Inside Job Storyville

Iceland is a stable democracy with a high standard of living

and until recently, extremely low unemployment and government debt.

We had the complete infrastructure of a modern society -

clean energy, food production,

fisheries with a quota system to manage them.

Good health care, good education, clean air.

Not much crime. It's a good place for families to live.

We had almost end-of-history status.

But in 2000, Iceland's government began a broad policy of deregulation

that would have disastrous consequences,

first for the environment and then for the economy.

They allowed multinational corporations like Alcoa to build giant aluminum-smelting plants

and exploit Iceland's natural geothermal and hydroelectric energy sources.

Many of the most beautiful areas in the highlands with the most spectacular colours are geothermal.

So nothing comes without consequence

At the same time, the government privatised Iceland's three largest banks.

The result was one of the purest experiments in financial deregulation ever conducted.

VARIOUS VOICES INTERMINGLE

We've had enough. How could all of this happen?

Finance took over

and more or less wrecked the place.

In a five-year period, these three tiny banks, which had never operated outside of Iceland,

borrowed 120 billion dollars, ten times the size of Iceland's economy.

The bankers showered money on themselves, each other and their friends.

There was a massive bubble. Stock prices went up by a factor of nine.

House prices more than doubled.

Iceland's bubble gave rise to people like Jon Asgeir Johannesson.

He borrowed billions from the banks to buy up high-end retail businesses in London.

He also bought a pin-striped private jet, a 40 million yacht and a Manhattan penthouse.

Newspapers had the headline, "This millionaire bought this company"

in the UK or in Finland or in France or wherever,

instead of saying, "This millionaire took a billion-dollar loan

"to buy this company and he took it from your local bank."

The banks set up money market funds and the banks advised deposit holders to withdraw money

and put them in the money market funds. The Ponzi scheme needed everything it could.

American accounting firms, like KPMG, audited the Icelandic banks

and investment firms and found nothing wrong.

And American credit-rating agencies said Iceland was wonderful.

In February 2007, the rating agencie decided to upgrade the banks

to the highest possible rate - AAA.

It went so far as the government here travelling with the bankers

as a...as a PR show.

When Iceland's banks collapsed at the end of 2008,

unemployment tripled in six months.

There is nobody unaffected in Iceland.

So a lot of people here lost their savings?

Yes, that's the case.

The government regulators who should have been protecting

the citizens of Iceland had done nothing.

You have two lawyers from the regulator going to a bank to talk about some issue.

When they approach the bank, they would see 19 SUVs outside...outside the bank.

So you enter the bank and you have the 19 lawyers sitting in front of you, right?

They are very well prepared, ready to kill any argument you make.

Then if you do really well, they'll offer you a job, right?

One-third of Iceland's financial regulators went to work for the banks.

But this is a universal problem, huh? In New York, you have the same problem, right?

# I'm on my way, I'm making it

# Huh!

# I've got to make it show, yeah

# Hey!

# So much larger than life

# I'm gonna watch it growing... #

What do you think of Wall Street incomes these days?

Excessive.

-I was told it's extremely difficult for the IMF to criticise the United States.

-I wouldn't say that.

We deeply regret our breaches of US law.

# ..is a small town... #

They're amazed at how much cocaine these Wall Streeters can use and get up and go to work the next day.

# But not me... #

I didn't know what credit default swaps are.

I'm a little bit old-fashioned.

# I'll be stretching my mouth to let those big words... #

-Has Larry Summers ever expressed remorse?

-I don't hear confessions.

# I've had enough

# I'm getting out

# To the city, the big, big city

# I'll be a big noise with all the big boys... #

The government's just writing cheques. That's Plan A, that's Plan B and that's Plan C.

Would you support legal controls on executive pay?

I would not.

# Big time, I'm on my way... #

-Are you comfortable with the level of compensation in financial services?

-If they've earned it, yes.

-Do you think they've earned it?

-I think they've earned it.

-So you've helped these people blow the world up?

-You could say that.

# So much larger than life

# Big time I'm gonna watch it growing... #

They had massive private gains at public loss.

# Big time... #

When you start thinking that you can create something out of nothing, it's very difficult to resist.

# My parties have all the big names

# And I greet them with the widest smile

# Tell them how my life is one big adventure

# And always they're amazed... #

I'm concerned that people want to go back to the way they were operating prior to the crisis.

# I had it made

# Like a mountain rage with a snow-white pillow for my big, fat head... #

I was getting many anonymous emails from bankers saying, "You can't quote me, but I'm really concerned."

# ..walk through the front door Big time

# I'm on my way, I'm making it... #

Why isn't there a more systematic investigation being undertaken?

Because you'll find the culprits.

# ..make it show, yeah Big time... #

-Does Columbia Business School have any significant conflict-of-interest problem?

-I don't see that we do.

# Big time I'm gonna watch you growing... #

The regulators didn't do their job.

They had the power to do every case that I made when I was state attorney-general, but didn't want to

# And the bulge in my big, big, big, big, big, big

# Big, big, big, big, big, big, big, big, big... #

'Over the weekend, Lehman Brothers, one of the biggest investment banks,

'was forced to declare itself bankrupt. Merrill Lynch was forced to sell itself. Crisis talks...'

Financial markets are way down after dramatic developments...

SPEAKS IN ORIENTAL LANGUAGE

'..crise indique. La presse francais annonce clairement la couleur...'

In September 2008, the bankruptcy

of the US investment bank Lehman Brothers

and the collapse of the world's largest insurance company, AIG, triggered a global financial crisis.

-'Fears gripped markets overnight...'

-Stocks fell off a cliff, the largest single point drop in history

'Share prices continued to tumble in the aftermath of the Lehman collapse.'

The result was a global recession which cost the world tens of trillions of dollars,

rendered 30 million people unemployed and doubled the national debt of the US.

If you look at the cost, the destruction of equity wealth,

of housing wealth, the destruction of income, of jobs,

50 million people globally could end up below the poverty line again.

This is just a hugely, hugely expensive crisis.

This crisis was not an accident.

It was caused by an out-of-control industry.

Since the 1980s, the rise of the US financial sector

has led to a series of increasingly severe financial crises.

Each crisis has caused more damage while the industry has made more and more money.

After the Great Depression, the United States had 40 years of economic growth

without a single financial crisis. The financial industry was tightly regulated.

Most regular banks were local businesses and were not allowed to speculate with depositors' savings.

Investment banks, which handled stock and bond trading, were small, private partnerships.

In the traditional investment banking partnership model,

the partners put the money up and watched that money very carefully.

They wanted to live well, but they didn't want to bet the ranch on anything.

Paul Volcker served in the Treasury Department and was Chairman of the Federal Reserve from 1979 to 1987.

Before going into government, he was a financial economist at Chase Manhattan Bank.

When I left Chase to go in the Treasury

in 1969,

-I think my income was in the neighbourhood of 45,000 a year.

-45,000 a year?

Morgan Stanley in 1972 had approximately 110 total personnel,

one office and capital of 12 million dollars.

Now Morgan Stanley has 50,000 worker

and has capital of several billion

and has offices all over the world.

In the 1980s, the financial industry exploded.

The investment banks went public, giving them huge amounts of stockholder money.

People on Wall Street started getting rich.

I had a friend

who was a bond trader at Merrill Lynch in the 1970s.

He had a job as a train conductor at night

because he had three kids and couldn't support them on what a bond trader made.

By 1986, he was making millions of dollars and thought it was because he was smart.

The highest order of business before the nation is to restore our economic prosperity.

In 1981, President Ronald Reagan chose as Treasury Secretary

the CEO of the investment bank Merrill Lynch, Donald Regan.

Wall Street and the President do see eye to eye.

I've talked to many leaders of Wall Street. They all say, "We're behind the President 100%."

The Reagan administration, supported by economists and financial lobbyists,

started a 30-year period of financial deregulation.

In 1982, the Reagan administration deregulated savings and loan companies,

allowing them to make risky investments with depositors' money.

By the end of the decade, hundreds of savings and loan companies had failed.

This crisis cost taxpayers 124 billion and cost many people their life savings.

It may be the biggest bank heist in our history.

Thousands of savings and loan executives went to jail for looting their companies.

-One extreme case was Charles Keating.

-Mr Keating, got a word?

In 1985, when federal regulators began investigating him,

Keating hired an economist named Alan Greenspan.

In this letter to regulators, Greenspan praised Keating's sound business plans and expertise

and said he saw no risk in allowing Keating to invest his customers' money.

Keating reportedly paid Greenspan 40,000 dollars.

Charles Keating went to prison shortly afterwards.

As for Alan Greenspan, President Reagan appointed him Chairman of America's Central Bank,

the Federal Reserve.

Greenspan was reappointed by Presidents Clinton and George W Bush.

During the Clinton administration, deregulation continued under Greenspan

and Treasury Secretaries Robert Rubin, the former CEO of the investment bank Goldman Sachs,

and Larry Summers, a Harvard economics professor.

The financial sector, Wall Street being powerful, having lobbies, having lots of money,

step by step captured the political system both on the Democratic and the Republican side.

By the late 1990s, the financial sector had consolidated into a few gigantic firms,

each of them so large that their failure could threaten the whole system.

The Clinton administration helped them grow even larger.

In 1998, Citicorp and Travelers merged to form Citigroup,

the largest financial services company in the world.

The merger violated the Glass-Steagall Act, a law passed after the Great Depression,

to prevent banks with consumer deposits from engaging in risky investment banking activities.

It was illegal to acquire Travelers.

Greenspan said nothing.

The Federal Reserve gave them an exemption for a year, then they got the law passed.

In 1999, at the urging of Summers and Rubin,

Congress passed the Gramm-Leach-Bliley Act,

known to some as the Citigroup Relief Act.

It overturned Glass-Steagall and cleared the way for future mergers.

Why do you have big banks?

Markets are inherently unstable or at least potentially unstable.

An appropriate metaphor is the oil tankers.

They are very big and therefore you have to put in compartments

to prevent the sloshing around of oi from capsizing the boat.

The design of the boat has to take that into account.

And after the Depression,

the regulations actually introduced these very watertight compartments.

And deregulation has led to the end of compartmentalisation.

The next crisis came at the end of the '90s.

The investment banks fuelled a massive bubble in internet stocks

which was followed by a crash in 2001 that caused five trillion dollars in investment losses.

The Securities and Exchange Commission, the federal agency created during the Depression

to regulate investment banking, had done nothing.

In the absence of meaningful federal action, and there has been none,

and given the clear failure of self-regulation,

others have to step in and adopt the protections needed.

Eliot Spitzer's investigation revealed that investment banks

had promoted internet companies they knew would fail.

Stock analysts were being paid based on how much business they brought in

and what they said publicly was not what they said privately.

Infospace, given the highest possible rating,

dismissed by an analyst as "a piece of junk".

Excite, also highly rated, called "such a piece of crap".

The defence that was proffered by many of the investment banks

was not, "You're wrong."

It was, "Everybody's doing it and everybody knows it's going on,

"so nobody should rely on these analysts anyway."

In December 2002, ten investment banks settled the case

for a total of 1.4 billion and promised to change their ways.

Scott Talbott is chief lobbyist for the Financial Services Roundtable,

a very powerful group in Washington, which represents nearly all of the world's largest financial companies.

Are you comfortable with the fact that many of your member companies

have engaged in large-scale criminal activity?

-You'll have to be specific.

-OK...

-First of all, criminal activity shouldn't be accepted, period.

Since deregulation began, the world's biggest financial firms have been caught laundering money,

defrauding customers and cooking their books again and again and again.

# And I'll be taking care of busines every day

# Taking care of business every way

# I've been taking care of business... #

Credit Suisse helped funnel money for Iran's nuclear programme

and for the Aerospace Industries Organisation of Iran which builds ballistic missiles.

Any information that would identify it as Iranian would be removed.

The bank was fined 536 million.

Citibank helped funnel 100 million of drug money out of Mexico.

Did you comment that she should, quote,

"lose any documents connected with the account"?

I said that in a kidding manner. I did not mean it seriously.

Between 1998 and 2003, Fannie Mae overstated its earnings by more than 10 billion.

These accounting standards are highly complex

and require determinations over which experts often disagree.

CEO Franklin Raines, who used to be President Clinton's budget director,

received over 52 million in bonuses.

When UBS was caught helping wealthy Americans evade taxes, they did not co-operate with the US government.

-Would you supply the names?

-If there's a treaty framework...

-No treaty framework. You've agreed you participated in a fraud.

-Hmm.

# Take good care of my business... #

But while the companies face unprecedented fines,

the investment firms do not have to admit any wrongdoing.

When you deal with so many products and customers, mistakes happen.

The financial services industry seems to have a level of criminality that is somewhat distinctive.

You know, when was the last time that Cisco or Intel or Google or Apple or IBM...

I totally agree about hi-tech versus financial services.

-How come?

-Hi-tech is a creative business where the value generation

and income derives from creating something new and different.

Beginning in the 1990s, deregulation and advances in technology led to an explosion

of complex financial products called derivatives.

Economists and bankers claimed they made markets safer,

but instead they made them unstable.

Since the end of the Cold War,

a lot of former physicists and mathematicians decided

to apply their skills, not on Cold War technology, but on financial markets.

And together with investment bankers and hedge funds...

-Creating different weapons?

-Yes. As Warren Buffett said, weapons of mass destruction.

Regulators, politicians and business people did not take seriously

the threat of financial innovation

on the stability of the financial system.

Using derivatives, bankers could gamble on virtually anything.

They could bet on the rise or fall of oil prices, the bankruptcy of a company, even the weather.

By the late 1990s, derivatives were a 50-trillion-dollar unregulated market.

In 1998, someone tried to regulate them.

Brooksley Born graduated first in her class at Stanford Law School

and was the first woman to edit a major law review.

After running the derivatives practice at Arnold & Porter, Born was appointed by President Clinton

to chair the Commodity Futures Trading Commission which oversaw the derivatives market.

Brooksley Born asked me if I would come work with her.

We decided that this was a serious,

potentially destabilising market.

In May of 1998, the CFTC issued a proposal to regulate derivatives.

Clinton's Treasury Department had an immediate response.

I happened to go into Brooksley's office

and she was just putting down the receiver on her telephone.

And the blood had drained from her face.

And she looked at me and said, "That was Larry Summers."

He had 13 bankers in his office.

He conveyed it in a very bullying fashion,

sort of directing her to stop.

The banks were now heavily reliant for earnings on these activities.

That led to a titanic battle

to prevent this set of instruments from being regulated.

Shortly after the phone call from Summers,

Greenspan, Rubin and SEC Chairman Arthur Levitt issued a joint statement condemning Born

and recommending legislation to keep derivatives unregulated.

Regulation of derivatives transactions

that are privately negotiated by professionals is unnecessary.

She was overruled, unfortunately, first by the Clinton administration,

then by the Congress. In 2000, Senator Phil Gramm took a major role

in getting a bill passed to exempt derivatives from regulation.

They are unifying markets, they are reducing regulatory burden.

I believe that we need to do it.

It is our very great hope

that it will be possible to move this year on legislation

that in a suitable way goes to create legal certainty

for OTC, uh, derivatives.

I wish to associate myself

with all of the remarks of Secretary Summers.

In December of 2000, Congress passed the Commodity Futures Modernization Act.

Written with the help of financial industry lobbyists,

it banned the regulation of derivatives.

Once that was done, it was off to the races.

The use of derivatives and financial innovation

exploded dramatically after 2000.

-So help me God.

-So help me God.

By the time George W Bush took office in 2001,

the US financial sector was vastly more profitable, concentrated and powerful than ever before.

Dominating this industry were five investment banks,

two financial conglomerates,

three securities insurance companies

and three rating agencies.

And linking them all together was the securitisation food chain,

a new system connecting trillions of dollars in mortgages and other loans

with investors all over the world.

30 years ago, if you went to get a loan for a home

the person lending you the money expected you to pay him or her back.

We've since developed securitisation whereby the people who make the loan

are no longer at risk if there is a failure to repay.

In the old system, when a home owner paid their mortgage every month,

the money went to their local lender.

And since mortgages took decades to repay, lenders were careful.

In the new system, lenders sold the mortgages to investment banks.

The investment banks combined thousands of mortgages and other loans,

including car loans, student loans and credit card debt,

to create complex derivatives called "collateralized debt obligations"

or CDOs.

The investment banks then sold the CDOs to investors.

Now when home owners paid their mortgages, the money went to investors all over the world.

The investment banks paid rating agencies to evaluate the CDOs

and many of them were given a AAA rating which is the highest possible investment grade.

This made CDOs popular with retirement funds

which could only purchase highly rated securities.

This system was a ticking time bomb.

Lenders didn't care any more about whether a borrower could repay, so they started making riskier loans.

The investment banks didn't care either.

The more CDOs they sold, the higher their profits.

And the rating agencies, which were paid by the investment banks,

had no liability if their ratings of CDOs proved wrong.

You weren't going to be on the hook

and there weren't regulatory constraints.

It was a green light to pump out more and more loans.

Between 2000 and 2003,

the number of mortgage loans made each year nearly quadrupled.

Everybody in this securitisation food chain, from the very beginning until the end,

they didn't care about the quality of the mortgage.

They were caring about maximising their volume and getting a fee out of it.

In the early 2000s, there was a huge increase in the riskiest loans called sub-prime.

But when thousands of sub-prime loans were combined to create CDOs,

many of them still received AAA ratings.

Now, it would have been possible to create derivative products that don't have these risks,

that carry the equivalent of deductibles where there are limits

on the risks that can be taken on and so forth.

-They didn't do that, did they?

-No. In retrospect, they should have done

-Did these guys know they were doing something dangerous?

-I think so.

All the incentives that the financial institutions offered

to their mortgage brokers were based

on selling the most profitable products which were predatory loans.

If the banker makes more money

if they put you in a sub-prime loan, that's where they'll put you.

Suddenly, hundreds of billions of dollars a year were flowing through the securitisation chain.

Since anyone could get a mortgage, home purchases and housing prices sky-rocketed.

The result was the biggest financial bubble in history.

Real estate is real. They can see their asset, they can live in their asset and rent it out.

You had a huge boom in housing that made no sense.

The financing appetites of the financial sector

drove what everybody else did.

The last time we had a housing bubbl was in the late '80s.

In that case, the increase in home prices had been relatively minor.

That housing bubble led to a relatively severe recession.

From 1996 until 2006,

real home prices effectively doubled

'At 500 dollars a ticket, they've come to hear how to buy their very own piece of the American dream.'

Goldman Sachs, Bear Stearns,

Lehman Brothers, Merrill Lynch were all in on this.

The sub-prime lending alone increased from 30 billion a year in funding

to over 600 billion a year in ten years.

They knew what was happening.

Countrywide Financial, the largest sub-prime lender,

issued 97 billion worth of loans.

It made over 11 billion in profits as a result.

On Wall Street, annual cash bonuses spiked.

Traders and CEOs became enormously wealthy during the bubble.

Lehman Brothers was a top underwriter of sub-prime lending

and their CEO, Richard Fuld,

took home 485 million.

On Wall Street, this housing and credit bubble was leading

to hundreds of billions of dollars of profits.

By 2006, about 40% of all profits of S&P 500 firms was coming from financial institutions.

It wasn't real profits or real income.

It was just money being created by the system and booked as income.

Two, three years later, there's a default, it's wiped out.

It was in fact, in retrospect,

a great big, national, and not just national, global Ponzi scheme.

Through the Home Ownership and Equity Protection Act,

the Federal Reserve Board had broad authority to regulate the mortgage industry.

But Fed Chairman Alan Greenspan refused to use it.

Alan Greenspan said, "Ideologically, I don't believe in regulation."

For 20 years, Robert Gnaizda was the head of Greenlining, a powerful consumer advocacy group.

He met with Greenspan on a regular basis.

We gave him an example of Countrywide

and 150 different, complex, adjustable rate mortgages.

He said, "If you had a doctorate in math, you wouldn't be able to understand them enough

"to know which was good for you and which wasn't."

So we thought he was going to take action,

but as the conversation continued, it was clear he was stuck with his ideology.

We met again with Greenspan in '05.

Often we met with him twice a year and never less than once a year.

And he wouldn't change his mind.

In this amazing world of instant global communications,

the free movement of capital

is helping to create the greatest prosperity in human history.

146 people were cut from the enforcement division of the SEC.

Is that what you testified to?

Yes.

Yeah, I think there has been a systematic gutting,

or whatever you want to call it, of the agency and its capability through cutting back of staff.

The SEC Office of Risk Management was reduced to a staff,

did you say, of one?

Yes. When that gentleman went home a night, he could turn the lights out.

During the bubble, the investment banks were borrowing heavily

to buy more loans and create more CDOs.

The ratio between borrowed money and the bank's own money was called leverage.

The more the banks borrowed, the higher their leverage.

In 2004, Henry Paulson, the CEO of Goldman Sachs,

helped lobby the Securities and Exchange Commission to relax limits on leverage,

allowing the banks to sharply increase their borrowing.

The SEC somehow decided

to let investment banks gamble a lot more. That was nuts. I don't know why they did that, but they did that

The degree of leverage in the financial system became absolutely frightening,

investment banks leveraging up to the level of, you know, 33 to 1,

which means that a tiny 3% decrease in the value of their asset base would leave them insolvent.

There was another ticking time bomb in the financial system.

AIG, the world's largest insurance company,

was selling huge quantities of derivatives called credit default swaps.

For investors who owned CDOs,

credit default swaps worked like an insurance policy.

An investor who purchased a credit default swap paid AIG a quarterly premium.

If the CDO went bad,

AIG promised to pay the investor for their losses.

But unlike regular insurance, speculators could also buy credit default swaps from AIG

in order to bet against CDOs they didn't own.

In insurance, you can only insure something you own.

Let's say you and I own property. I own a house.

I can only insure that house once.

The derivatives universe essentially enables anybody to insure that house

So you could insure that. 50 people might insure my house.

What happens is, if my house burns down,

the number of losses in the system becomes proportionately larger.

Since credit default swaps were unregulated,

AIG didn't have to put aside any money to cover potential losses.

Instead, AIG paid its employees huge cash bonuses

as soon as contracts were signed.

But if the CDOs later went bad,

AIG would be on the hook.

People were essentially being rewarded for taking massive risks.

In good times, they generate short-term revenues and profits and therefore bonuses,

but that will lead the firm to be bankrupt over time. That's a totally distorted system of compensation.

AIG's Financial Products Division in London

issued 500 billion worth of credit default swaps during the bubble,

many of them for CDOs backed by sub-prime mortgages.

The 400 employees at AIGFP made 3.5 billion between 2000 and 2007.

Joseph Cassano, the head of AIGFP,

personally made 315 million.

'It's hard for us, without being flippant,

'to even see a scenario within any kind of realm of reason

'that would see us losing one dollar in any of those transactions.'

In 2007, AIG's auditors raised warnings.

One of them, Joseph St Denis, resigned in protest

after Cassano blocked him from investigating AIGFP's accounting.

Let me tell you one person that didn't get a bonus.

That was Mr St Denis who tried to alert the two of you

to the fact that you were running into big problems. He quit in frustration. He didn't get a bonus.

In 2005, Raghuram Rajan, then the chief economist of the International Monetary Fund,

delivered a paper at the Jackson Hole Symposium, the most elite banking conference in the world.

Who was in the audience?

It was, I guess, the central bankers of the world,

ranging from Mr Greenspan himself,

Ben Bernanke, Larry Summers was there, Tim Geithner was there.

The title of the paper was, essentially, Is Financial Developmen Making The World Riskier?

And the conclusion was, um, it is.

Rajan's paper focused on incentive structures

that generated huge cash bonuses based on short-term profits,

but which imposed no penalties for later losses.

Rajan argued that these incentives encouraged bankers to take risks

that might eventually destroy their own firms or even the entire financial system.

It is very easy to generate performance

by taking on more risk,

so you need to compensate for risk-adjusted performance.

That's where all the bodies are buried.

Rajan, you know, hit the nail on the head.

What he said was, "You guys have claimed you have found a way

"to make more profits with less risk.

"You've found a way to make more profits with more risk. There's a big difference."

Summers was...was vocal.

He basically thought that I was criticising the change in the financial world

and was worried about regulation which would reverse this whole change.

So essentially he accused me of being a Luddite.

He wanted to make sure that we didn't bring in a whole new set of regulations

to constrain the financial sector at that point.

You'll make an extra 2 million or 10 million a year

for putting your financial institution at risk.

Someone else pays the bill. You don't pay the bill.

Would you make that bet? Most people working on Wall Street said, "Sure."

# Many years since I was here

# On the street I was passing my time away

# To the left and to the right

# Buildings towering to the sky

# It's outta sight In the dead of night

-# Ooh

-Here I am

# And in this city

# With a fistful of dollars

# And baby, you'd better believe

# I'm back, back in the New York groove

# I'm back, back in the New York groove... #

It never was enough. They don't want to own one home, they want to own five homes.

And they want to have an expensive penthouse on Park Avenue.

And they want to have their own private jet.

You think this is an industry

where very high compensation levels are justified?

I think I would take caution or take heed

or take exception to "very high". It's all relative.

You have a 14 million home in Florida, a summer vacation home

in Sun Valley, Idaho. You and your wife have million-dollar paintings.

Richard Fuld never appeared on the trading floor. There were art advisers up there.

He had a private elevator. He went out of his way to be disconnected.

They hired technicians to program his elevator,

so his driver would call in in the morning and a security guard would hold it.

There's only a two or three-second window where he has to see people.

He hops into this elevator and goes straight to 31.

-Lehman owned a bunch of corporate jets. Do you know about this?

-Yes.

-How many were there?

-There were six, including the 767s.

-They also had a helicopter.

-Isn't that a lot of planes to have for...?

They're Type A personalities and they know everything in the world.

Banking became a pissing contest - "mine's bigger than yours".

It was all men that ran it.

50 billion deals were not large enough, so we do 100 billion deals.

These people are risk takers, they're impulsive.

It's part of their behaviour and personality. That manifests outside of work as well.

It's quite typical for the guys to go out, to go to strip bars,

to use drugs. I see a lot of cocaine use, a lot of use of prostitution.

Recently, neuroscientists have done experiments

where they've put individuals into an MRI machine.

And they have them play a game where the prize is money.

And they noticed that when these subjects earn money,

the part of the brain that gets stimulated is the same par that cocaine stimulates.

A lot of people feel that they need to participate in that behaviour to get promoted, to get recognised.

According to a Bloomberg article, business entertainment represents 5% of revenue

for New York derivatives brokers and often includes strip clubs, prostitution and drugs.

A New York broker filed a lawsuit in 2007 against his firm,

alleging he was required to retain prostitutes to entertain traders.

There's a blatant disregard for the impact their actions might have on society, on family.

They have no problem using a prostitute and going home to their wife.

-How many customers?

-About 10,000 at that point in time.

What fraction were from Wall Street?

Of the higher-end clients, probably 40 to 50%.

-Were all the major Wall Street firms represented? Goldman Sachs?

-Lehman Brothers, yeah, they're all in there

Morgan Stanley was a little less of that.

I think Goldman was pretty big with that.

A lot of clients would say, "Can you get me a Lamborghini for the girl?"

These guys were spending corporate money.

I had many black cards from the various financial firms.

What's happening is services are being charged to computer repair.

Trading research, you know, consulting for market compliance.

I gave them a letterhead and said, "Make your own invoice."

-This pattern of behaviour extends to the senior management of the firm?

-Absolutely.

I know for a fact that it does.

It extends to the very top.

A friend who's involved in a company with a big financial presence said,

"It's about time you learned about sub-prime mortgages."

So he set up a session with his trading desk and me.

And a techie who did all this gets very excited, runs to his computer,

pulls up in about three seconds.

This Goldman Sachs issue of securities was a complete disaster.

Borrowers had borrowed on average 99.3% of the price of the house, so they have no money in the house.

If anything goes wrong, they'll walk away from the mortgage. This is not a loan you'd really make, right?

You've got to be crazy.

Somehow you took 8,000 of these loan

and by the time the guys were done at Goldman Sachs and the rating agencies,

two-thirds of the loans were rated AAA, so they were rated as safe as government securities. Utterly mad!

Goldman Sachs sold at least 3.1 billion worth of these toxic CDOs

in the first half of 2006.

The CEO of Goldman Sachs at this time was Henry Paulson, the highest paid CEO on Wall Street.

Good morning. Welcome to the White House.

I'm pleased to nominate Henry Paulso to be the Secretary of the Treasury.

He has an intimate knowledge of financial markets.

He's earned a reputation for candour and integrity.

You might think it would be hard for Paulson to adjust to a meagre government salary,

but taking the job as Treasury Secretary was the best financial decision of his life.

Paulson had to sell his 485 million of Goldman stock when he went to work for the government,

but because of a law passed by the first President Bush, he didn't have to pay any taxes on it.

It saved him 50 million.

The article came out in October of 2007.

Already a third of the mortgages defaulted.

Now most of them are going.

One group that had purchased these now worthless securities

was the Public Employees Retirement System of Mississippi

which provides monthly benefits to over 80,000 retirees.

They lost millions of dollars and are now suing Goldman Sachs.

By late 2006, Goldman had taken things a step further.

It didn't just sell toxic CDOs.

It started actively betting against them

at the same time it was telling customers that they were high quality investments.

By purchasing credit default swaps from AIG,

Goldman could bet against CDOs it didn't own and get paid when the CDOs failed.

I asked if anybody called the customers and said,

"We don't like this kind of mortgage now and we thought you should know."

They didn't say anything, but you could feel the laughter coming over the phone.

Goldman Sachs bought at least 22 billion of credit default swaps from AIG.

It was so much that Goldman realised that AIG itself might go bankrupt,

so they spent 150 million insuring themselves against AIG's potential collapse.

Then in 2007,

Goldman went even further.

They started selling CDOs specifically designed so that the more money their customers lost,

the more money Goldman Sachs made.

600 million of Timberwolf Securities is what you sold.

Before you sold them,

this is what your sales team were telling to each other.

"Boy, that Timberwolf was one shitty deal!"

This was an email to me in late June...

-Right.

-..after the transaction.

No, no, you sold Timberwolf after as well.

-We did trades after that.

-Yeah, OK.

The next email, take a look, July 1, '07. Tells the sales force,

"The top priority is Timberwolf."

Your top priority to sell is that shitty deal.

If you have an adverse interest to your client, do you have the duty

to tell that client of your adverse interest? That's my question.

-I'm trying to understand...

-I don't think you want to answer it.

Do you believe that you have a duty

to act in the best interests of your clients?

Again, Senator, I will repeat, we have a duty to serve our clients

by showing prices on transactions that they ask us to show prices for.

What do you think about selling securities

which your own people think are "crap"?

-Does that bother you?

-I think they would...

-Again as a hypothetical?

-No, this is real.

-Then I don't...

-We heard it today.

We heard it today. "This is a shitty deal. This is crap."

I-I heard nothing today that makes me think anything, um, went wrong.

Is there not a conflict when you sell something to somebody

and then are determined to bet against that same security

and you don't disclose that to the person you're selling it to?

-Do you see a problem?

-In market making, that is not a conflict.

When you heard that your employees in these emails said, "God, what a shitty deal. What a piece of crap,"

-did you feel anything?

-It's very unfortunate to have on email.

LAUGHTER And very unfortunate. I don't...

How about feeling that way?

It's very unfortunate for anyone to have said that in any form.

Were your competitors engaged in similar activities?

Yes, and to a greater extent than us in most cases.

Hedge fund manager John Paulson made 12 billion betting against the mortgage market.

When he ran out of mortgage securities to bet against,

he worked with Goldman Sachs and Deutsche Bank to create more.

Morgan Stanley also sold mortgage securities that it bet against and is now being sued

by the government employees' retirement fund of the Virgin Islands for fraud.

The lawsuit alleges that Morgan Stanley knew the CDOs were junk.

Although they were rated AAA, Morgan Stanley bet they would fail.

A year later, Morgan Stanley had made hundreds of millions,

while the investors had lost almost all of their money.

You would have thought that pension funds would have said, "Those are subprime. Why am I buying them?"

And they had these guys at Moody's and Standard and Poor's who said, "That's AAA."

None of these securities got issued without the imprimatur, the seal of approval, of the rating agencies.

The three rating agencies - Moody's, S&P and Fitch -

made billions of dollars giving high ratings to risky securities.

Moody's, the largest rating agency,

quadrupled its profits between 2000 and 2007.

Moody's and S&P get compensated based on putting out ratings reports

and the more structured securities they gave a AAA rating to, the higher their earnings.

Imagine if you went to the New York Times and said, "Write a positive story and I'll pay you 500,000."

The rating agencies could have stopped the party and said, "Sorry.

"We're tightening our standards."

This would immediately cut off a lot of funding to risky borrowers.

AAA-rated instruments

mushroomed from just a handful to thousands and thousands.

-Hundreds of billions of dollars were being rated and...

-Per year.

-Per year. Oh, yeah.

I've now testified before both houses of Congress on the credit rating agency issue

and both times they trot out very prominent First Amendment lawyers

and argue, "When we say something is rated AAA,

"that is merely our 'opinion'. You shouldn't rely on it."

S&P's ratings express our opinion.

Our ratings are our opinions.

Opinions. They are just opinions.

I think we are emphasising the fact that our ratings are, uh, opinions.

They do not speak to market value of a security, volatility of its price or its suitability as an investment.

We have so many economists coming on our air and saying, "This is a bubble and it's going to burst

"and this will be a real issue for the economy." Some say a recession.

What is the worst-case scenario if we were to see prices come down substantially across the country?

I don't buy your premise. It's pretty unlikely. We've never had a decline of house prices nationwide.

Ben Bernanke became chairman of the Federal Reserve Board in February, 2006,

the top year for subprime lending.

But despite numerous warnings, Bernanke and the Federal Reserve Board did nothing.

Robert Gnaizda met with Ben Bernanke and the Federal Reserve Board three times after he became chairman.

Only at the last meeting did he suggest that there was a problem

-and that the government ought to look into it.

-When was that?

-It's 2009, March 11th. In DC.

-This year?

-This year we met, yes.

-And so for the two previous years you met him, even in 2008...?

-Yes.

One of the six Federal Reserve Board governors serving under Bernanke was Frederic Mishkin,

appointed by President Bush in 2006.

Did you participate in the semi-annual meetings that Robert Gnaizda and Greenlining had?

Yes, I did. I was on the committee involved with that, the Consumer Community Affairs Committee.

He warned in an extremely explicit manner about what was going on

and he came with loan documentation of the kind of loans being made

-and he was listened to politely and nothing was done.

-Yeah.

So...I don't know the details in terms of, um...

In fact, I just don't know... Whatever information he provided, I'm not sure exactly...

Uh, to be honest, I can't remember this kind of discussion,

but certainly there were issues that were, uh, coming up.

Then it's how pervasive are they?

-Why didn't you try looking?

-I think people did. We had a whole group of people looking at this...

-You can't be serious. If you'd looked, you'd have found things.

-You know, it's very easy to say that.

As early as 2004, the FBI was already warning about an epidemic of mortgage fraud.

They reported inflated appraisals, doctored loan documentation and other fraudulent activity.

In 2005, the IMF's chief economist, Raghuram Rajan,

warned that dangerous incentives could lead to a crisis.

Then came Nouriel Roubini's warnings in 2006,

Allan Sloan's articles in Fortune and the Washington Post in 2007

and repeated warnings from the IMF.

I said it, and on behalf of the institution, the crisis in front of us is a huge crisis.

-Who did you talk to?

-The government, Treasury, the Fed, everybody.

In May of 2007, hedge fund manager Bill Ackman circulated a presentation

called Who's Holding The Bag?, which described how the bubble would unravel.

And in early 2008, Charles Morris published his book about the impending crisis.

You're just not sure. What do you do? You might have some suspicions

about underwriting standards, but should you do anything about it?

By 2008, home foreclosures were skyrocketing

and the securitisation food chain imploded. Lenders could no longer sell their loans to investment banks

and as the loans went bad, dozens of lenders failed.

Chuck Prince of Citibank famously said that...

we have to dance until the music stops. Actually, the music had stopped already when he said that.

The market for CDOs collapsed, leaving the investment banks

holding hundreds of billions of dollars in loans, CDOs and real estate they couldn't sell.

When the crisis started, both the Bush administration and the Federal Reserve

were totally behind the curve. They did not understand the extent.

At what point do you remember thinking for the first time

"This is dangerous, this is bad"?

I remember very well one... I think it was a G7 meeting of February, 2008.

I remember discussing the issue with Hank Paulson

and I clearly remember telling Hank, "We are watching this tsunami coming

"and you're just proposing that we ask which swimming costume we're going to put on".

What was his response, his feeling?

"Things are pretty much under control. We are looking at this situation carefully.

"Yeah, it's under control."

We're gonna keep growing, OK?

And obviously, if you're growing, you're not in recession, right?

I mean, we all know that.

One of the pillars of Wall Street...

In March of 2008, investment bank Bear Stearns ran out of cash

and was acquired for 2 a share by JP Morgan Chase.

The deal was backed by 30 billion in emergency guarantees from the Federal Reserve.

That was the time when the administration could have come in

and put in place various measures to reduce system risk.

The information I'm receiving from some entities is the end is not here. There are other shoes to fall.

I-I've seen those investment banks working with the Fed and the SEC

to strengthen their liquidity, strengthen their capital positions.

I get reports all the time. Our regulators are very vigilant.

On September 7th, 2008, Paulson announced the federal takeover of Fannie Mae and Freddie Mac,

two giant mortgage lenders on the brink of collapse.

Nothing about our actions today in any way reflects a changed view

of housing or the strength of other US financial institutions.

Two days later, Lehman Brothers announced record losses of 3.2 billion and its stock collapsed.

The effects of Lehman and AIG in September still came as a surprise.

This is even after July and Fannie and Freddie.

So clearly there was stuff that - as of September - major stuff that nobody knew about.

I think that's fair.

Bear Stearns was rated AAA a month before it went bankrupt.

-More likely A2.

-A2?

-Yeah.

-OK.

-A2 is still not bankrupt.

-No, no, it's a high investment grade. Solid rating.

Lehman Brothers - A2 within days of failing.

AIG - AA within days of being bailed out.

Fannie Mae and Freddie Mac were AAA when they were rescued.

Citigroup, Merrill, all of them had investment-grade ratings.

-How can that be?

-Well, that's a good question.

That's a great question!

At no point did the administration go to all the major institutions and say, "This is serious.

"Tell us what your positions are. You know, no bullshit. Where are you?"

Well, first, that's what the regulators... That's their job.

Their job is to understand the exposure across these institutions

and they have a very refined understanding that became more refined as the crisis proceeded.

-So...

-Forgive me, but that's clearly not true.

-What do you mean, not true?

In August of 2008, were you aware of the credit ratings

held then by Lehman Brothers,

Merrill Lynch, AIG, and did you think they were accurate?

Well, uh...by that time it was clear that earlier credit ratings were inaccurate

-because they had been downgraded substantially.

-No, they hadn't.

-There was still some downgrading in terms of the industry...

-All those firms were rated at least A2

-until a couple of days before they were rescued.

-Then I just don't know enough to answer your question.

Fred Mishkin is resigning effective August 31 to return to teaching at Columbia School of Business.

Why did you leave the Federal Reserve in August, 2008, the middle of the worst financial crisis...?

So, uh, that I had to revise a textbook.

His departure leaves the Fed with three of seven seats vacant, just when the economy needs it most.

I'm sure your textbook is important, but more important things were going on in the world, don't you think?

By Friday, September 12th, Lehman Brothers had run out of cash

and the entire investment banking industry was sinking fast.

The stability of the global financial system was in jeopardy.

Henry Paulson and Timothy Geithner, president of the NY Federal Reserve,

called an emergency meeting with the CEOs of the major banks in an effort to rescue Lehman.

But Lehman wasn't alone.

Merrill Lynch, another major investment bank, was also on the brink of failure.

That Sunday it was acquired by Bank of America.

The only bank interested in Lehman was Barclays,

but British regulators demanded a financial guarantee from the US Government. Paulson refused.

We all jumped into a yellow cab and went to the Federal Reserve Bank.

They wanted the bankruptcy case commenced before midnight of September 14th.

We kept pressing that this would be a terrible event

and at some point I used the word Armageddon.

Had they fully considered the consequences?

-The effect on the market would be extraordinary.

-You said this?

-Yes.

They said they had considered all of the comments we had made

and they were still of the belief that in order to calm the markets and move forward,

-it was necessary for Lehman to enter bankruptcy.

-"Calm the markets".

-Yes.

When were you first told that Lehman was going to go bankrupt?

-After the fact.

-After the fact?

-Mm-hm.

Wow. OK.

Um, and...

..what was your reaction when you learned of it?

Holy cow!

Paulson and Bernanke had not consulted with other governments

or understood the consequences of foreign bankruptcy laws.

Under British law, Lehman's London office had to be closed immediately.

All transactions came to a halt. There are thousands of transactions.

The hedge funds who had had assets with Lehman in London discovered overnight, to their horror,

-that they couldn't get them back.

-One of the points of the hub failed.

That had huge knock-on effects around the system.

The oldest money market fund in the nation wrote off roughly 0.75 billion dollars in bad debt...

Lehman's also caused a collapse in the commercial paper market,

which many companies depend on to pay for operating expenses, such as payroll.

They have to lay off employees. It stops business in its tracks.

Suddenly, people stood and said, "There is nothing we can trust now."

That same week, AIG owed 13 billion to holders of credit default swaps and it didn't have the money.

AIG was another hub.

If AIG had stopped, all planes may have to stop flying.

On September 17th, AIG is taken over by the government.

One day later, Paulson and Bernanke ask Congress for 700 billion to bail out the banks.

They warn that the alternative would be catastrophic financial collapse.

It was scary. The entire system froze up. Every part of the financial system, the credit system.

Nobody could borrow money. It was like a cardiac arrest of the global financial system.

I'm playing the hand that was dealt me. A lot of what I'm dealing with,

I'm dealing with the consequences of things done many years ago.

Paulson spoke throughout the fall and all the potential root causes of this, he called them.

-So I'm not sure...

-You're not being serious, are you?

-I am.

What would you have expected?

He was the senior advocate for prohibiting the regulation of credit default swaps

and also lifting the leverage limits on the investment banks.

-So again, what...?

-He mentioned those things? I never heard it.

Can we turn this off for a second?

When AIG was bailed out, the owners of its credit default swaps - the most prominent being Goldman Sachs -

were paid 61 billion the next day.

Paulson, Bernanke and Tim Geithner forced AIG to pay 100 cents on the dollar,

rather than negotiate lower prices.

Eventually, the AIG bailout cost taxpayers over 150 billion.

160 billion went through AIG. 14 billion went to Goldman Sachs.

Paulson and Geithner forced AIG to surrender its right to sue Goldman and the other banks for fraud.

Isn't there a problem when the person in charge of dealing with this crisis

is the former CEO of Goldman Sachs, someone with a major role in causing it?

I think it's fair to say that the markets are incredibly complicated.

On October 4th, 2008, President Bush signs a 700 billion bailout bill.

But world stock markets continue to fall, amid fears that a global recession is now underway.

The bailout legislation does nothing to stem the tide of layoffs and foreclosures.

Unemployment in the US and Europe quickly rises to 10%.

The recession accelerates and spreads globally.

I began to get really scared

because I hadn't foreseen the whole world going down at the same rate at the same time.

By December of 2008, General Motors and Chrysler are facing bankruptcy.

And as US consumers cut back on spending, Chinese manufacturers see sales plummet.

Over 10 million migrant workers in China lose their jobs.

At the end of the day,

the poorest, as always, pay the most.

We were growing at about 20%.

It was a super year. And then we suddenly went

to minus 9 this quarter.

Exports collapsed. And we're talking, like, 30%.

So we just took a hit, you know. Fell off a cliff. Bump.

Even as the crisis unfolded, we didn't know how wide it would spread or how severe it'd be.

We were still hoping for some way for us to have a shelter and be less battered by the storm.

But it is not possible. It's a very globalised world. The economies are all linked together.

Every time a home goes into foreclosure, it affects everyone.

When that property goes on the market, it's at a lower price, it won't be well maintained.

We estimate another 9 million home owners will lose their homes.

The vast majority I've seen lately

are people hurt by the economy.

They were living day to day.

Unemployment isn't going to pay a house mortgage.

I was a log truck driver.

And they shut down all the logging systems, sawmills and everything.

I moved down here on a construction job and those got shut down, too.

Things are so tough. There's a lot of people out there and soon you'll be seeing more camps like this.

There's just no jobs right now.

When the company did well, we did well.

When the company did not do well, sir, we did not do well.

The men who destroyed their own companies and plunged the world into crisis walked away

with their fortunes intact.

The top five executives at Lehman's made over a billion dollars between 2000 and 2007.

-When the firm went bankrupt, they kept all the money.

-The system worked.

It doesn't make any sense for us to make a loan that's gonna fail. They lose and we lose.

Countrywide CEO Angelo Mozilo

made 470 million between 2003 and 2008.

140 million came from dumping his Countrywide stock in the 12 months before the company collapsed.

Ultimately, I hold the board accountable when a business fails. They hire and fire the CEO

and oversee big strategic decisions. The problem in America is the way boards are elected -

pretty much picked by the CEO.

The directors and the compensation committees are best situated to determine executive pay packages.

-How do you think they've done over the past 10 years?

-If you look at those... I would give about a B.

-A B?

-Yes.

-Not an F?

-Not an F. Not an F.

Stan O'Neal, CEO of Merrill Lynch, received 90 million in 2006 and 2007 alone.

After driving his firm into the ground, the board of directors allowed him to resign

and he collected 161 million in severance.

Instead of being fired, Stan O'Neal is allowed to resign and takes away 151 million.

-That's a decision that that board made...

-What grade do you give that?

That's tougher. I don't know if that's a B.

O'Neal's successor, John Thain, was paid 87 million in 2007

and in December of 2008, two months after Merrill was bailed out by US taxpayers,

Thain and Merrill's board handed out billions in bonuses.

In March of 2008, AIG's Financial Products Division lost 11 billion.

Instead of being fired, Joseph Cassano, the head of AIGFP, was kept on as a consultant -

for a million dollars a month.

You want to make sure that the key players within AIGFP, that we retain that intellectual knowledge.

I attended a very interesting dinner organised by Hank Paulson a little more than one year ago

with some officials and a couple of CEOs from the biggest US banks

and, surprisingly enough, all of these gentlemen were arguing we were too greedy.

So we have part responsibility, fine. Then they turned to the Secretary of the Treasury and say,

"You should regulate more. We are too greedy. The only way to avoid this is more regulation."

I have spoken to many bankers about this question, including very senior ones,

and this is the first time that I've ever heard anybody say they wanted their compensation regulated.

It was at a moment when they were afraid. And after, when solutions to the crisis began to appear,

probably they changed their mind.

In the US, the banks are now bigger, more powerful and more concentrated than ever before.

There are fewer competitors. A lot of smaller banks were taken over.

JP Morgan today is even bigger.

JP Morgan took over first Bear Stearns and then WAMU.

Bank of America took over Countrywide and Merrill Lynch.

Wells Fargo took over Wachovia.

After the crisis, the financial industry including the Financial Services Roundtable,

worked harder than ever to fight reform. The financial sector employs 3,000 lobbyists,

more than five for each member of Congress.

-Do you think the financial services industry has excessive political influence in the US?

-No.

I think every person in the country is represented here in Washington.

And you think all segments of American society have equal and fair access to the system?

You can walk into any hearing room that you would like. Yes, I do.

One can walk into any hearing room. One could not write the lobbying cheques your industry writes

or engage in the level of political contributions it engages in.

Between 1998 and 2008, the financial industry spent over 5 billion

on lobbying and campaign contributions. Since the crisis, they're spending even more money.

The financial industry also exerts its influence in a more subtle way, one most Americans don't know about.

It has corrupted the study of economics itself.

Deregulation had tremendous financial and intellectual support

because people argued it for their own benefit.

The economics profession was the main source of that illusion.

Since the 1980s, academic economists have been major advocates of deregulation

and played powerful roles in shaping US government policy. Very few of these experts warned of the crisis

and even after the crisis many of them opposed reform.

The guys who taught these things tended to get paid a lot of money being consultants.

Business school professors don't live on a faculty salary.

They do very, very well.

Over the last decade, the financial services industry has made

about 5 billion of political contributions in the US.

That's kind of a lot of money.

That doesn't bother you?

No.

Martin Feldstein is a professor at Harvard and one of the world's most prominent economists.

As President Reagan's chief economic advisor, he was a major architect of deregulation

and from 1988 until 2009 he was on the board of directors of both AIG

and AIG Financial Products, which paid him millions of dollars.

-You have any regrets about being on AIG's board?

-I have no comments.

No, I have no regrets about it. That I can say. Absolutely none.

OK.

Um...

Do you have any regrets about AIG's decisions?

I cannot say anything more about AIG.

I've taught at Northwestern and Chicago, Harvard and Columbia.

Glenn Hubbard is Dean of Columbia Business School

and was chairman of the Council of Economic Advisers to George W Bush.

Do you think the financial services industry has too much political power in the United States?

I don't think so, no. You wouldn't get that impression by the drubbing they regularly get in Washington.

Many prominent academics quietly make fortunes

while helping the financial industry shape public debate and government policy.

The Analysis Group, Charles River Associates, Compass Lexecon

and the Law and Economics Consulting Group manage a multi-billion-dollar industry of academics for hire.

Two bankers who used these services were Ralph Ciofi and Matthew Tannin,

Bear Stearns hedge fund managers prosecuted for securities fraud.

After hiring the Analysis Group, both were acquitted. Hubbard was paid 100,000 to testify for them.

-Do you think economics has a conflict of interest problem?

-I'm not sure I know what you mean.

Do you think a significant fraction of the economics discipline

-have financial conflicts of interest that might call into question or colour...

-Oh, I see.

I doubt it. Most academic economists, you know, aren't wealthy businesspeople.

Hubbard makes 250,000 a year as a board member of Met Life

and was formerly on the board of Capmark, a major mortgage lender which went bankrupt in 2009.

He also advised Nomura Securities, KKR Financial Corporation and many other financial firms.

Laura Tyson, who declined to be interviewed for this film, is a professor at UC Berkeley.

She was the chair of the Council of Economic Advisers,

then director of the National Economic Council in the Clinton administration. After leaving this,

she joined the board of Morgan Stanley for 350,000 a year.

Ruth Simmons, president of Brown University, makes over 300,000 a year on the board of Goldman Sachs.

Larry Summers, who as Treasury Secretary played a critical role in the deregulation of derivatives,

became president of Harvard in 2001.

While at Harvard, he made millions consulting to hedge funds and millions more in speaking fees,

much of it from investment banks.

According to his federal disclosure report, Summer's net worth is between 16.5 million

and 39.5 million.

Frederic Mishkin, who returned to Columbia Business School after leaving the Federal Reserve,

reported that his net worth was between 6 million and 17 million.

-In 2006, you co-authored a study of Iceland's financial system.

-Right.

"Iceland is also an advanced country with excellent institutions, low corruption, rule of law.

"The economy has already adjusted and prudential regulation and supervision is quite strong."

That was the mistake. It turns out that the prudential regulation and supervision was not strong there.

-What made you think that it was?

-I think you go with the information that you had

and, generally, the view was that Iceland had very good institutions.

-It was a very advanced country...

-Who told you that? What research did you do?

-You talk to people,

you have faith in the Central Bank, which did fall down on the job. And clearly this, uh...

-Why do you have faith in a central bank?

-That's... You go with the information you have.

-How much were you paid to write it?

-I was paid, uh... It's public information.

On your CV, the title of this report has been changed from Financial Stability In Iceland

-to Financial INSTABILITY In Iceland.

-Oh, well, I don't know... If there's a typo, there's a typo.

What should be publicly available is whenever anybody researches a topic,

they disclose any financial conflict with that research.

But, if I recall, there is no policy to that effect.

I can't imagine anybody not doing that, in terms of putting it in a paper.

There would be significant professional sanction for that.

I didn't see any place in the study where you indicated you had been paid

-by the Icelandic Chamber of Commerce to produce it.

-No, I...

-OK.

Richard Portes, the most famous economist in Britain and a professor at London Business School,

was also commissioned by the Icelandic Chamber of Commerce in 2007 to write a report

praising Iceland's financial sector.

The banks are highly liquid. They've made money on the fall of the krona.

These are strong banks. Their market funding is assured. These are well-run banks.

Like Mishkin, Portes's report didn't disclose his payment from the Icelandic Chamber of Commerce.

Does Harvard require disclosures of financial conflict of interest in publications?

-Not to my knowledge.

-Do you require people to report their compensation from outside activities?

-No.

-Don't you think that's a problem?

-I don't see why.

-Martin Feldstein on the board of AIG,

Laura Tyson on the board of Morgan Stanley, Larry Summers making 10 million from consulting...

Irrelevant?

Well, yeah. Basically, irrelevant.

You've written a large number of articles on a wide array of subjects

and you never saw fit to investigate the risks

-of unregulated credit default swaps?

-I never did.

Same question with regard to executive compensations, regulation of corporate governance,

-the effect of political contributions...

-I don't know that I would have anything to add on those.

I'm looking at your resume now. It looks to me as if the majority of your outside activities

are consulting and directorship arrangements with the financial services industry.

-Would you not agree with that?

-I don't think my consulting clients are even on my CV, so...

-Uh, who are your consulting clients?

-I don't believe I have to discuss that with you.

-OK.

You have a few more minutes and then the interview is over.

-Do you consult for any financial services firms?

-The answer is I do.

-And...

-But I do not want to go into details about that.

-Do they include other financial services firms?

-Possibly.

-You don't remember?

-This isn't a deposition, sir.

I was polite enough to give you time. Foolishly, I now see. You have 3 minutes. Give it your best shot.

In 2004, the height of the bubble, Hubbard co-authored a widely-read paper with William C Dudley,

the chief economist of Goldman Sachs. In the paper, Hubbard praised credit derivatives

and the securitisation chain as they had improved allocation of capital and enhanced financial stability.

He cited reduced volatility in the economy and stated that recessions had become less frequent and milder.

Credit derivatives were protecting banks against losses and helping to distribute risk.

A medical researcher writes an article saying to treat this disease you should prescribe this drug.

The doctor makes 80% of personal income from the manufacturer of this drug. It does not bother you?

I think it's certainly important to disclose the, um...

..the, um...

Well, I think that's also a little different from cases we are talking about here because, um...

Um...

So what do you think this says about the economics discipline?

Well, it has no relevance to anything, really.

Indeed, I think, it's a part of...

It's an important part of the problem.

The rising power of the US financial sector was part of a wider change in America.

Since the 1980s, the United States has become a more unequal society,

and its economic dominance has declined.

Companies like General Motors, Chrysler and US Steel, formerly the core of the US economy,

were poorly managed and falling behind their foreign competitors.

And as countries like China opened their economies,

American companies sent jobs overseas to save money.

For many, many years

the 660 million people in the developed world were sheltered

from all of this additional labour that existed on the planet.

Suddenly, the Bamboo Curtain and the Iron Curtain are lifted and you have 2.5 billion additional people.

American factory workers were laid off by the tens of thousands.

Our manufacturing base was destroyed over a few years.

As manufacturing declined, other industries rose.

The United States leads the world in information technology, where high-paying jobs are easy to find,

but those jobs require an education and, for average Americans, college is increasingly out of reach.

While top private universities like Harvard have billions of dollars in their endowments,

funding for public universities is shrinking and tuition is rising.

Tuition for California's public universities rose from 650 in the 1970s

to over 10,000 in 2010.

Increasingly, the most important determinant of whether Americans go to college

is whether they can find the money to pay for it. Meanwhile, tax policy shifted to favour the wealthy.

When I first came to office, I thought taxes were too high. They were.

The most dramatic change was a series of tax cuts designed by Glenn Hubbard,

who was President Bush's chief economic advisor.

They sharply reduced taxes on investment gains, stock dividends and eliminated estate tax.

We had a comprehensive plan that, when acted, has left nearly 1.1 trillion in the hands

of American workers, families, investors and small business owners.

Most of the benefits of these cuts went to the wealthiest 1% of Americans.

And, by the way, it was really the cornerstone of our economic recovery policy.

Inequality of wealth in the United States is now higher than in any other developed country.

American families responded to these changes in two ways: by working longer hours and going into debt.

As the middle class falls further and further behind,

there is a political urge to respond by making it easier to get credit.

You don't have to have a lousy home.

The low-income home buyer can have just as nice a house as anybody else.

American families borrowed to finance their homes, their cars,

their healthcare and their children's educations.

People in the bottom 90% lost ground between 1980 and 2007.

It all went to the top 1%.

For the first time in history,

average Americans have less education and are less prosperous than their parents.

The era of greed and irresponsibility on Wall Street

and in Washington has led us to a financial crisis

as serious as any we've faced since the Great Depression.

When the crisis struck, just before the 2008 election, Barack Obama pointed to Wall Street greed

and regulatory failures as examples of the need for change in America.

A lack of oversight in Washington and on Wall Street is exactly what got us into this mess.

In office, he spoke of the need to reform the financial industry.

We want a systemic risk regulator,

a consumer financial protection agency, and to change Wall Street.

But when finally enacted in mid-2010 the administration's financial reforms were weak

and, in some critical areas, including the rating agencies, lobbying and compensation,

nothing significant was proposed.

Addressing Obama and "regulatory reform", my response, if it was one word, would be: ha!

There's very little reform.

How come?

It's a Wall Street government.

Obama chose Timothy Geithner as Treasury Secretary.

Geithner was president of the New York Federal Reserve in the crisis

and a key player in the decision to pay Goldman Sachs 100 cents on the dollar for bets against mortgages.

When Tim Geithner was testifying to be confirmed as Treasury Secretary,

he said, "I have never been a regulator." He didn't understand his job as president of the NY Fed.

The new president of the New York Fed is William C Dudley, former chief economist of Goldman Sachs,

whose paper with Glenn Hubbard praised derivatives.

Geithner's chief of staff is Mark Patterson, former Goldman lobbyist,

and one of the senior advisors is Lewis Sachs, who oversaw Tricadia,

a company heavily involved in betting against the mortgage securities it was selling.

To head the Commodity Futures Trading Commission, Gary Gensler,

a former Goldman Sachs executive who helped ban derivatives regulation.

To run the Securities and Exchange Commission, Obama picked Mary Shapiro, former CEO of FINRA,

the investment banking industry's self-regulation body.

Obama's chief of staff, Rahm Emanuel, made 320,000 serving on the board of Freddie Mac.

Both Martin Feldstein and Laura Tyson are members of Obama's Economic Recovery Advisory Board

and Obama's chief economic advisor is Larry Summers.

The most senior economic advisors are the very people who built the structure.

The Obama administration resisted regulation of bank compensation even as foreign leaders took action.

The financial industry is a service industry. It should serve others before it serves itself.

In September of 2009, Christine Lagarde and the finance ministers of Sweden, the Netherlands,

Luxembourg, Italy, Spain and Germany called for the G20 nations, including the United States,

to impose strict regulations on bank compensation.

And in July of 2010, the European Parliament enacted those very regulations.

The Obama administration had no response.

Their view is it's a temporary blip. Things will go back to normal.

That is why I am reappointing him to another term as chairman of the Federal Reserve.

-In 2009, Barack Obama reappointed Ben Bernanke.

-Thank you, Mr President.

As of mid-2010, not a single senior financial executive had been criminally prosecuted

or even arrested. No special prosecutor had been appointed,

not a single financial firm had been prosecuted criminally for securities fraud or accounting fraud.

Obama has made no attempt to recover any of the compensation

given to financial executives during the bubble.

I certainly would think of criminal action against some of Countrywide's top leaders, like Mozilo.

I'd certainly look at Bear Stearns, Goldman Sachs, Lehman Brothers and Merrill Lynch.

-For criminal prosecutions?

-Yes.

They'd be very hard to win,

but I think they could do it if they got enough underlings to tell the truth.

In an industry in which drug use, prostitution and fraudulent billing of prostitutes as a business expense

occur on an industrial scale, it wouldn't be hard to make people talk if you really wanted to.

They gave me a plea bargain and I took it.

-They were not interested in any of my records.

-They were not interested in your records?

-That's correct.

There's a sensibility that you don't use people's...personal vices

in the context of Wall Street cases, necessarily, to get them to flip.

I think maybe after the cataclysms that we've been through, maybe people will re-evaluate that.

I'm not the one to pass judgment on that right now.

You come to us today telling us, "We're sorry, we didn't mean it.

"We won't do it again. Trust us."

Well, I have some people in my constituency that actually robbed some of your banks

and they say the same thing! They're sorry. They won't do it again.

In 2009, as unemployment hit its highest level in 17 years,

Morgan Stanley paid its employees over 14 billion and Goldman Sachs paid out over 16 billion.

In 2010, bonuses were even higher.

Why should a financial engineer

be paid four times to a hundred times more than a real engineer?

A real engineer builds bridges.

A financial engineer builds dreams.

And, uh, you know, when those dreams turn out to be nightmares,

other people pay for it.

For decades, the American financial system was stable and safe.

But then something changed.

The financial industry turned its back on society, corrupted our political system

and plunged the world economy into crisis.

At enormous cost, we've avoided disaster and are recovering,

but the men and institutions that caused the crisis are still in power and that needs to change.

They will tell us that we need them and that what they do is too complicated for us to understand.

They will tell us it won't happen again.

They will spend billions fighting reform.

It won't be easy,

but some things are worth fighting for.

# Dead in the water

# It's not a paid vacation

# The sons and daughters of city officials... #