> this cult of "more, more, more, grow, grow, grow." >> being antagonistic to your client took on a significant life on wall street. >> a global crisis... >> investment banks such as goldman sachs were eager to lend to risky places such as greece. >> and an epidemic of greed. >> they came down here like sharks to raw meat in the water. >> have i got a deal for you. >> can the system be reformed? >> we can absolutely reform banks. we just have to care enough about it, and we have to trust that the world won't collapse in the meantime. >> the dramatic conclusion of "money, power and wall street" begins right now.
(sleigh bells ringing) >> narrator: every year in december, bankers find out if the bets they've made that year have paid off. it's christmastime on wall street. ("jingle bells" playing) by some measures, 2011 was a dismal year to be a banker. their stocks took a nose dive. but this season, new york banks set aside $20 billion in bonuses. since the crash of '08, banks have paid out more than $80 billion in bonuses.
while officials in washington focus on rule-making, nothing seems to have really changed the culture of wall street... a culture some feel has simply lost its bearings. >> i think it's probably not an over-exaggeration to say wall street kind of lost its senses. >> narrator: john fullerton is a former banker who says it all began when banks started trading for their own gain and not for their customers. >> it was the rise of trading that shifted the culture. and with that came this much more short-term, profit- generating, competitive mentality. there was just this kind of cult of more, more, more, grow, grow, grow. and i think now the culture on wall street is fundamentally unhealthy. >> ...commodity prices rising...
>> i grew less happy about my work and what i was doing every day. candidly, i felt it was beginning to change my own values-- you know, how i looked at myself and how i valued myself. >> ...managed to finish with a triple-digit gain today, but behind the scenes, another nail-biter. >> i never really cared about money per se. i never really wanted to become a rich person. i knew that the people i was working with wanted to be rich. so i wasn't offended by that idea. it seemed like a pretty typical american goal, in fact. >> narrator: cathy o'neil, a mathematician, came to wall street in 2007 after beginning her career in academia. >> i went to u.c. berkeley as an undergrad. i went to harvard for grad school. and then i was a postdoc for five years at mit. and i applied to work at a hedge fund, d.e. shaw, and i got the job. and i thought, "this was great." i was a quant.
a quant uses statistical methods to try to predict patterns in the market. >> narrator: her work was used to predict when big pension funds would buy or sell so the firm could jump in ahead of their trades. >> i just felt like i was doing something immoral. i was taking advantage of people i don't even know whose retirements were in these funds. we all put money into our 401(k)s. and wall street takes this money and just skims off, like, a certain percentage every quarter. at the very end of somebody's career, they retire and they get some of that back. this is this person's money, and it's just basically going to... to wall street. just doesn't seem right. >> everybody kind of knows in their heart that something's not right. but once you are making money for a while, you don't ever want to stop making money. >> narrator: caitlin kline came
to wall street in 2004. she says it was all very seductive. >> your whole first summer is taken up with things like golf lessons and negotiation classes, wine tastings, things to make sure you know how to handle yourself in a business environment. >> narrator: kline was a math major at new york university and considered becoming a teacher. but she remained on wall street for six years. >> you have the sneaking suspicion that you're not contributing to society. but it was always really easy to say, "i know the risks. "they know the risks. "none of this is our money. so, you know, we can kind of do these things, and it's all fair game." >> i don't think i at any point thought i was doing anything harmful. i just didn't think i was doing something necessarily positive. >> narrator: alexis goldstein graduated from columbia with a degree in computer science.
she then designed trading software for deutsche bank and merrill lynch. >> there's an incentive to make as much money as you can for the firm. and in some senses, i think, for the traders, they think, "hey, i earned a billion dollars this year. i deserve some small percentage of that." what i think is incorrect about that is the behavior that that incentivizes is, "i'm gonna go for broke. i'm gonna try and make as much money as i can. and if it blows up three years from now, that's not gonna affect the bonus i make today." >> yahoo, 250 to buy, and i'm selling hewlett-packard about 200... >> narrator: the incentives are powerful. a young trader at a big wall street bank can make around $150,000 a year. >> all right, let's put all hands on deck. i'm tempin' up these mus... >> narrator: but based on performance, that number can rise quickly. star traders make huge sums. >> martin smith: how much are you making if you're a star trader?
>> for a star trader, you could, after ten years, reach pay above $5 million or $10 million for the star performers. that wasn't the average. >> smith: $10 million a year. how much did you make as a trader? >> i think i was a star performer, so i probably followed the pay curve of the star performers, yeah. >> smith: so, between $5 million to $10 million a year. >> i mean, i guess so. >> smith: is that... is it a secret? >> (chuckling) well, it... it was a secret, in fact. i mean, compensations were not public, for all the obvious reasons. >> i'd really rather not say. if that's okay, 'cause i... i just don't know if that's publicly available information. but it's certainly like more than you would get at most first-time jobs. >> i shouldn't talk about that. that's in... that's in the contract. i can't talk about any salaries or bonuses or anything like that. but it was a lot of money. especially for young people, you
know. >> narrator: it wasn't always this way. for most of the last century, bankers made the same salaries as lawyers, doctors and engineers. the last time wall street saw extravagant compensation was in the run-up to the crash of 1929. >> the 1920s, of course, were a period of financial frenzy and and a big stock market boom. and there was a lot of innovating, risk-taking banking at that time. >> narrator: at the time, it wasn't uncommon for bankers to take home paychecks that, when adjusted for inflation, rival those earned by bankers today. but it didn't last. >> from the 1930s we got a period of reform and constraints placed on banks. they became much more regulated. and many of the banks were forced to do what you might call plain vanilla business.
take in deposits, lend it out. >> by looking in on frank hamilton, we'll learn the meaning of credit. >> you could make good money. don't get me wrong. but it was boring. it was very straightforward. it was about being in the community. it was about understanding who was a good credit risk. that's the history of american banking. >> when i started life in banking, it was basically a simple profession, very much like being an executive at an electrical company, or some sort of utility. you provided some essential services. >> in the old days, wall street and the finance industry financed things that got done, be they the railroads, or the interstate system... all of that has to be financed. that's what finance is supposed to be about. what has entirely changed is that they're in the business of making money for themselves. if it happens that they can also finance something along the way, okay.
but that's really no longer part of the core business. (applause) >> now it gives me great pleasure to introduce the president of the united states, william jefferson clinton. (applause) >> narrator: the changes were formalized in the late '90s, as the last of the depression-era reforms were lifted. >> the glass-steagall law is no longer appropriate.. >> narrator: and traditional commercial banks could merge with trading-oriented investment banks. trading activity and bank profits rose quickly. >> the trading side became overwhelming-- three, four, five times bigger than the banking side. but the banking side grew as well, but not as much as the trading side. >> this is very much the beginning of the brain drain, when wall street looked at people who had technical, scientific training, and it said, "we'll pay you double, triple, five times what you could make in any other field."
and if you're looking at those kinds of incentives, you're trained as an engineer, why wouldn't you want to make three times more money? >> two and a quarter points at five million. >> narrator: so they came. and many ended up doing what is called proprietary trading-- trading for the bank's own account. some bankers were uncomfortable. >> i think that sometimes we weren't really serving the interests of the clients. but we were serving our interests. and i didn't like that. >> narrator: claudio costamagna was the co-head of european investment banking for goldman sachs. >> everybody was making money. everybody jumped in. it's sort of, you know, human nature. you see your neighbor making tons of money in that activity. even if you don't understand it, you just walk in. >> smith: by "that activity," you mean what exactly? >> yeah, you know, selling derivatives, making proprietary bets and so forth and so on. >> narrator: derivatives.
it's where the really big money is made. >> i'm going to propose here a micron swap. >> narrator: derivatives can be many things but are basically contracts or bets that derive their value from the performance of something else: an interest rate, a bond or stock, a loan, a currency, a commodity... virtually anything. for traders, derivatives are a perfect product. >> smith: a derivative is something can be made up, crafted right on the trading floor and sold the next day? >> absolutely. most derivatives you don't need to have them in warehouses, you don't need to find them to sell them. you just can create them. >> narrator: they are also very profitle. >> if you take the trading revenues, i would say they would probably be easily two-third of the trading revenues was directly or indirectly associated with derivatives. >> smith: so, it's not exaggeration to say that trading of derivatives was really the lifeblood of the banks. >> yes, i think it's fair to
say. >> hey, listen, i'd buy ten million of these things at 6 3/8 points, and i'll show you 10 million of the as here. >> narrator: the problem with derivatives is that they can be very dgerous for unsophisticated customers. >> they come out at 10.33, versus 9.99. >> narrator: they often involve highly leveraged bets. a small change in market conditions can mean huge losses. >> the credit spread in here is about six fifty. >> narrator: and traders are incentivized to get the deals done, even if it's at the customer's expense. >> there was a phrase, "ripping someone's face off," that was used on the trading floor to describe when you sold something to a client who didn't understand it and you were able to extract a massive fee because they didn't understand it. and the idea was that this was a good thing, because what you were doing was making more money for the bank. and that sort of spirit of being antagonistic to your client actually took on significant
life on wall street. >> guys, halliburton the better side's the buy side here. we pay 85 for any part of 150 right now halliburton. >> narrator: banks want to do business where there is less regulation. >> and this week's program hears from some of the people who are being called "the new kings of capitalism." >> narrator: beginning in the '90s, many american banks found london preferable to new york. >> the two big markets that rival each other are new york, with wall street, and london-- the city of london. and in some instances, the key risk-taking activities were in london. they were outside the purview of american regulators. >> narrator: hundreds of young bankers moved here from wall street to pursue careers in derivative trading. as the economy boomed, british and american bankers became the toast of the town. >> these are the rock stars of london at the time. people being paid, you know,
$10-$15 million a year. and you saw them in their expensive shirts and in these vip places where there's like a £500 bottle of vodka, and there were all these girls in miniskirts flocking to these vip rooms, enjoying this, you know, once-in-a-lifetime opportunity, people in their 20s making this kind of money. >> you lived and breathed for the firm. i mean, the hours were insane. you never questioned it. and on a relative basis, you were making so much money and you felt grateful. you felt indebted to the bank. >> narrator: desiree fixler, a graduate of the london school of economics, sold derivatives for deutsche bank and j.p. morgan. >> i didn't think for myself. you know, i was so desperate to perform for the bank. i mean, for so many of us, if you slit our wrists, corporate logos would jump out. >> narrator: fixler was part of a small army of bankers pushing
derivatives to european markets. (phones ring) on the trading floor, they were known as f9 monkeys. >> smith: you were an f9 monkey? >> half of me was an f9 monkey. and the other half would be out on the road, marketing to accounts. >> smith: so what was an f9 monkey? >> well, just somebody who's just simply pricing all of these structures. >> smith: these are on the computer. >> exactly right. so you just had to put in a few inputs and press f9 and it would determine the price of the instrument and, in fact, your hedge as well. >> smith: and who did you... who did you sell to? >> hedge funds, to pension funds, to insurance companies, to all sorts of different types of banks. and there were many uses to the product. so it just... it naturally grew. >> narrator: after pricing the derivatives, teams of investment bankers hit the road. >> they're called investment bankers, but they're effectively salesmen.
their job is to go out and sell the stuff that the bank is creating. just in the same way a pharmaceuticals company would have a very large sales force, who go around selling their latest version of whatever the particular drug of the moment is. >> what sticks out in my mind is going to a group of italian companies and local governments and even convents that had been sold derivatives to try and make their accounts look better. and the theory was that these were sophisticated financial investors who could tell the risks. in reality, you had a bunch of nuns who knew nothing about this, but basically had bought it, hoping that this would somehow be financial alchemy that would solve their problems. >> these bankers were fanning out across europe, finding all of these clients that were... they were lapping up these deals. it's what you might call a form of governance arbitrage. where the bankers will find the... the type of client that
doesn't understand the product in order to sell the product that the client shouldn't be buying. >> smith: how many of these deals were being done? >> we don't know. these deals are confidential. we only know about them when the... when they go wrong. >> narrator: take, for instance, this small town, cassino, an hour south of rome. in 2003 a team of investment bankers from bear stearns arrived at cassino's city hall and met with officials. >> they went to cassino and they said, "we can lower your borrowing." they'd be saying, "you're paying five percent a year on your debt. we can reduce it to one percent or two percent. but you have to enter into a derivative with us-- an interest rate swap or an option, some kind of derivative where as long as something doesn't happen in the market, your rates will stay low." so they signed this contract with bear stearns, now j.p. morgan, and they got a benefit
from it in terms of lower borrowing costs. >> narrator: but it didn't work out that way. soon after the deal was signed, the interest rate the deal was pegged to began to rise. cassino found itself paying hundreds of thousands of dollars more in interest than it bargained for. (speaking italian): >> narrator: carmelo palombo is a former city councilman. >> smith: how well do these people understand the deals that they're buying? >> they had very little
understanding of them at all. they should never have been allowed to have been even talking to these investment banks. it was... it was a crazy idea for them even to get into these kind of conversations. >> smith: and when you talk to bankers, what justification do they offer for selling to rubes out there these complex financial instruments that they know they don't understand? >> they'd be saying, "well, they might win." you know? i can tell you... i can tell you a client who's done that bet and did very well out of it. >> i think very few people knew what they were buying. >> smith: but if they don't know what they're buying, then somebody's failing to do their job, aren't they? >> but in a way, i think that it's more on the investor's side that the due diligence has to be done. i mean, you know, it's-it's- it's... it's an open market. and so i'd put more blame on investors than on the banks that were selling them. >> smith: but who could understand these products besides the bankers? >> even the bankers didn't understand them.
>> narrator: cassino ended up paying bear stearns over a million dollars in interest. the town sued the bank now owned by j.p. morgan and received a half-million dollar settlement. but it was still left in the red. >> smith: you bought bear stearns in 2008. and they had done some deals in the town of cassino outside of rome? >> mm-hmm. >> smith: which... are you familiar with those? >> yeah. >> smith: was that a clean deal? >> i don't know. at the time that the deals were entered into... hard to tell. would j.p. morgan have done those deals? no. no. too complicated, too small a counterparty. >> smith: so in this case, i mean, you're holding banks responsible for leading less sophisticated municipal officials, you know, down the... down the wrong path? >> yeah, i would hold banks responsible for that. >> smith: that was the abuse of derivatives, right? >> there were abuses. in every market, there are
abuses. there were abuses in the derivative markets. because of the opaqueness of derivatives, it was probably easier to abuse in some cases. >> smith: and what does that say about the profession? >> it obviously doesn't cover the profession in glory. when you go through a period-- like we all did-- where really large amounts of money were available to individuals-- we're talking bonuses-- the incentive to cheat is very high. it's very high. >> narrator: by last count, over 1,000 municipalities and institutions across europe entered into similar deals with other banks like merrill lynch, ubs and deutsche bank. potential losses are estimated to be in the billions. scores of lawsuits have been filed. and it wasn't just in europe. the banks did deals in america, too, in places like birmingham, alabama, seat of jefferson
county. >> they came down here like sharks to raw meat in the water and... took advantage, full advantage of the opportunity that was here to make a lot of money. >> narrator: jefferson county had a problem. in 1996, it had squandered $2 billion to build a state-of-the- art sewage system. people were left with sewers to nowhere and huge monthly bills. >> if my bill is $30, i now have to pay $90. most of the people in this neighborhood are on fixed income. so even if you're paying $70 a month for water and sewage, and that $700 a year, that's pretty much the sum of their checks for the month. >> narrator: in 2002, the county was looking to refinance their sewer debt by issuing $3 billion worth of bonds. wall street bankers came knocking. >> the jefferson county sewer financing in $3 billion worth of
borrowing over a two- or three- year period would be a huge financing at that time in the marketplace. it would be a huge financing today in the marketplace. those numbers gets wall street's attention. >> narrator: one banker who called was charles lecroy. >> he was the leading producer at j.p. morgan, and supposedly, street talk is he was the largest profit center that j.p. morgan had for several years running. so he was hustling this product not just in jefferson county, but all over the country. >> narrator: one of the products lecroy was pitching to jefferson county was an interest rate swap similar to the one cassino had entered into. >> he says, "have i got a deal for you. we've got this new product, it's called a sp. and we know how to work this swap program to help write off, where you don't have to raise rates on your citizens." >> he said, with the refinancing, it would hold the sewer rate increases to single
digits, and it would also, over the long run, save the county $300-$400 million. >> narrator: in late 2002, a former local tv reporter turned politician named larry langford took charge of the county's finances. >> i think the bankers in new york with larry langford sitting across from them had to stifle the laugh. because you had a guy here who had no idea about swaps, had no idea about auction rate securities, had no idea about the financial market. >> nartor: langford decided to consult a friend, birmingham financial advisor bill blount. >> blount looks at it. says, "yeah, it's a pretty good deal, larry. we just swap this debt, you won't have to raise rates, everything looks great, here we go."
they didn't just do it once. they did it several times. they were swapping low to high, or variable to fixed, and they were swapping fixed back-- back to variable. where's the market going? if it goes up, we do this. if it goes down, we do this. very sophisticated transactions. i mean it was just basically commodity trading, because they were just literally betting against the market. >> today wall street had one of its worst days on record. >> narrator: but what the county didn't account for was a big change in the markets. in 2008, it all went horribly wrong. >> it was the day we were afraid to wake up to... >> financial institutions are in trouble. lehman brothers filed for bankruptcy. the worst financial crisis in modern times, and perhaps the end of an era in american... >> then in 2008, when the music stopped, in the fall, they pull out the chairs, they're several chairs short. >> narrator: the county suddenly
owed hundreds of millions of dollars in fees and penalties to its debt holders, including j.p. morgan. >> we knew we could not pay the warrants. you know, we knew we could not sustain the debt that we had amassed when the derivatives and the variable rates shot up. and so we just put off the fact that we were in bankruptcy, just like an alcoholic who never admits that they're alcoholic. >> narrator: and there was more. it turns out lecroy had paid money to langford's friend bill blount. >> if you didn't pay blount, you weren't in the deal. if you look at the timing of the transactions between langford and blount, you'll see that they correspond closely with the timing of the jefferson county financial transactions. >> narrator: according to federal prosecutors, the money was for bribes. $3 million from j.p. morgan to blount, who in turn passed money
and gifts to langford. >> i can't say that j.p. morgan paid bribes. certainly didn't pay any bribes to... to larry. now, what j.p. morgan did is they paid some benefits to bill blount. is it bribery, is it undue influence, is it good or is it not good? it depends on the situation. but certainly it's at least got the potential for corruption. >> narrator: in 2010, langford went to jail on charges of bribery and fraud. he is currently serving a 15-year sentence. langford's friend bill blount cooperated with authorities and is serving four and a half years. j.p. morgan settled with the sec for $25 million and was ordered to forgive the county fees totaling $697 million. charles lecroy was sentenced to three months in jail after a similar deal in philadelphia. >> jefferson county, alabama, was going to teach america how
to use swaps and derivatives. now it's running out of money. >> narrator: in november 2011, after years of corruption and mismanagement, jefferson county filed the largest municipal bankruptcy in u.s. history. >> ...markets for derivatives... >> ...worries about the economy... >> ...filing for bankruptcy... >> narrator: across the country, over 100 school districts, hospitals, as well as scores of state and local governments bought interest rate swaps. >> ...on the brink of financial disaster... >> narrator: with the crash, the deals backfired. in the last five years, swaps have cost american taxpayers $20 billion. >> today, in a strong day for the markets, the dow is up 30 points. it is above 12,000. nasdaq up six and a quarter, and the... >> narrator: on wall street, the derivatives business is sometimes called the solutions business. traders are constantly looking for big problems to solve.
>> ...1,000 in total... >> for a derivative person-- trader, marketer for the business-- naturally, you tend to focus your... attention to big problems. usually, big problems become a big source of opportunities and... and business. >> narrator: and some of the biggest problems and opportunities were in europe, when, starting in the '90s, countries were bidding to join the euro club. >> it became very clear that the question of who was going to be let into the club or not was going to rely very heavily on statistics. it's a bit like your sat scores for university. the question of how those are calculated is absolutely key. and what happened, as so often in finance, was that bankers bought it, a similarly dull geeky area that was incredibly important, that almost no one understo, and the politicians certainly weren't looking at and thought, "aha, here is a chance for arbitrage."
>> regulatory arbitrage. this is a kind of esoteric term. but basically what it means is figuring out a way to get around the law. and wall street has become very good at regulatory arbitrage. they're very good at figuring out a complicated financial structure that achieves some objective that you couldn't achieve otherwise in a legal way. >> your job was to find a solution, a legal solution, to selling these derivative products. and the more of this-- if you want to say regulatory accounting arbitrage-- that happened, um, the more you got promoted and the more you were paid. >> smith: so violating the spirit of... >> absolutely, yes. >> ...of regulations. >> yes, that... >> smith: that was very much the game? >> absolutely. >> narrator: so bankers descended on european capitals offering derivative solutions. >> derivatives became the name
of the game, became some kind of magic formula through which you could readjust macroeconomic imbalances across the border by speculating. it almost became something that you had to do, or you had to try. >> everybody was using derivatives. all agencies were looking somewhere else. all statutory auditors were looking somewhere else, all supervisors were looking somewhere else. many shareholders were looking somewhere else. >> narrator: countries also used other tricks. >> the french were cooking their books by reclassifying their pensions. the germans were cooking their books with gold transactions. this was a time when... when europeans were generally cooking their books. >> narrator: the first known case of a country using a derivative to window-dress its accounts was in italy. officials in rome had been struggling. >> in italy, the fear was that if we are not going to get hooked to europe, we are going
to get hooked to north africa. and so there was not much of a chance, there was not much of a choice about what to do about this. we had to be in europe, period. >> narrator: they turned to j.p. morgan for help. the bank sent the head of derivatives for italy, bertrand des pallieres. >> smith: you went to rome. you helped them enter a derivative contract. did it effectively lower their deficit? >> this transaction? did it lower their deficit? it's... this transaction probably had... yeah, this transaction lowered the deficit, absolutely. but... it's probably inappropriate for me to discuss, you know, too specific details. because i think i have duty towards clients. i have duty towards my employer. >> narrator: not all the details are known. but italy and j.p. morgan entered into a currency swap, a commonly used derivative. except in this case, the swap
was more complex. it had a built-in loan. >> this was done with j.p. morgan and italy as a derivative rather than as a traditional loan. it was not put on the financial statements. it potentially deceives the other countries in the euro zone into thinking that they are cleaning up their books more than they really are. (crowd cheering) >> narrator: in 1999, italy was allowed into the euro zone. >> the euro is the beginning of a strong european union. we shall be the best in the world. the best in the world. >> narrator: italy said derivative deals had little effect on their acceptance. but nobody really knows how many deals they entered into. >> derivatives are opaque. they're not publicly listed. no one knows who has what. even the central bankers don't
know who holds what in many cases. and so we don't know how many more of these trades j.p. morgan did with the government of italy. >> narrator: j.p. morgan declined to discuss the deal, but des pallieres says the bank did nothing to fool regulators or other european countries about italy's financial health. >> smith: did the deal with italy change the perception of the nation? >> absolutely not, absolutely not. and, furthermore, every transaction that we were involved in europe-- every transaction we were involved in europe-- were not hidden to the other european partners. >> narrator: des pallieres insists that his deals for j.p. morgan were all aboveboard. he won't vouch for other banks. but in 2003, nick dunbar published a story in risk magazine uncovering a secret deal between goldman sachs and greece.
the article revealed that goldman had sold greece several giant swaps to help greece meet its targets. >> smith: what was the reaction when your story came out? >> what happened was complete silence. i think i did one radio appearance and the story was just buried. nothing happened at all. >> narrator: the silence was surprising. this was the largest sovereign derivative deal ever reported. the deal cut greece's debt by around two percent. what other deals there were is not known. >> it was a secret off-balance- sheet loan. legal within the rules of the time, as goldman would say, but it was an off-balance-sheet loan. it's a very expensive form of borrowing for greece. by going through goldman, greece ended up paying something like 16% a year. it's a bit like a subprime mortgage or something like that. it's a crazy borrowing rate for
someone that's desperate to borrow money. >> smith: and how much did goldman make in the deal? >> i think you can safely say that goldman earned hundreds of millions on that deal. >> narrator: desiree fixler was working at j.p. morgan when the news hit. >> smith: when nick dunbar's story came out in 2003, what was the reaction inside the bank? >> the reaction wasn't... scandal-- "my goodness, i can't believe goldman sachs has pushed it this far and clearly has broken the spirit of the law." the reaction was, "you better go down to athens and find out if there's any more to do. how did you miss this?" so, most banks were trying to see if they could replicate it. >> i can tell you it's absolutely false. i was in charge. and i... you know, extremely knowledgeable in that domain. the position didn't make much sense. for greece, the transaction was
disguised from greece's partners and a number of other... and i think the margins didn't really make sense. >> smith: because it was too much dressing of the books. >> absolutely. >> smith: so you were leaving a lot of bonus on the table. >> oh, yes. when you drop... and when i speak about, you know, several hundred million transaction, it's several people around the table leaving several million of personal money. that's absolutely right. >> narrator: with its books dressed, greece had kicked their problems down the road. for the next several years, greece would also go on a massive spending spree. >> credit was easy, and big global investment banks such as goldman sachs were eager to lend to relatively risky places such as greece. and they were eager to tell their customers that these risks were not very big. >> banks considered greece almost as safe as germany.
so greece could borrow on german interest rates, and they were very low indeed. >> there was a bubble, a consumption bubble, i would say. banks were intermediating that. so we had an increase in expenditures way above our means. >> citizens of the world, welcome to athens! >> it has a special twist in greece because of the olympic games. there was a euphoria that led to irresponsibility. >> no one was thinking, you know, "the money's available, but we're borrowing it. and this is very expensive. and at some stage, we're gonna have to pay it back. well, how is that ing to work out?" greece being such a small country, being a small economy and one that wasn't really going anywhere, it was a disastrous mix. >> narrator: between 2001 and
2008, greece's debt had doubled. no one, it seemed, wanted to ask any hard questions, including the european regulator eurostat. >> i find it hard to believe that a continent that can figure out, you know, pretty precisely how many centrifuges iran is running at this moment enriching plutonium and uranium couldn't figure out that the greeks were cooking their books doing currency transactions with goldman sachs. i think they knew. in fact, i know they knew. and they just didn't care. >> smith: how do you know they knew? >> because i talked to them. they knew. the greeks had a constant dialogue with eurostat. now, doesn't mean that they didn't play a few tricks along the way that eurostat didn't know about, but eurostat knew the big ones. >> i would put it cynically as follows. for several years, greek governments pretended that to keep their public finances in order.
and their european partners pretended to believe them. >> narrator: the reckoning came in 2009. the newly elected government of george papandreou would arrive in office claiming to have no idea what the true size of the debt was or what tricks had been used to hide it. george papakonstantinou was the minister of finance. >> not until we sat down in the general accounting office and sort of slowly stripped the layers of expenditures that were due, but not really being recorded or declared... not until that time did we realize that what we had was a very, very serious problem. >> narrator: papakonstantinou had to deliver the bad news to his fellow european finance
ministers. >> our deficit for this year is going to be double the one previously projected. in double digits, around 12.5%. this means... i showed up and i had to tell them that the deficit was twice as big as they thought, twice as big as the previous government had told them, and six times as big as was originally planned. >> we felt betrayed, to be fair. because, you know, all of a sudden the public deficit that had been reported by the greek authorities at the time suddenly, you know, ballooned. and then it went, you know, sort of downhill from there on, because there were successive revisions of those numbers, on several occasions. >> some creative accounting is used by virtually every self-respecting government that i can think of, right?
but here again the greeks went a bit beyond the pale. >> there could be extensive foreign exchange volatility at the risk... >> a decade of frantic overspending has left... >> they will default... >> investors are ignoring greece at their own risk. >> yeah, i bid 35 for 50, so... >> narrator: bond traders from new york to london started dumping greek sovereign bonds. the very same institutions that had happily fueled the euro spending spree pulled back. >> and in 2009, this whole thing fell apart. and what you're seeing at the moment is this sort of crumbling edifice that was built over the last few decades. >> narrator: with the markets no longer willing to provide greece cheap credit, the country had to cut spending. people took to the streets in protest. other european countries had no plan in place to deal with the situation. >> i think everybody knew that the construction of the euro was not a finished construction--
because, you know, when you don't have a real, common economic policy and fiscal policy, clearly, you know, a common currency theoretically doesn't work. >> narrator: in 2010, the value of the euro dropped precipitously. ireland, portugal and italy started their own downward spirals. today it's spain, an economy four and a half times larger than that of greece. >> it became apparent that greece was not alone, that this was not just a greek issue, that there were other countries that had similar problems. so what was originally perceived as an isolated problem quickly became a systemic problem for the rest of the euro zone. >> could this affect the united states? absolutely. of course. our banks would be the obvious conduit for any... any shock. they lend a lot to europe. they transact a lot with european banks.
and we in the united states have not sufficiently prepared for those difficulties. >> the debt crisis and economic chaos could have a dangerous ripple effect around the world... >> narrator: if difficulties in europe lead to the failure of a big american bank, it could be catastrophic. >> how palpable is the fear? how much of an impact could this have in the u.s.? >> narrator: since 2007, the five biggest banks in america have become larger. today, they control assets equal to 56% of the american economy. (protestors chanting) >> narrator: last fall as the european debt crisis worsened, occupy wall street launched its protests in new york. >> i remember sending e-mail to my boss asking, "is anybody watching? does anybody care about this?" "what? the protests? no." that was the response, you know? i mean, just wasn't an issue. they didn't seem to care down on
wall street. >> when i first saw occupy wall street, i was highly skeptical. and i just thought it would be shut down on day one, like i think most people did. and then they had this momentum. and then there was the pepper spray incident. (protestors screaming) >> those three girls were kettled in the orange netting and sprayed in the face. and that was the moment where i said, "i have to get down there. and i have to be involved in this." >> people took to the streets to express their anger. but what exactly is their message? >> i don't think they know what it is. what do these people want? >> you know, occupy wall street from the very beginning was being criticized for not really knowing how the system works. and what i realized was, you know what? nobody knows how the system works. even the people in finance don't understand the system. >> the yields come down, the prices go up... >> go from bonds into stocks... (mixed voices of tv
commentators) >> they understand their little corner of the system. but very few people would come forward and say, "i'm an expert on the financial system. i know how everything works." >> we are occupy wall street! >> we are occupy wall street! >> the occupiers, they know that the result of this system is not working for them. that's enough. the system is a huge black box, and they are seeing the output of that black box. you know, a lot of them are college educated, they have enormous student loans, and they don't have a job. and that is the output-- them and all the people around them don't have jobs and are in huge debt. (protestors shouting) >> they don't have the power, in fact, to address the system and to question it. and i feel like the occupiers should be appreciated. that in spite of the fact that
they don't understand it, they're willing to come out and say, "this isn't working. the system isn't working." >> occupy everything! >> occupy everything! (crowd cheering) >> narrator: in washington, other battles are being fought. on one side are the 12 federal agencies responsible for protecting the public interest. on the other, the bank lobby. ever since the passage of the dodd-frank financial reform act in 2010, the two groups have been in a virtual deadlock over what kind of rules are acceptable. the industry has spent over $320 million lobbying lawmakers. the regulators face an uphill battle.
>> generally speaking, it's not a level playing field. the banks have got vast resources. they have very highly paid inside counsels whose job it is to outwit the regulators. it's a game. and over time what we've seen is that the winners of this game are usually the banks rather than regulators. >> narrator: to date, the rule-writing process has been slow. few rules have been finalized. >> i'd like to call this meeting of our advisory committee to order and begin by thanking you all for agreeing... >> narrator: at the federal deposit insurance corporation, regulators are meeting to discuss banks that are "too big to fail." >> i think this is the most important part of dodd-frank. >> narrator: they've pulled together a group of financial heavyweights, among them former citigroup ceo john reed, wall street super-lawyer rodgin cohen. former sec chairman william donaldson and former fed chief
paul volcker. across the table are officials from the fdic's office of complex financial institutions. it is their job to plan for a big bank failure. >> ...mitigate systemic risk. >> so the scenario is sort of everything but title ii. >> narrator: there are many questions. >> non-bank operations... >> narrator: how to unwind derivative contracts? >> billions of dollars notional value of derivative trades... >> narrator: how to protect customers' money? >> the funding is provided by a line of credit provided... >> narrator: how to deal with foreign subsidiaries? >> the subsidiaries went into the solvency, value was eliminated... >> narrator: how to prevent catastrophe? >> this is a problem for the entire strategy. you continue to have mega-banks. because from a market point of view, surely what you're looking through to how disruptive would that be, what kind of systemic knock-on effects could it create? >> i don't know how this ends. we like to think that we live in unique times, but during the 1920s, we had a tremendous
amount of financial innovation. and when we had the great crash and we came out of it, we had a series of investigations that led to the securities laws. my hope is that we'll learn the lessons that we learned from 1929. maybe it'll take longer for us to learn the lessons of 2007 and 2008. maybe we'll need another several crises to get us there. >> you got two main business lines-- good old commercial banking and capital markets. >> narrator: some believe the answer is to roll back time. former fed chief volcker has proposed a rule that would in effect reinstate a cornerstone of the depression-era glass-steagall act: separating proprietary trading from traditional customer-oriented banking. >> you're in a big mess if they're in the same legal entity. >> well, we aren't going to be instructing the companies what to do. they're going to be telling us how they're going... >> there seems to be no willingness to address the conflict of interest inherent in modern banking, because that would mean essentially pulling
apart the two parts of the bank, the proprietary trading and the client-focused businesses. and there is no real energy or traction for dealing with that issue. >> and then a year down the road, you have 37 different offsetting trades just to hedge this one stock buy that you made. >> i mean, it makes sense in as much as the rule is supposed to prevent... p&l due to prop trading, right? >> narrator: in new york, occupy wall street has formed its own group to review the volcker rule. >> you know, this would be a good question to just straight-up ask the sec. >> narrator: after extensive industry lobbying, the rule has ballooned from ten pages to almost 300 of exemptions and loopholes. >> what are they going to say specifically about funds that are not risky... >> the risk section of the volcker rule is really vague-- really vague. and, you know, i worked in risk. i mean, if i'm a bank, i can game this. we need people who are experts, who have gamed the system.
>> when things like lehman happen, the unwind process is just mind-boggling, and nobody can handle it. >> we decided we would read through the rule and figure out what the rule was trying to do and then sit and try and figure out how we would get around it. if we were still working on wall street, what are the ways that we would try and evade it? >> i have no faith that it will ever make it through into the final rule under any circumstances, but we can make a very, very strong case for continuity. >> narrator: recently they submitted their proposal to the sec, the fdic and the fed in the hope that the volcker rule would be tightened up. >> normally the only people that comment on these regulations are the industries that are about to be regulated. and you can probably guess what they say, right? they say, "this is too harsh. you have to take this out. this is going to ruin our business." they'll say, "this will ruin the economy." >> the cynic in me will say that even under the best
circumstances, if this law went through and all speculative proprietary trading was cut from the banks, and they just couldn't do it anymore, they will find something else. they always do. >> we can absolutely reform banks. we just have to care enough about it and we have to... we have to trust that the world won't collapse in the meantime. banks were reformed after the great depression. they absolutely were. it was a political will issue and it continues to be. and the question isn't, "are we going to create something perfect?" the question is, "are we going to create something better than this?" it's actually a pretty low bar. so i think it's... it's definitely achievable. >> narrator: recently, the government tried to create tougher rules for banks that trade more than $100 million of swaps annually.
the bank lobby swung into action. the outcome: only banks trading more than $8 billion will be subject to oversight. leaving 85% of all derivative players outside the reach of regulators. >> we now somehow believe that finance sort of drives everything. the crisis was an opportunity to change that. to ask questions like, "what is the role of finance in our economy? what is the role of banks?" but i suspect it's very hard. change gods. very difficult to and in the modern age, our god is finance. except it's turned out to be a very cruel and destructive god.
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