0:00:03 > 0:00:07I'm New Jersey Governor Jon Corzine and I should be dead.
0:00:07 > 0:00:13Jon Corzine was a titan at the pinnacle of politics and finance.
0:00:13 > 0:00:15He was a friend of presidents, a former
0:00:15 > 0:00:19chairman of the investment bank Goldman Sachs...
0:00:19 > 0:00:23And a financial trader to his core.
0:00:23 > 0:00:27Traders have a feeling that they're controlling events.
0:00:27 > 0:00:32It's true for gamblers everywhere. It's that illusion of control.
0:00:34 > 0:00:38One day in 2007, Jon Corzine was late for a meeting.
0:00:40 > 0:00:42He had chosen not to wear a seatbelt.
0:00:42 > 0:00:45ENGINES REVS
0:00:45 > 0:00:48TYRES SCREECH
0:00:48 > 0:00:52POLICE RADIO: Troopers requesting paramedics, EMS,
0:00:52 > 0:00:54anything you can send out there.
0:00:54 > 0:00:58He broke 15 bones and lost more than half the blood in his body.
0:01:01 > 0:01:04Corzine's car crash reveals something about his risk appetite,
0:01:04 > 0:01:09a belief in one's own invulnerability and perhaps a belief
0:01:09 > 0:01:13that the rules, as they should apply to other people, don't apply to you.
0:01:13 > 0:01:18Nobody shows better than Jon Corzine how high the stakes can be
0:01:18 > 0:01:21when it comes to risk in life or in finance.
0:01:21 > 0:01:23SIRENS BLARE
0:01:23 > 0:01:25We're going to work very hard...
0:01:25 > 0:01:29Just two years ago he took a huge gamble in the markets
0:01:29 > 0:01:32that went catastrophically wrong.
0:01:32 > 0:01:35I would punch him in the face, I swear. I would.
0:01:36 > 0:01:40Often, characters like that do end up destroying businesses.
0:01:40 > 0:01:43The financial crash was meant to have put an end
0:01:43 > 0:01:45to dangerous risk taking by bankers.
0:01:45 > 0:01:48THEY SHOUT OVER EACH OTHER
0:01:48 > 0:01:50But it hasn't.
0:01:50 > 0:01:53We've got to stop problems caused by risk-taking
0:01:53 > 0:01:56here in the City of London spilling onto the high streets
0:01:56 > 0:01:59and putting taxpayers' money at risk.
0:01:59 > 0:02:05The risks bankers take in their pursuit of profits are double-edged.
0:02:05 > 0:02:08Risk has the power to drive society forwards.
0:02:08 > 0:02:11And the potential to destroy it.
0:02:11 > 0:02:14Risk is good. People need to take risk, but they need to take risk
0:02:14 > 0:02:19in ways that they don't bring the entire system down with them.
0:02:19 > 0:02:20With the economy on its knees
0:02:20 > 0:02:25and the reputation of banks shredded by scandal after scandal,
0:02:25 > 0:02:28this series asks what do we want from our bankers?
0:02:29 > 0:02:32Can we ever trust them again?
0:02:32 > 0:02:36Can we stop them taking dangerous risks?
0:02:37 > 0:02:40And if not, can we stop them taking us all down again?
0:02:52 > 0:02:54Our main headline this morning,
0:02:54 > 0:02:56Britain has lost its triple-A credit rating.
0:02:56 > 0:02:59Stripped of its triple-A credit rating
0:02:59 > 0:03:01for the first time in 30 years.
0:03:01 > 0:03:04The credit rating agencies have stripped the UK
0:03:04 > 0:03:07of its prized triple-A status because of the weakness...
0:03:07 > 0:03:11Five years on and the fallout from the crash keeps coming.
0:03:13 > 0:03:15After the banks failed across Europe,
0:03:15 > 0:03:18now it's nation states in the firing line.
0:03:18 > 0:03:22Government debt is piling up, making the world a more dangerous place.
0:03:23 > 0:03:27The pre-crash world, European Sovereign States
0:03:27 > 0:03:33were regarded as safe as safe can be.
0:03:33 > 0:03:38The thought that they would EVER not pay back their money was ludicrous.
0:03:38 > 0:03:41Post-crash, that has changed.
0:03:43 > 0:03:47Britain now joins France and 14 other heavily indebted European countries
0:03:47 > 0:03:51downgraded by credit rating agencies since the crash.
0:03:51 > 0:03:54Many of the things we're seeing in the market place today,
0:03:54 > 0:03:58are almost unprecedented or certainly haven't been seen
0:03:58 > 0:04:01for decades in the United Kingdom and internationally.
0:04:03 > 0:04:06Europe's leaders are lurching from one crisis to another,
0:04:06 > 0:04:11as they struggle to stay on top of 11 trillion euros of debt.
0:04:11 > 0:04:14The key question for the financial markets is
0:04:14 > 0:04:18how far will governments go to save the Euro?
0:04:19 > 0:04:23You can't sit down with a spreadsheet and probabilities
0:04:23 > 0:04:27and decide what Angela Merkel is going to do with the Eurozone project.
0:04:27 > 0:04:31And that means that markets are quite scared and nervous
0:04:31 > 0:04:35and worried about what politicians say and do.
0:04:38 > 0:04:42That's driving up the cost of borrowing for countries in trouble.
0:04:42 > 0:04:47Before the crash, Italy paid 4%. Since then it has hit 7%.
0:04:49 > 0:04:53That shows how the markets have changed their view of risk.
0:04:54 > 0:04:57They're taking note of things like political risk.
0:04:57 > 0:04:58That's not surprising,
0:04:58 > 0:05:01because the reality is that governments are essentially
0:05:01 > 0:05:05behaving in ways that are very much driven by social factors
0:05:05 > 0:05:08and cultural factors, rather than just hard-headed economic logic.
0:05:10 > 0:05:13But there is a flip side to Europe's sovereign debt nightmare.
0:05:16 > 0:05:19Every crisis is a chance for bankers
0:05:19 > 0:05:21to make money by taking higher risks.
0:05:23 > 0:05:26In Europe's debt markets, bankers are still
0:05:26 > 0:05:29feeding on the entrails of the crash.
0:05:29 > 0:05:31That's how capitalism works.
0:05:33 > 0:05:38If you take on higher risk, the quid pro quo is you get a higher return
0:05:38 > 0:05:43and therefore if you want to buy Spanish bonds or Italian bonds,
0:05:43 > 0:05:48which are regarded as being higher risk, then you get a higher return.
0:05:48 > 0:05:53There's always people willing to take the trade that others fear to.
0:05:56 > 0:05:59One banker who would hunt for profits in Europe's debt crisis
0:05:59 > 0:06:03was Jon Corzine, who nearly died in that horrific car accident.
0:06:07 > 0:06:11The story of his disastrous 6 billion gamble
0:06:11 > 0:06:14shows how the promise of high returns
0:06:14 > 0:06:18can still blind bankers to the risks they take.
0:06:21 > 0:06:25It all began in New York in March 2010.
0:06:25 > 0:06:30Jon Corzine was making an audacious return to Wall Street.
0:06:30 > 0:06:33Former New Jersey Governor Jon Corzine is returning
0:06:33 > 0:06:36to the private sector after nearly a decade in government.
0:06:36 > 0:06:39He has taken the helm of futures and options brokers, MF Global.
0:06:39 > 0:06:44It was a total mismatch between, you know, a guy who had been
0:06:44 > 0:06:47senior partner of Goldman Sachs, a Senator
0:06:47 > 0:06:51and a Governor of a major industrial state,
0:06:51 > 0:06:54going to this two-bit futures broker
0:06:54 > 0:06:57that had very much seen better days.
0:06:57 > 0:07:00It made absolutely no sense whatsoever.
0:07:00 > 0:07:03I'm really excited about the opportunity to lead MF Global.
0:07:03 > 0:07:08We're going to work very hard to get the earnings back on track.
0:07:08 > 0:07:14MF Global set up shop as a barrel maker in London in 1783.
0:07:14 > 0:07:21By 2010, it employed more than 3,000 people in 12 countries.
0:07:23 > 0:07:25And its business was brokerage.
0:07:25 > 0:07:30That means it acted on behalf of its clients in return for a fee.
0:07:32 > 0:07:34It did not take risks with its own money.
0:07:36 > 0:07:39We didn't care which way a market moved,
0:07:39 > 0:07:41we just cared that it DID move, because we made our profits
0:07:41 > 0:07:44by transacting business on behalf of our customers.
0:07:44 > 0:07:45We didn't make our money
0:07:45 > 0:07:48by transacting business on our own account.
0:07:48 > 0:07:52But Jon Corzine had taken on a huge challenge.
0:07:52 > 0:07:57By 2010, MF Global had seen better days.
0:07:57 > 0:08:02Its revenues had fallen from six billion to two billion dollars.
0:08:02 > 0:08:05It urgently needed new ways to make money.
0:08:07 > 0:08:11Its business model was completely falling apart, so Corzine had to find
0:08:11 > 0:08:14profits somewhere, he was under the gun to figure out
0:08:14 > 0:08:16a way for MF Global to make money.
0:08:18 > 0:08:22Since the crash, the Bank of England, like other central banks,
0:08:22 > 0:08:25had cut interest rates to near zero.
0:08:25 > 0:08:28The decision meant that businesses like MF Global,
0:08:28 > 0:08:32which survived by investing clients' money, lost income.
0:08:32 > 0:08:37At our peak we had about 24 billion dollars of customer money,
0:08:37 > 0:08:42and that clearly represented a significant part of our income.
0:08:42 > 0:08:47As interest rates went down to zero, those revenues began to dry up.
0:08:49 > 0:08:53Inside central banks, the idea was that cutting interest rates
0:08:53 > 0:08:57would encourage borrowing which had dried up after the crash.
0:08:58 > 0:09:03The policy has another consequence which may be hard to control.
0:09:03 > 0:09:06It leads to a fresh search for yield.
0:09:06 > 0:09:09Now, the only way you can do that is to take more risk.
0:09:09 > 0:09:11And there's no question
0:09:11 > 0:09:13that this search for yield is reappearing.
0:09:13 > 0:09:18People are now actively taking more risk to get a higher return.
0:09:20 > 0:09:22One of those was Jon Corzine.
0:09:22 > 0:09:26Facing declining revenues at MF Global,
0:09:26 > 0:09:30he turned to what he thought he knew best - risk.
0:09:32 > 0:09:35More than 30 years earlier, Corzine had been a trader for
0:09:35 > 0:09:40one of the world's most successful investment banks, Goldman Sachs.
0:09:41 > 0:09:43His reputation was made in 1986,
0:09:43 > 0:09:48when he managed to turn a huge failing trade into a profit.
0:09:49 > 0:09:54You can be lucky and you will never know how lucky you were,
0:09:54 > 0:09:57you will take credit for lucky successes.
0:09:57 > 0:09:59It's terrible for decision makers
0:09:59 > 0:10:02to have those great experiences of success.
0:10:02 > 0:10:07They become convinced that they're all-knowing, and that makes them a real menace.
0:10:10 > 0:10:13At MF Global's headquarters in New York,
0:10:13 > 0:10:15Jon Corzine hatched a radical plan.
0:10:15 > 0:10:17To stem the firm's losses,
0:10:17 > 0:10:21MF Global would start taking risks itself in the markets.
0:10:23 > 0:10:28We can't turn this into a camouflaged hedge fund,
0:10:28 > 0:10:31but I do believe we can take more principal risk
0:10:31 > 0:10:33in some of the businesses involved.
0:10:35 > 0:10:39Jon Corzine had lunch with a former chief executive to discuss
0:10:39 > 0:10:43his plan for the firm to take risk by trading with its own money.
0:10:44 > 0:10:48He wanted to take risks that the company wasn't used to taking,
0:10:48 > 0:10:50which was trading risk.
0:10:50 > 0:10:54I told him that really there wasn't very much in the DNA
0:10:54 > 0:10:56of the company that would support that sort of activity,
0:10:56 > 0:11:00and that he would have to change the entire senior management
0:11:00 > 0:11:04and ethos of the business if he was going to take that course.
0:11:04 > 0:11:10How we manage risk, how we take decisions with regard to
0:11:10 > 0:11:14how we use our capital, is going to determine our success.
0:11:16 > 0:11:20MF Global had survived for more than 200 years.
0:11:22 > 0:11:26Now, under a man supremely confident in his ability to take risk,
0:11:26 > 0:11:29it was just 19 months from destruction.
0:11:35 > 0:11:40In Britain, reckless risk taking by bankers was becoming a hot issue
0:11:40 > 0:11:42in a tight general election.
0:11:45 > 0:11:49Retail banks, banks that you and I put our deposits into,
0:11:49 > 0:11:53they should not be behaving like casinos, taking wild bets.
0:11:55 > 0:11:59But at that time, few in Britain were taking much risk.
0:12:01 > 0:12:05When you go through a crisis, people become cautious. Individuals
0:12:05 > 0:12:08become cautious and so they want to pay down their mortgages.
0:12:08 > 0:12:11And traders become cautious
0:12:11 > 0:12:16so they don't tend to provide money for mergers and acquisitions,
0:12:16 > 0:12:21etc, so there is a natural tendency to caution, post a crisis.
0:12:23 > 0:12:26Risk aversion in the financial system
0:12:26 > 0:12:29is a symptom of Britain's economic woes.
0:12:31 > 0:12:32Since the crash,
0:12:32 > 0:12:36banks have focused on repairing their damaged balance sheets.
0:12:36 > 0:12:39And regulators have told them to hold more capital.
0:12:41 > 0:12:44Banks appear to have backed away from riskier trading.
0:12:46 > 0:12:48And they've cut back on the lending
0:12:48 > 0:12:50that could help fuel economic recovery.
0:12:52 > 0:12:56There's no doubt that the financial crisis
0:12:56 > 0:12:59when it broke in its most severe form, caused a sort of severe
0:12:59 > 0:13:04retraction in terms of taking risk and attitudes towards taking risks.
0:13:04 > 0:13:07And there's no doubt that of course that spilled over
0:13:07 > 0:13:10from those sectors of risk-taking that we sort of don't want to see
0:13:10 > 0:13:15in the future into the basic credit creation functions of the economy.
0:13:18 > 0:13:22One bank with a huge presence in Britain was different.
0:13:22 > 0:13:25JP Morgan came through the financial crisis in good shape.
0:13:27 > 0:13:30But the bank's success would contain the seeds of disaster.
0:13:34 > 0:13:38The story of how a London team of JP Morgan traders
0:13:38 > 0:13:42lost 6 billion last year shows how even a well-run bank
0:13:42 > 0:13:46can take ever more complex and risky gambles.
0:13:50 > 0:13:53The bets that spiralled out of control
0:13:53 > 0:13:55were made in this anonymous office.
0:13:58 > 0:14:02They were dubbed the London Whale Trades, because they were so vast.
0:14:05 > 0:14:08One of the huge problems in the modern world is the extreme
0:14:08 > 0:14:10complexity of many parts of,
0:14:10 > 0:14:13you know, 21st century life
0:14:13 > 0:14:16and the story of the whale illustrates that very well indeed,
0:14:16 > 0:14:19because the sheer volume of trades that are now going
0:14:19 > 0:14:22through banks like JP Morgan and the extraordinary
0:14:22 > 0:14:26complexity of these financial deals, means that it's way beyond
0:14:26 > 0:14:30the ability of any one individual or any one group of individuals
0:14:30 > 0:14:34to really track, in detail, what's happening on these trading desks.
0:14:38 > 0:14:41JP Morgan is a global giant.
0:14:42 > 0:14:47Like Barclays and RBS, it combines investment, or corporate banking,
0:14:47 > 0:14:51with serving retail customers.
0:14:54 > 0:14:56From its headquarters in New York, JP Morgan employs nearly
0:14:56 > 0:14:59a quarter of a million people in 60 countries.
0:15:01 > 0:15:03Tony Blair is a paid advisor.
0:15:06 > 0:15:10JP Morgan is so large, the American taxpayer would step in
0:15:10 > 0:15:12if things went wrong.
0:15:12 > 0:15:17But until the London Whale losses, the bank seemed invincible.
0:15:17 > 0:15:21The story tells us that risk always lurks in unexpected places,
0:15:21 > 0:15:26that in the very complex, modern financial world, you can have
0:15:26 > 0:15:30an inordinate amount of risk on your books and actually not know
0:15:30 > 0:15:35that you have it, and even a CEO who is extremely talented and brilliant
0:15:35 > 0:15:39and cares deeply and works really hard can still miss it.
0:15:46 > 0:15:52That CEO is Jamie Dimon, who has run JP Morgan since 2005.
0:15:54 > 0:15:56While other banks struggled after the crash,
0:15:56 > 0:15:59Dimon made his the envy of the world.
0:16:02 > 0:16:05In 2012, he earned 23 million.
0:16:07 > 0:16:11Each decade produces, you know, the King of Wall Street,
0:16:11 > 0:16:16somebody who is on the cover of the various financial magazines and
0:16:16 > 0:16:21Jamie Dimon was the new poster child for being the King of Wall Street.
0:16:23 > 0:16:28He became known as America's least hated banker.
0:16:28 > 0:16:31He's not the imperial CEO sitting on high,
0:16:31 > 0:16:33not really understanding how the firm works,
0:16:33 > 0:16:36he's the guy down in the minutiae of the numbers, managing risk.
0:16:36 > 0:16:39And a lot of people give him a lot of credit for steering
0:16:39 > 0:16:43JP Morgan clear of the worse excesses of sub prime
0:16:43 > 0:16:46mortgage related products that brought down so many other firms.
0:16:53 > 0:16:57Under Jamie Dimon, JP Morgan sailed through the financial crisis
0:16:57 > 0:17:00without losing money.
0:17:00 > 0:17:04It avoided overdosing on the toxic sub prime debts by sticking
0:17:04 > 0:17:08to a tried and tested rule, just as a well-run bank should.
0:17:09 > 0:17:11Too much of anything can become malignant,
0:17:11 > 0:17:15so what really bailed us out, as it were,
0:17:15 > 0:17:18was the discipline around not having too much of anything.
0:17:21 > 0:17:23But abandoning that discipline
0:17:23 > 0:17:25would contribute to the London Whale losses.
0:17:28 > 0:17:31Any sense that existed before that JP Morgan was somehow infallible,
0:17:31 > 0:17:34of course, is gone and I don't think that will probably ever come back.
0:17:37 > 0:17:40At the heart of the Whale Trades is one of the fundamental
0:17:40 > 0:17:42functions in banking.
0:17:44 > 0:17:48Some of the money of the depositors is kept behind
0:17:48 > 0:17:50the great door of this vault.
0:17:52 > 0:17:57For more than a century, JP Morgan has done what banks do -
0:17:57 > 0:18:02taken money in as deposits and lent money out, as loans.
0:18:02 > 0:18:06If the money coming in is greater than the money being lent out,
0:18:06 > 0:18:08there is a surplus.
0:18:08 > 0:18:13Part of the money that comes into a bank is kept in cash.
0:18:13 > 0:18:17But the rest of it must be put to work to earn a profit for the bank.
0:18:19 > 0:18:22At JP Morgan, the spare money was put to work
0:18:22 > 0:18:24by the Chief Investment Office or CIO.
0:18:27 > 0:18:31Banks are in the risk business. The CIO of JP Morgan was
0:18:31 > 0:18:34part of the risk-taking machinery.
0:18:36 > 0:18:40These investments must be safe investments
0:18:40 > 0:18:44such as government bonds, municipal bonds and mortgages.
0:18:48 > 0:18:52At first, the CIO stuck to safe investments like government bonds.
0:18:53 > 0:18:55But it didn't stay that way.
0:18:57 > 0:19:01After Jamie Dimon took over JP Morgan, it was decided
0:19:01 > 0:19:05the CIO should boost its profits by investing in new areas.
0:19:11 > 0:19:14The financial crash was a perfect opportunity.
0:19:15 > 0:19:19Troubled banks began selling off their mortgage and loan assets.
0:19:19 > 0:19:21And because frightened investors
0:19:21 > 0:19:26were sheltering their money in JP Morgan, the CIO was flush with cash.
0:19:30 > 0:19:34They were the bank to talk to if you had something to sell.
0:19:34 > 0:19:39They helped RBS and Lloyds and some of the UK banks to offload
0:19:39 > 0:19:43some of their...some of the assets they had on the balance sheet.
0:19:46 > 0:19:50Buying billions of dollars of these assets meant taking on more risk.
0:19:52 > 0:19:56But if any bank was confident it could handle it, it was JP Morgan.
0:20:00 > 0:20:04After all, 30 years earlier the bank had embarked on a huge effort
0:20:04 > 0:20:08to tame risk that would give all bankers confidence
0:20:08 > 0:20:10they can control the gambles they take.
0:20:19 > 0:20:21Saratoga, California.
0:20:21 > 0:20:26High above the cauldron of hi-tech innovation, Silicon Valley.
0:20:26 > 0:20:31And home to the man who defined the risk paradigm for JP Morgan
0:20:31 > 0:20:36and the entire financial system for the last 30 years.
0:20:36 > 0:20:40Till Guldimann's work has helped us believe we've harnessed
0:20:40 > 0:20:43one of the forces driving civilisation forwards.
0:20:44 > 0:20:48Capitalism is all about risk taking.
0:20:48 > 0:20:52Whenever you want to make money or earn a return on capital,
0:20:52 > 0:20:54you have to take risks.
0:20:54 > 0:20:56Without risks there is no return.
0:20:59 > 0:21:02Till was asked to measure the amount of risk
0:21:02 > 0:21:04taken by traders at JP Morgan.
0:21:06 > 0:21:10While they were guided by intuition, Till turned to maths.
0:21:10 > 0:21:13The traders took the risks out of their gut feeling.
0:21:13 > 0:21:18They were not very analytical, or not very numerical, but I was
0:21:18 > 0:21:24at headquarters, at the centre,
0:21:24 > 0:21:28we needed to understand what was going on in this network
0:21:28 > 0:21:32of risk takers, so I was the policeman,
0:21:32 > 0:21:35or the aggregator, the accountant,
0:21:35 > 0:21:38so I, of course, needed the numbers.
0:21:41 > 0:21:45So began his quest for a formula to measure the risks taken by banks.
0:21:47 > 0:21:51The goal is to have as much return as possible
0:21:51 > 0:21:55for the least amount of risk to take.
0:21:55 > 0:21:57That's the Holy Grail.
0:22:05 > 0:22:08Till's work at JP Morgan went hand in hand with the birth
0:22:08 > 0:22:13of the complex global financial system we rely on today.
0:22:15 > 0:22:19In the early 1980s, governments began deregulating their financial
0:22:19 > 0:22:23markets so banks opened new trading operations across the world.
0:22:25 > 0:22:30All of a sudden, you didn't have your daily coffee talk
0:22:30 > 0:22:32with your traders anymore,
0:22:32 > 0:22:35they were in a different time zone, a different location,
0:22:35 > 0:22:39so it became important to have a good accounting system, not just
0:22:39 > 0:22:45for the positions and the profits and losses, but also for risks.
0:22:48 > 0:22:52To measure risk, Till first had to define it.
0:22:52 > 0:22:56Risk is the potential change in value.
0:22:56 > 0:23:01In other words, how much money did a trader stand to lose?
0:23:01 > 0:23:05Till realised the only evidence he had, was how an investment
0:23:05 > 0:23:07had performed before.
0:23:07 > 0:23:09The only way to tell the future
0:23:09 > 0:23:13is to think about what happened in the past.
0:23:13 > 0:23:16By analysing the past performance of an investment,
0:23:16 > 0:23:18Till came up with a formula
0:23:18 > 0:23:22that converted the intangible idea of risk into a single number.
0:23:24 > 0:23:29How many dollars could an investment lose most of the time?
0:23:29 > 0:23:30It was a godsend for bosses
0:23:30 > 0:23:34struggling to stay on top of what their trading teams were up to.
0:23:36 > 0:23:41That number tells you that 95% of the time,
0:23:41 > 0:23:44you will not lose more than that.
0:23:46 > 0:23:49Every day, at four o'clock in the afternoon,
0:23:49 > 0:23:52we had this report which said over the next 24 hours, Mr Chairman,
0:23:52 > 0:23:56you could lose 2 million or 10 million or whatever.
0:23:59 > 0:24:03Till Guldimann had found a way to predict financial risk
0:24:03 > 0:24:0595% of the time.
0:24:08 > 0:24:11But the story of how bankers embraced his Value at Risk
0:24:11 > 0:24:16formula, or VaR, shows how attempts to measure risk can
0:24:16 > 0:24:19encourage them to act as if they have mastered it.
0:24:22 > 0:24:25It was developed at JP Morgan by a group of people who saw exactly what
0:24:25 > 0:24:27it was and exactly what it wasn't.
0:24:27 > 0:24:29In other words, they understood it was
0:24:29 > 0:24:34a number that captured historical likelihoods, but that didn't
0:24:34 > 0:24:37mean that that was truth with a capital T. But I think as
0:24:37 > 0:24:41top executives became more and more divorced from the complicated nature
0:24:41 > 0:24:44of what happened on trading floors, they began to see VaR as truth
0:24:44 > 0:24:48with a capital T. It meant this was how much money you could lose.
0:24:48 > 0:24:53During the 1990s, Value at Risk was adopted by regulators
0:24:53 > 0:24:54as well as banks.
0:24:54 > 0:24:56Value at Risk became
0:24:56 > 0:25:00the all-pervasive model that every financial institution used.
0:25:00 > 0:25:03It was seductive because you could create a model, so you'd run
0:25:03 > 0:25:06a computer model, you'd plug a set of numbers in and something
0:25:06 > 0:25:10would come out, which told you how much capital you needed to hold.
0:25:10 > 0:25:12The executive in banks liked it
0:25:12 > 0:25:15because it meant they had to hold less capital,
0:25:15 > 0:25:19and they therefore could take bigger bets, if you like, with their bank,
0:25:19 > 0:25:22and regulators like it, because it convinced us that all banks had
0:25:22 > 0:25:26a system in place which was allowing the banks to understand risk.
0:25:29 > 0:25:34From the late 1990s, banks lent around a trillion dollars
0:25:34 > 0:25:37to Americans on low incomes to buy houses.
0:25:37 > 0:25:42Even if your credit is less than perfect, Ameriquest can help!
0:25:42 > 0:25:44Most bankers thought it wasn't risky
0:25:44 > 0:25:47because that's what they thought Value at Risk was telling them.
0:25:49 > 0:25:53People thought the future would look like the past.
0:25:53 > 0:25:56So you could look over the last one or two years,
0:25:56 > 0:26:00and just say, OK, we know what the risks look like and we'll just
0:26:00 > 0:26:04manage going forward, as if the next period will play out with
0:26:04 > 0:26:08the same types of risks and level of risk as we've seen in the past.
0:26:08 > 0:26:12There was a sense that the future was predictable
0:26:12 > 0:26:15and forecast-able and understandable.
0:26:15 > 0:26:18There was this idea that
0:26:18 > 0:26:21if you plugged enough numbers into a computer model or a spread sheet,
0:26:21 > 0:26:26you could actually predict what was going to happen in the future.
0:26:28 > 0:26:32The faith placed in models like Value at Risk before 2008
0:26:32 > 0:26:36mirrored the economic optimism that swept across the West,
0:26:36 > 0:26:38buoyed up by a rising tide of wealth.
0:26:41 > 0:26:42In 2006 and 2007,
0:26:42 > 0:26:46we were coming to the end of this fantastic boom period.
0:26:46 > 0:26:48I'm sure many people will recognise the expression,
0:26:48 > 0:26:50no more boom and bust.
0:26:50 > 0:26:53There was a perception that the economic cycle had been managed
0:26:53 > 0:26:56in some way that had never happened before,
0:26:56 > 0:26:59and people were in quite a different mindset.
0:26:59 > 0:27:01As it turned out, it was a fool's paradise,
0:27:01 > 0:27:04but it was a fool's paradise with many fools in it.
0:27:04 > 0:27:07But it wasn't obvious at the time.
0:27:07 > 0:27:11Because the system seemed to work, the authorities believed risk
0:27:11 > 0:27:14needed only the lightest touch of regulation.
0:27:14 > 0:27:18The very, very strong view globally was that risk was
0:27:18 > 0:27:22well managed, well diversified, that a light touch regulation
0:27:22 > 0:27:25was appropriate, that banks could look after themselves
0:27:25 > 0:27:27and frankly all of that was wrong.
0:27:27 > 0:27:33In 2008, the financial crash hit the world like a natural disaster.
0:27:35 > 0:27:38We are in the midst of a once-in-a-century credit tsunami.
0:27:40 > 0:27:42Northern Rock's share price plunges
0:27:42 > 0:27:45after it negotiates emergency funding.
0:27:45 > 0:27:48Financial markets across the globe are in turmoil this afternoon.
0:27:48 > 0:27:50TRADERS SHOUT
0:27:50 > 0:27:53Lehman Brothers is now officially the largest corporate bankruptcy
0:27:53 > 0:27:55in American history.
0:27:58 > 0:28:02Nothing on this scale had been predicted by Value at Risk.
0:28:04 > 0:28:08The crash essentially ripped apart the illusion that finance was
0:28:08 > 0:28:12just a game about money and just a game about numbers.
0:28:13 > 0:28:16Nearly three trillion dollars was lost.
0:28:18 > 0:28:20It was the catastrophic end to an era
0:28:20 > 0:28:23built on the global assumption that risk had been mastered.
0:28:27 > 0:28:33It drove home a point that we made very starkly in the first edition
0:28:33 > 0:28:35of the technical document,
0:28:35 > 0:28:40and that said no amount of quantitative numbers
0:28:40 > 0:28:43or quantitative methodology,
0:28:43 > 0:28:47will allow you to abandon judgment.
0:28:47 > 0:28:51Judgment is far more important than numbers.
0:28:54 > 0:28:56One of the biggest failures of judgment was over
0:28:56 > 0:28:59the historical data fed in to the Value at Risk models.
0:29:02 > 0:29:05Banks relied mostly on statistics from the 1990s onwards,
0:29:05 > 0:29:09when markets were on an upward path.
0:29:09 > 0:29:12That meant the models had underestimated
0:29:12 > 0:29:15the riskiness of lending money to people on low incomes.
0:29:17 > 0:29:19It was very profitable in the short term.
0:29:19 > 0:29:22But proved lethal in the end.
0:29:25 > 0:29:27There were people who were benefiting
0:29:27 > 0:29:30from the fact that the wrong models were in place.
0:29:30 > 0:29:31There was a big flow of profit,
0:29:31 > 0:29:34the system seemed to be working in the short term
0:29:34 > 0:29:41and stopping a train that's going extremely well is not a happy job.
0:29:43 > 0:29:46Although Value at Risk has taken a battering,
0:29:46 > 0:29:49it remains at the heart of the financial system.
0:29:51 > 0:29:52And what happened at JP Morgan
0:29:52 > 0:29:57and MF Global suggests it is still providing false confidence.
0:30:01 > 0:30:04New York. April 2010.
0:30:07 > 0:30:11Jon Corzine, the new boss of MF Global, was about to take
0:30:11 > 0:30:15the sort of gamble he used to on Wall Street in the 1990s.
0:30:17 > 0:30:20He would act as if the risks were predictable,
0:30:20 > 0:30:22just like bankers had before the crash.
0:30:24 > 0:30:29But in the post-crash world, that miscalculation would prove costly.
0:30:29 > 0:30:33Jon Corzine was kind of this figure out of the past.
0:30:33 > 0:30:35He was out of it, for all intents and purposes,
0:30:35 > 0:30:38as the financial system blew itself up,
0:30:38 > 0:30:40so he was a Rip Van Winkle-ish figure
0:30:40 > 0:30:43who woke up in the post crash world but still thought
0:30:43 > 0:30:47he was back in the 1990s in the swashbuckling era of risk.
0:30:49 > 0:30:52In the offices of MF Global, a battle was starting
0:30:52 > 0:30:54between the Chief Executive and his supporters
0:30:54 > 0:30:57and others who would try to stop him.
0:30:58 > 0:31:03Back on Wall Street, Jon Corzine was in his element.
0:31:03 > 0:31:07He was pretty excited. He liked that he was back in business
0:31:07 > 0:31:12and that he was running a global, worldwide firm and that
0:31:12 > 0:31:14you know, he thought that he could make a difference.
0:31:16 > 0:31:19He made a difference straight away, becoming
0:31:19 > 0:31:22chairman of the company's board, as well as Chief Executive.
0:31:24 > 0:31:28He was an extremely strong-minded,
0:31:28 > 0:31:32single-minded individual, who obviously enjoyed his power.
0:31:33 > 0:31:36Taking gambles was at the heart of Jon Corzine's
0:31:36 > 0:31:38vision of the firm's future.
0:31:40 > 0:31:43He believed it would help MF Global become an investment bank
0:31:43 > 0:31:45like the one he used to run.
0:31:47 > 0:31:50He would say, I'm going to make this into the next Goldman Sachs,
0:31:50 > 0:31:54he would say that the traders who work here don't take enough risk,
0:31:54 > 0:31:59but Corzine was absolutely intent on ratcheting up the risk of MF Global.
0:32:01 > 0:32:03Before long, every mechanism that could have controlled
0:32:03 > 0:32:08the amount of risk Jon Corzine would take would fail.
0:32:08 > 0:32:12Those sort of characters effectively can end up doing what they want.
0:32:18 > 0:32:22In Canary Wharf, MF Global employed around 700 staff
0:32:22 > 0:32:24under its own management.
0:32:26 > 0:32:30One of their money-making strategies caught Jon Corzine's eye.
0:32:36 > 0:32:39The chaos in the Eurozone was driving up the returns to investors
0:32:39 > 0:32:42willing to lend to troubled governments.
0:32:43 > 0:32:47MF Global in London was on the frontline,
0:32:47 > 0:32:53buying around half a billion dollars of bonds, most of them Italian.
0:32:56 > 0:32:58Over the summer of 2010,
0:32:58 > 0:33:04Jon Corzine told staff in London to buy around a billion dollars more.
0:33:04 > 0:33:08And it happened behind the back of the British chief executive.
0:33:09 > 0:33:13That's disgraceful. I mean, what else can I say?
0:33:13 > 0:33:17I mean, but equally, I can say that, you know, if Jon,
0:33:17 > 0:33:20if Jon Corzine calls from New York and says, you know,
0:33:20 > 0:33:25put on more Italian debt, and he's your boss,
0:33:25 > 0:33:27ideally that person who receives that instruction,
0:33:27 > 0:33:32in any better governed organisation, would report up to his boss.
0:33:32 > 0:33:36And the culture should be that the senior management in the UK
0:33:36 > 0:33:38ring him and say, "We're not prepared to do it,
0:33:38 > 0:33:41"this, anyway, needs to be reported through to our regulator,
0:33:41 > 0:33:44"because it's outside our sort of normal remit."
0:33:44 > 0:33:48In normal companies, that sort of thing does not go on.
0:33:48 > 0:33:51After the British chief executive found out about the bond purchases,
0:33:51 > 0:33:54he went to Jon Corzine.
0:33:56 > 0:33:58Soon after, he left the firm.
0:33:59 > 0:34:02It tells us that he hadn't bought into
0:34:02 > 0:34:04the Jon Corzine way of doing things.
0:34:07 > 0:34:10Jon Corzine pressed on with his strategy.
0:34:11 > 0:34:15Under his orders, MF Global bought more bonds from Italy
0:34:15 > 0:34:19and other struggling countries, including Portugal and Spain.
0:34:20 > 0:34:23The returns were high, because the market couldn't be sure these
0:34:23 > 0:34:26governments would pay back their debt.
0:34:27 > 0:34:31But Jon Corzine believed he was on top of the risk,
0:34:31 > 0:34:35just as many bankers had before the crash.
0:34:37 > 0:34:40His bet was that the European Central Bank or the IMF
0:34:40 > 0:34:44or whatever the international financial structures,
0:34:44 > 0:34:47were going to come to the rescue of these sovereign nations.
0:34:47 > 0:34:50So this is, you know, was kind of a no-brainer bet.
0:34:53 > 0:34:57As so often in our interconnected global financial system,
0:34:57 > 0:35:00the risk was transferred across borders.
0:35:03 > 0:35:06MF Global bought the bonds in London.
0:35:07 > 0:35:11Then it used them as collateral to borrow money to buy more bonds.
0:35:12 > 0:35:16And then the bonds were transferred to New York.
0:35:16 > 0:35:19American accounting rules meant the profits could be booked
0:35:19 > 0:35:23straight away, before the bonds had matured.
0:35:23 > 0:35:25A kind of financial alchemy.
0:35:27 > 0:35:29It inflates your profits in the short term.
0:35:29 > 0:35:33It makes it look like you're doing much better than you actually are.
0:35:33 > 0:35:37Accounting games are always a drug, because you start off saying,
0:35:37 > 0:35:39"We're just going to do this for the short term."
0:35:39 > 0:35:42And suddenly what was only supposed to be a short little bridge
0:35:42 > 0:35:44to get you from here to there becomes this monstrous creation.
0:35:47 > 0:35:48By March 2011,
0:35:48 > 0:35:54MF Global had borrowed around 6 billion to buy European bonds.
0:35:56 > 0:36:00He kept increasing that bet. Anybody who questioned him,
0:36:00 > 0:36:06he eliminated. I mean, it is, you know, incredibly ruthless behaviour.
0:36:08 > 0:36:10MF Global's strategy depended
0:36:10 > 0:36:13on the market's perception of risk in the Eurozone.
0:36:13 > 0:36:16The company had borrowed heavily to buy its bonds.
0:36:18 > 0:36:23If MF Global's creditors thought the risk of default in the Eurozone was
0:36:23 > 0:36:26rising, they could demand millions of dollars of extra collateral.
0:36:28 > 0:36:31But with Jon Corzine at full tilt,
0:36:31 > 0:36:33the board went along with his huge bet.
0:36:35 > 0:36:37What was the board going to do?
0:36:37 > 0:36:40Were they going to resign? They clearly couldn't persuade him.
0:36:40 > 0:36:43They clearly sought as much information as they could -
0:36:43 > 0:36:45very difficult.
0:36:46 > 0:36:49There was one more control mechanism - Value at Risk.
0:36:51 > 0:36:56Every financial firm is required to disclose its risks to the market.
0:36:56 > 0:37:00The main tool to do so is publishing their Value at Risk figures.
0:37:01 > 0:37:04But those figures don't always tell the whole story.
0:37:04 > 0:37:07You have a number that stands for risk,
0:37:07 > 0:37:11but the number is not really risk, it's a number, and so people
0:37:11 > 0:37:16have an incentive to play with that number. That's just human nature.
0:37:16 > 0:37:19You have to anticipate that this will happen.
0:37:20 > 0:37:25Unusually, MF Global chose not to include its European bonds
0:37:25 > 0:37:28in its published Value at Risk.
0:37:28 > 0:37:32Anyone relying only on those figures to judge the firm's risks
0:37:32 > 0:37:34would lack the complete picture.
0:37:36 > 0:37:39But MF Global's risks wouldn't remain out of sight forever.
0:37:45 > 0:37:48London. 2008.
0:37:48 > 0:37:51At the bank that had pioneered Value at Risk,
0:37:51 > 0:37:54a drama was unfolding that shows how bankers can become
0:37:54 > 0:37:58desensitised to risk by the huge amounts of money they trade.
0:38:01 > 0:38:05The road to JP Morgan's 6 billion London Whale losses
0:38:05 > 0:38:08ironically began with a decision to try to reduce risk.
0:38:12 > 0:38:15The Chief Investment Office was worried the mortgage assets
0:38:15 > 0:38:18it had bought would lose money if the economy crashed again.
0:38:21 > 0:38:24Could it use its vast cash reserves to play the markets
0:38:24 > 0:38:27to try to offset that risk, to hedge it?
0:38:29 > 0:38:33What the CIO was allegedly doing was taking steps
0:38:33 > 0:38:41to reduce the risk that its firm was undertaking through the purchases of
0:38:41 > 0:38:47that firm. This was supposed to be a risk-reducing operation.
0:38:47 > 0:38:49That's the theory of this London firm.
0:38:56 > 0:38:58The task fell to a French trader
0:38:58 > 0:39:02who commuted from Paris each week to the CIO in London.
0:39:04 > 0:39:07No photograph has ever been published of Bruno Iksil.
0:39:10 > 0:39:14To build the hedge, he wouldn't trade simple stocks and shares.
0:39:14 > 0:39:18Instead he would become a giant player in a shadowy global trade,
0:39:18 > 0:39:20centred in London.
0:39:22 > 0:39:26Bruno Iksil would buy billions of dollars of what bankers call
0:39:26 > 0:39:28synthetic derivatives.
0:39:30 > 0:39:33Derivatives in many cases, are just simply bets,
0:39:33 > 0:39:37particularly what they call synthetic derivatives,
0:39:37 > 0:39:40which mean instead of having an asset,
0:39:40 > 0:39:45that they have to back something, for instance a mortgage.
0:39:45 > 0:39:52They're simply betting that something else will go up or down in value
0:39:52 > 0:39:56and that is a high risk deal because there's nothing to back it up.
0:39:59 > 0:40:03Bruno Iksil gambled on the prospects of hundreds of major companies.
0:40:05 > 0:40:07The Whale Trades would pay out
0:40:07 > 0:40:09if there was another global financial shock.
0:40:11 > 0:40:14But what began as a hedge would become one of the biggest bets
0:40:14 > 0:40:16the world has ever seen.
0:40:18 > 0:40:23We may never know what JP Morgan Chase's strategy was.
0:40:23 > 0:40:25What they have said publicly
0:40:25 > 0:40:29is that it was part of their portfolio hedging.
0:40:29 > 0:40:32Hedging their overall risk of their business.
0:40:32 > 0:40:38It's very hard to say where hedging stops and speculation starts.
0:40:43 > 0:40:46The CIO gambled on whether some big companies would fail.
0:40:49 > 0:40:54In September 2011, Bruno Iksil made a billion dollar bet for the CIO
0:40:54 > 0:40:57that two companies listed on an index
0:40:57 > 0:40:59would go bust by late December.
0:41:04 > 0:41:08Sure enough, when American Airlines went bankrupt,
0:41:08 > 0:41:13Christmas came early for the CIO, as it collected a cool 400 million.
0:41:15 > 0:41:18The traders in London were rewarded to take big risks
0:41:18 > 0:41:19with other peoples' money.
0:41:19 > 0:41:23People are pretty simple, they do what they're rewarded to do.
0:41:26 > 0:41:29The Whale Trades were making huge profits.
0:41:29 > 0:41:32In 2011, Bruno Iksil
0:41:32 > 0:41:38and his two managers in London were paid 32 million between them.
0:41:38 > 0:41:43The bets grew until 51 billion was in play,
0:41:43 > 0:41:45almost the size of the UK's annual defence budget.
0:41:48 > 0:41:51That would bring about a risk no-one could control.
0:41:52 > 0:41:56Complexity is a huge problem in the modern financial system,
0:41:56 > 0:41:59I sometimes think of it as Frankenstein.
0:41:59 > 0:42:02Something built by man, that man can no longer control.
0:42:07 > 0:42:11Summer 2011. A torrid time in the Eurozone.
0:42:12 > 0:42:16Greece tottered on the brink of plunging out of the Euro.
0:42:16 > 0:42:18Fear stalked the markets.
0:42:26 > 0:42:30But at MF Global in New York, there was no sense of crisis.
0:42:32 > 0:42:36Even though the firm was holding 6 billion of risky European bonds.
0:42:38 > 0:42:42But what happened when word got out shows how in the post-crash world,
0:42:42 > 0:42:46the perception of risk can be the biggest risk of all.
0:42:49 > 0:42:51In mid-September,
0:42:51 > 0:42:56Anthony Abruzzo was among around a dozen new staff hired by MF Global.
0:42:56 > 0:42:59He was welcomed aboard by Jon Corzine.
0:42:59 > 0:43:03My impression was I just met the former Governor of New Jersey
0:43:03 > 0:43:07and the president of the company. It wasn't that deep of a conversation,
0:43:07 > 0:43:13but he did say, "We have a lot of things going on here,
0:43:13 > 0:43:17"we are looking to become one of the big players."
0:43:17 > 0:43:20It was exciting. It was very exciting.
0:43:23 > 0:43:26But all that was to prove short lived.
0:43:26 > 0:43:29Just a month later, the Wall Street Journal revealed
0:43:29 > 0:43:33the regulators had finally got wind of MF Global's 6 billion risk.
0:43:35 > 0:43:39It took a week for the markets to absorb the news.
0:43:39 > 0:43:41Then all hell broke loose.
0:43:41 > 0:43:44MF Global Holdings,
0:43:44 > 0:43:47the firm run by former New Jersey Governor Jon Corzine, had its credit
0:43:47 > 0:43:51rating cut to the lowest investment grade by Moody's Investors Service.
0:43:51 > 0:43:56It was only when Anthony Abruzzo caught sight of an internal company
0:43:56 > 0:44:00report that he realised how much trouble his new employers were in.
0:44:03 > 0:44:10I said, "Holy shit, that's... What? You know, what is this?"
0:44:10 > 0:44:13And then I looked up exactly what they were
0:44:13 > 0:44:19and they were all Euro bonds and you had the big Euro crisis going on.
0:44:19 > 0:44:26I was just, you know, I just put my head down and like, what do you say?
0:44:29 > 0:44:33But the man at the top still believed he could control events.
0:44:33 > 0:44:35He was taking the position that
0:44:35 > 0:44:37if, working 24 hours a day could fix something,
0:44:37 > 0:44:39he would work 24 hours a day.
0:44:39 > 0:44:42He just sort of had a confidence
0:44:42 > 0:44:48that if he worked hard enough at this, that he could solve things.
0:44:48 > 0:44:51It was a nightmare. I mean, it was just
0:44:51 > 0:44:54one note of bad news after the other.
0:44:54 > 0:44:58MF Global Holdings recorded its largest quarterly loss ever.
0:44:58 > 0:45:00Corzine is trying to turn...
0:45:00 > 0:45:05That spooked the markets and MF Global's share price halved.
0:45:05 > 0:45:09Investors have not forgotten the shock they had in 2008
0:45:09 > 0:45:13and inevitably every time a new shock hits the markets of any sort
0:45:13 > 0:45:16or the markets start to melt down a bit, investors start
0:45:16 > 0:45:19to freeze and think, goodness me, what's going to happen next?
0:45:19 > 0:45:21It's a bit like if you've been in a war zone
0:45:21 > 0:45:25and you hear a car exhaust back-fire suddenly, you know,
0:45:25 > 0:45:28part of you goes, ohh, could that be another gun?!
0:45:31 > 0:45:34The death spiral began in London.
0:45:34 > 0:45:38MF Global had always faced the threat of sudden demands for
0:45:38 > 0:45:42extra collateral from those who had lent the firm money to buy bonds.
0:45:44 > 0:45:47Millions of dollars were demanded by creditors in London,
0:45:47 > 0:45:49anxious about their European bond holdings.
0:45:51 > 0:45:53The firm was on the brink.
0:45:55 > 0:45:58I knew it was the end unless somebody had bought them.
0:45:58 > 0:46:02The brokerage MF Global has filed for bankruptcy in the United States
0:46:02 > 0:46:04and called in the administrators in this country.
0:46:04 > 0:46:08MF Global, that firm led by former New Jersey Governor Jon Corzine,
0:46:08 > 0:46:12has been hit hard by its holdings of European sovereign debt.
0:46:12 > 0:46:17Jon Corzine's bet helped bring about one of the biggest financial
0:46:17 > 0:46:19bankruptcies since the crash.
0:46:19 > 0:46:24You take a gamble and put us out of work? Why? Greed.
0:46:24 > 0:46:27Jon Corzine, this is going to come and haunt you
0:46:27 > 0:46:29for the rest of your life.
0:46:29 > 0:46:30Despite everything,
0:46:30 > 0:46:33Jon Corzine still believes his bet was a good one.
0:46:35 > 0:46:38I think, in hindsight, he believed that had he had enough time,
0:46:38 > 0:46:42that his positions were still the right positions,
0:46:42 > 0:46:47that bonds were going to pay off, that he wasn't taking undue risk.
0:46:47 > 0:46:51And yet obviously, the bankruptcy, you know, was sort of irrefutable
0:46:51 > 0:46:55and as I understand it, the bonds ended up paying off.
0:46:55 > 0:46:59So, you know, it was a little bit of having been proven right,
0:46:59 > 0:47:02but not going to do him any good.
0:47:02 > 0:47:05I mean this with all sincerity.
0:47:05 > 0:47:11I apologise both personally and on behalf of the company.
0:47:13 > 0:47:17MF Global's European bonds were sold by the firm's administrators
0:47:17 > 0:47:18and ultimately paid off.
0:47:21 > 0:47:25Jon Corzine's misjudgement was not that he took a big risk.
0:47:25 > 0:47:30It was that he failed to understand how risk can be seen
0:47:30 > 0:47:31in the post-crash world.
0:47:31 > 0:47:34I don't think Corzine was wrong, essentially, about the risk
0:47:34 > 0:47:38and this debt. What he was wrong about, is that it's not
0:47:38 > 0:47:42always the real risk that does you in, it's the perception of risk.
0:47:43 > 0:47:46What he failed to realise is actually, at the end of the day,
0:47:46 > 0:47:49finance is a social game. It's not a mathematical game.
0:47:49 > 0:47:50Human beings have a habit
0:47:50 > 0:47:53of changing their behaviour radically when shocks occur
0:47:53 > 0:47:56and that is precisely what's happened in the Eurozone.
0:47:59 > 0:48:02March 2012.
0:48:02 > 0:48:06Four years after the crash, nobody outside JP Morgan knew the bank
0:48:06 > 0:48:11was holding dangerous levels of risk through its lucrative Whale Trades.
0:48:11 > 0:48:13But that was about to change.
0:48:16 > 0:48:19Just three blocks away, a newspaper reporter was
0:48:19 > 0:48:23working on a story about the bank's secretive Chief Investment Office.
0:48:25 > 0:48:27After a tip off,
0:48:27 > 0:48:30Gregory Zuckerman was on the hunt for the London Whale.
0:48:31 > 0:48:35JP Morgan Chase wasn't known for any kind of aggressive trading,
0:48:35 > 0:48:38wasn't known for taking big positions, dominant positions
0:48:38 > 0:48:40within markets,
0:48:40 > 0:48:43and here it was, somebody senior on Wall Street telling me
0:48:43 > 0:48:45that not only was JP Morgan doing it,
0:48:45 > 0:48:48just a few years after the financial crisis, but it was one individual
0:48:48 > 0:48:53in an office in London that no-one had ever heard of.
0:48:53 > 0:48:57Bruno Iksil's luck was starting to run out.
0:48:57 > 0:48:58The Whale Trades -
0:48:58 > 0:49:02bets on the prospects of hundreds of companies - were vast.
0:49:05 > 0:49:07But they were starting to lose money
0:49:07 > 0:49:10because, overall, the trades were positioned to profit
0:49:10 > 0:49:15if the economy got worse, and in fact it was improving.
0:49:16 > 0:49:21They took some losses in the hedges and the hedges started to
0:49:21 > 0:49:27look like just betting on the markets, possibly
0:49:27 > 0:49:32in ways that even senior management didn't fully understand at the time.
0:49:32 > 0:49:34As the losses hit 100 million,
0:49:34 > 0:49:38Bruno Iksil advocated a new strategy to his bosses
0:49:38 > 0:49:40to shore up the Whale Trades.
0:49:42 > 0:49:45He said, "Sell the forward spread and buy protection on the
0:49:45 > 0:49:49"tightening move. Use indices to add existing to position.
0:49:49 > 0:49:51"Go long-risk on some belly tranches,
0:49:51 > 0:49:53"especially where defaults may realise.
0:49:53 > 0:49:57"And buy protection on HY," which means high yield, "and cross over
0:49:57 > 0:50:00"in rallies and turn the position over to monetise volatility."
0:50:00 > 0:50:03Now, it would probably take me a good hour to work out all
0:50:03 > 0:50:06the different layers of trades that he is explaining there,
0:50:06 > 0:50:09and even then I'm not quite sure I would completely understand it,
0:50:09 > 0:50:12and I've spent 20 years in the financial industry.
0:50:14 > 0:50:17The manager running the Chief Investment Office later said
0:50:17 > 0:50:21she could not explain exactly what Iksil's presentation meant.
0:50:23 > 0:50:28Despite that, he was allowed to expand the Whale Trades threefold.
0:50:31 > 0:50:33There's a very well-known phenomenon
0:50:33 > 0:50:35at the race track that at the last
0:50:35 > 0:50:40race of the day, people bet on long shots. That is they try to catch up.
0:50:40 > 0:50:45That's the mechanism - that is risk-taking when you're losing.
0:50:45 > 0:50:51The Whale Trades grew until 157 billion was in play,
0:50:51 > 0:50:55the same size as the UK's annual spending on the NHS.
0:50:58 > 0:51:00But the losses kept on growing.
0:51:01 > 0:51:06In the process of losing, people tend to take more risk,
0:51:06 > 0:51:12rather than less, and they take more risk because they try to escape.
0:51:14 > 0:51:16But there was no escape.
0:51:19 > 0:51:23What finally brought the risky Whale Trades to an end
0:51:23 > 0:51:27was not the oversight of regulators, but the vigilance of the media.
0:51:29 > 0:51:32Once the trades were splashed by the Wall Street Journal,
0:51:32 > 0:51:35the market turned against Bruno Iksil.
0:51:35 > 0:51:37JP Morgan had little choice,
0:51:37 > 0:51:41but to sell off the Whale Trades at a huge loss.
0:51:41 > 0:51:45The financial world is still shaking today over JP Morgan's
0:51:45 > 0:51:472 billion bet gone wrong.
0:51:47 > 0:51:50The boss of America's biggest bank, which saw one of its traders
0:51:50 > 0:51:52lose over a billion pounds in just six weeks,
0:51:52 > 0:51:54has admitted they were wrong
0:51:54 > 0:51:56to ignore concerns over the bank's trading practices.
0:51:58 > 0:52:01They just got too big, relative to the market
0:52:01 > 0:52:04and I mean, that is lesson number one, it's not impossible to know
0:52:04 > 0:52:07when you've become a very large chunk of the market.
0:52:07 > 0:52:09So that was a real lapse at JP Morgan.
0:52:11 > 0:52:14The bank's losses are yet another sobering moment
0:52:14 > 0:52:18in the financial system's continuing attempt to tame risk.
0:52:20 > 0:52:23The Value at Risk formula was invented by JP Morgan to help
0:52:23 > 0:52:25avoid dangerous risk.
0:52:27 > 0:52:32But the bank's CIO seemed to see it as a hurdle to overcome.
0:52:32 > 0:52:35As the Whale Trades grew, they breached the bank's
0:52:35 > 0:52:36Value at Risk limit.
0:52:38 > 0:52:42But rather than reduce its risk, the CIO simply swapped
0:52:42 > 0:52:45the model for another one that produced a lower risk number.
0:52:47 > 0:52:48That allowed them to press on,
0:52:48 > 0:52:52taking bigger bets in their pursuit of profits.
0:52:52 > 0:52:55They changed the way that model worked
0:52:55 > 0:52:58so that all of a sudden, overnight,
0:52:58 > 0:53:01the Value at Risk was cut by about 50%.
0:53:01 > 0:53:06Suddenly, instead of that particular limit being exceeded,
0:53:06 > 0:53:08it was not. It was not exceeded.
0:53:08 > 0:53:12So if suddenly it's half of what it was the day before,
0:53:12 > 0:53:16that means they can continue on the course they were on,
0:53:16 > 0:53:19which was making these very high-risk bets.
0:53:21 > 0:53:24For the man who pioneered Value at Risk for JP Morgan,
0:53:24 > 0:53:28the Whale losses show how the bank had come to mistake modelling risk,
0:53:28 > 0:53:30for managing it.
0:53:34 > 0:53:38What seems to have been absent is somebody at the top of the bank
0:53:38 > 0:53:43who takes the opposite viewpoint of what the traders take.
0:53:43 > 0:53:46The traders will always argue there's actually less risk
0:53:46 > 0:53:49in what I have, that's how they get incented.
0:53:49 > 0:53:52So you need somebody at the top,
0:53:52 > 0:53:55a chief risk officer who says no,
0:53:55 > 0:54:00we shall put higher risk number, and the top executive has to
0:54:00 > 0:54:05listen to this dialogue and respect both sides. It's a very hard job,
0:54:05 > 0:54:08but at least you have to have that opinion coming up.
0:54:08 > 0:54:11It appears to me that this hadn't happened.
0:54:16 > 0:54:17The storm over the losses
0:54:17 > 0:54:22has engulfed JP Morgan's hugely admired Chief Executive.
0:54:22 > 0:54:27Jamie Dimon's had his bonus cut in half...to 10 million.
0:54:27 > 0:54:30And he's struck his own humble note.
0:54:32 > 0:54:35This is a stupid thing that we should never have done.
0:54:35 > 0:54:38But we're still going to earn a lot of money this quarter.
0:54:38 > 0:54:40So it isn't like the company is jeopardised.
0:54:40 > 0:54:42We hurt ourselves and our credibility yes
0:54:42 > 0:54:45and you've got to fully expect to pay the price for that.
0:54:47 > 0:54:53Bruno Iksil has now left JP Morgan along with his two managers.
0:54:53 > 0:54:56The bank says it is learning lessons
0:54:56 > 0:55:00and will never carry out this kind of trading in the CIO again.
0:55:00 > 0:55:04But as the losses have grown to more than 6 billion,
0:55:04 > 0:55:08there are new fears about dangerous risk infecting the financial system.
0:55:11 > 0:55:14What's scary about the JP Morgan story is that most people
0:55:14 > 0:55:17in the markets think that JP Morgan is one of the better-run
0:55:17 > 0:55:18of the larger banks.
0:55:18 > 0:55:23And yet if even a bank like JP Morgan can be tripped up this badly
0:55:23 > 0:55:25and wrong-footed by the complexity,
0:55:25 > 0:55:27what on earth are the other banks doing?
0:55:30 > 0:55:33There's growing political pressure to stop vast multinational banks,
0:55:33 > 0:55:37like JP Morgan, from taking reckless risks,
0:55:37 > 0:55:42or at least to stop those risks affecting us all.
0:55:42 > 0:55:45Because no other industry's failure has such power
0:55:45 > 0:55:47to bring down nation states.
0:55:50 > 0:55:52We have a choice.
0:55:52 > 0:55:55We're either going to have to put the cop back on the beat,
0:55:55 > 0:55:59get some regulations in place to reduce the risks to these banks,
0:55:59 > 0:56:03or they've got to be broken up. It's one or the other.
0:56:03 > 0:56:07We cannot allow them to be too big to fail or too big to manage.
0:56:09 > 0:56:12The world has changed since the crash five years ago.
0:56:14 > 0:56:18Then the fallout from dangerous risk hit us all.
0:56:18 > 0:56:22That's not true of the risks that have gone wrong since.
0:56:22 > 0:56:25But things may not stay that way.
0:56:25 > 0:56:29We've had knocks to the financial system in the last five or six years
0:56:29 > 0:56:31which have hurt individual institutions,
0:56:31 > 0:56:34but not brought down the system. That's good news.
0:56:34 > 0:56:37The big problem though is that as of today, there isn't really
0:56:37 > 0:56:42a clear cut agreement or protocol in place for what would happen
0:56:42 > 0:56:45if one or two really big banks started to run in to problems.
0:56:47 > 0:56:51Risk remains at the heart of banking, the engine of its profits.
0:56:51 > 0:56:55But the amount and type of risk in the financial system is
0:56:55 > 0:56:57impossible to measure.
0:56:57 > 0:57:00As the losses at MF Global and JP Morgan show,
0:57:00 > 0:57:06many dangerous risks remain hidden until they go disastrously wrong.
0:57:07 > 0:57:11It's an uncomfortable reality for regulators in Britain and America.
0:57:11 > 0:57:14There's no question whatsoever we won't spot everything.
0:57:14 > 0:57:16There will be failures and scandals in the future,
0:57:16 > 0:57:18hopefully somewhat less than in the past,
0:57:18 > 0:57:22but it's a feature of a market as complex as financial services.
0:57:22 > 0:57:25What we have to ensure, as regulators,
0:57:25 > 0:57:28is that failure doesn't spill out
0:57:28 > 0:57:33to the rest of the economy, that the customers aren't hurt
0:57:33 > 0:57:38and also that no institution is so large that it's not allowed to fail.
0:57:40 > 0:57:43The relentless pursuit of profits means bankers will always
0:57:43 > 0:57:46find new ways to take risk.
0:57:46 > 0:57:49Something happens, regulation comes in,
0:57:49 > 0:57:52and you think, now this is going to be the end.
0:57:52 > 0:57:54It's not the end, it's just new opportunities
0:57:54 > 0:57:59to create new businesses outside that regulation and start afresh.
0:58:01 > 0:58:04And the stakes will rise again for all of us.
0:58:05 > 0:58:09I have to live with my mistake, you don't. Buckle up.
0:58:13 > 0:58:16Next time, how a cultural revolution inside Britain's
0:58:16 > 0:58:18high street banks helped them
0:58:18 > 0:58:22make billions by ripping off their own customers.
0:58:23 > 0:58:27How has the banking crisis affected you? Get your voice heard
0:58:27 > 0:58:30and join the debate at The Open University.
0:58:30 > 0:58:34Go to bbc.co.uk/bankers
0:58:34 > 0:58:37and follow the links to The Open University.
0:58:50 > 0:58:53Subtitles by Red Bee Media Ltd