Risking It All Bankers

I'm New Jersey Governor Jon Corzine and I should be dead.

Jon Corzine was a titan at the pinnacle of politics and finance.

He was a friend of presidents, a former

chairman of the investment bank Goldman Sachs...

And a financial trader to his core.

Traders have a feeling that they're controlling events.

It's true for gamblers everywhere. It's that illusion of control.

One day in 2007, Jon Corzine was late for a meeting.

He had chosen not to wear a seatbelt.

ENGINES REVS

TYRES SCREECH

POLICE RADIO: Troopers requesting paramedics, EMS,

anything you can send out there.

He broke 15 bones and lost more than half the blood in his body.

Corzine's car crash reveals something about his risk appetite,

a belief in one's own invulnerability and perhaps a belief

that the rules, as they should apply to other people, don't apply to you.

Nobody shows better than Jon Corzine how high the stakes can be

when it comes to risk in life or in finance.

SIRENS BLARE

We're going to work very hard...

Just two years ago he took a huge gamble in the markets

that went catastrophically wrong.

I would punch him in the face, I swear. I would.

Often, characters like that do end up destroying businesses.

The financial crash was meant to have put an end

to dangerous risk taking by bankers.

THEY SHOUT OVER EACH OTHER

But it hasn't.

We've got to stop problems caused by risk-taking

here in the City of London spilling onto the high streets

and putting taxpayers' money at risk.

The risks bankers take in their pursuit of profits are double-edged.

Risk has the power to drive society forwards.

And the potential to destroy it.

Risk is good. People need to take risk, but they need to take risk

in ways that they don't bring the entire system down with them.

With the economy on its knees

and the reputation of banks shredded by scandal after scandal,

this series asks what do we want from our bankers?

Can we ever trust them again?

Can we stop them taking dangerous risks?

And if not, can we stop them taking us all down again?

Our main headline this morning,

Britain has lost its triple-A credit rating.

Stripped of its triple-A credit rating

for the first time in 30 years.

The credit rating agencies have stripped the UK

of its prized triple-A status because of the weakness...

Five years on and the fallout from the crash keeps coming.

After the banks failed across Europe,

now it's nation states in the firing line.

Government debt is piling up, making the world a more dangerous place.

The pre-crash world, European Sovereign States

were regarded as safe as safe can be.

The thought that they would EVER not pay back their money was ludicrous.

Post-crash, that has changed.

Britain now joins France and 14 other heavily indebted European countries

downgraded by credit rating agencies since the crash.

Many of the things we're seeing in the market place today,

are almost unprecedented or certainly haven't been seen

for decades in the United Kingdom and internationally.

Europe's leaders are lurching from one crisis to another,

as they struggle to stay on top of 11 trillion euros of debt.

The key question for the financial markets is

how far will governments go to save the Euro?

You can't sit down with a spreadsheet and probabilities

and decide what Angela Merkel is going to do with the Eurozone project.

And that means that markets are quite scared and nervous

and worried about what politicians say and do.

That's driving up the cost of borrowing for countries in trouble.

Before the crash, Italy paid 4%. Since then it has hit 7%.

That shows how the markets have changed their view of risk.

They're taking note of things like political risk.

That's not surprising,

because the reality is that governments are essentially

behaving in ways that are very much driven by social factors

and cultural factors, rather than just hard-headed economic logic.

But there is a flip side to Europe's sovereign debt nightmare.

Every crisis is a chance for bankers

to make money by taking higher risks.

In Europe's debt markets, bankers are still

feeding on the entrails of the crash.

That's how capitalism works.

If you take on higher risk, the quid pro quo is you get a higher return

and therefore if you want to buy Spanish bonds or Italian bonds,

which are regarded as being higher risk, then you get a higher return.

There's always people willing to take the trade that others fear to.

One banker who would hunt for profits in Europe's debt crisis

was Jon Corzine, who nearly died in that horrific car accident.

The story of his disastrous 6 billion gamble

shows how the promise of high returns

can still blind bankers to the risks they take.

It all began in New York in March 2010.

Jon Corzine was making an audacious return to Wall Street.

Former New Jersey Governor Jon Corzine is returning

to the private sector after nearly a decade in government.

He has taken the helm of futures and options brokers, MF Global.

It was a total mismatch between, you know, a guy who had been

senior partner of Goldman Sachs, a Senator

and a Governor of a major industrial state,

going to this two-bit futures broker

that had very much seen better days.

It made absolutely no sense whatsoever.

I'm really excited about the opportunity to lead MF Global.

We're going to work very hard to get the earnings back on track.

MF Global set up shop as a barrel maker in London in 1783.

By 2010, it employed more than 3,000 people in 12 countries.

And its business was brokerage.

That means it acted on behalf of its clients in return for a fee.

It did not take risks with its own money.

We didn't care which way a market moved,

we just cared that it DID move, because we made our profits

by transacting business on behalf of our customers.

We didn't make our money

by transacting business on our own account.

But Jon Corzine had taken on a huge challenge.

By 2010, MF Global had seen better days.

Its revenues had fallen from six billion to two billion dollars.

It urgently needed new ways to make money.

Its business model was completely falling apart, so Corzine had to find

profits somewhere, he was under the gun to figure out

a way for MF Global to make money.

Since the crash, the Bank of England, like other central banks,

had cut interest rates to near zero.

The decision meant that businesses like MF Global,

which survived by investing clients' money, lost income.

At our peak we had about 24 billion dollars of customer money,

and that clearly represented a significant part of our income.

As interest rates went down to zero, those revenues began to dry up.

Inside central banks, the idea was that cutting interest rates

would encourage borrowing which had dried up after the crash.

The policy has another consequence which may be hard to control.

It leads to a fresh search for yield.

Now, the only way you can do that is to take more risk.

And there's no question

that this search for yield is reappearing.

People are now actively taking more risk to get a higher return.

One of those was Jon Corzine.

Facing declining revenues at MF Global,

he turned to what he thought he knew best - risk.

More than 30 years earlier, Corzine had been a trader for

one of the world's most successful investment banks, Goldman Sachs.

His reputation was made in 1986,

when he managed to turn a huge failing trade into a profit.

You can be lucky and you will never know how lucky you were,

you will take credit for lucky successes.

It's terrible for decision makers

to have those great experiences of success.

They become convinced that they're all-knowing, and that makes them a real menace.

At MF Global's headquarters in New York,

Jon Corzine hatched a radical plan.

To stem the firm's losses,

MF Global would start taking risks itself in the markets.

We can't turn this into a camouflaged hedge fund,

but I do believe we can take more principal risk

in some of the businesses involved.

Jon Corzine had lunch with a former chief executive to discuss

his plan for the firm to take risk by trading with its own money.

He wanted to take risks that the company wasn't used to taking,

which was trading risk.

I told him that really there wasn't very much in the DNA

of the company that would support that sort of activity,

and that he would have to change the entire senior management

and ethos of the business if he was going to take that course.

How we manage risk, how we take decisions with regard to

how we use our capital, is going to determine our success.

MF Global had survived for more than 200 years.

Now, under a man supremely confident in his ability to take risk,

it was just 19 months from destruction.

In Britain, reckless risk taking by bankers was becoming a hot issue

in a tight general election.

Retail banks, banks that you and I put our deposits into,

they should not be behaving like casinos, taking wild bets.

But at that time, few in Britain were taking much risk.

When you go through a crisis, people become cautious. Individuals

become cautious and so they want to pay down their mortgages.

And traders become cautious

so they don't tend to provide money for mergers and acquisitions,

etc, so there is a natural tendency to caution, post a crisis.

Risk aversion in the financial system

is a symptom of Britain's economic woes.

Since the crash,

banks have focused on repairing their damaged balance sheets.

And regulators have told them to hold more capital.

Banks appear to have backed away from riskier trading.

And they've cut back on the lending

that could help fuel economic recovery.

There's no doubt that the financial crisis

when it broke in its most severe form, caused a sort of severe

retraction in terms of taking risk and attitudes towards taking risks.

And there's no doubt that of course that spilled over

from those sectors of risk-taking that we sort of don't want to see

in the future into the basic credit creation functions of the economy.

One bank with a huge presence in Britain was different.

JP Morgan came through the financial crisis in good shape.

But the bank's success would contain the seeds of disaster.

The story of how a London team of JP Morgan traders

lost 6 billion last year shows how even a well-run bank

can take ever more complex and risky gambles.

The bets that spiralled out of control

were made in this anonymous office.

They were dubbed the London Whale Trades, because they were so vast.

One of the huge problems in the modern world is the extreme

complexity of many parts of,

you know, 21st century life

and the story of the whale illustrates that very well indeed,

because the sheer volume of trades that are now going

through banks like JP Morgan and the extraordinary

complexity of these financial deals, means that it's way beyond

the ability of any one individual or any one group of individuals

to really track, in detail, what's happening on these trading desks.

JP Morgan is a global giant.

Like Barclays and RBS, it combines investment, or corporate banking,

with serving retail customers.

From its headquarters in New York, JP Morgan employs nearly

a quarter of a million people in 60 countries.

Tony Blair is a paid advisor.

JP Morgan is so large, the American taxpayer would step in

if things went wrong.

But until the London Whale losses, the bank seemed invincible.

The story tells us that risk always lurks in unexpected places,

that in the very complex, modern financial world, you can have

an inordinate amount of risk on your books and actually not know

that you have it, and even a CEO who is extremely talented and brilliant

and cares deeply and works really hard can still miss it.

That CEO is Jamie Dimon, who has run JP Morgan since 2005.

While other banks struggled after the crash,

Dimon made his the envy of the world.

In 2012, he earned 23 million.

Each decade produces, you know, the King of Wall Street,

somebody who is on the cover of the various financial magazines and

Jamie Dimon was the new poster child for being the King of Wall Street.

He became known as America's least hated banker.

He's not the imperial CEO sitting on high,

not really understanding how the firm works,

he's the guy down in the minutiae of the numbers, managing risk.

And a lot of people give him a lot of credit for steering

JP Morgan clear of the worse excesses of sub prime

mortgage related products that brought down so many other firms.

Under Jamie Dimon, JP Morgan sailed through the financial crisis

without losing money.

It avoided overdosing on the toxic sub prime debts by sticking

to a tried and tested rule, just as a well-run bank should.

Too much of anything can become malignant,

so what really bailed us out, as it were,

was the discipline around not having too much of anything.

But abandoning that discipline

would contribute to the London Whale losses.

Any sense that existed before that JP Morgan was somehow infallible,

of course, is gone and I don't think that will probably ever come back.

At the heart of the Whale Trades is one of the fundamental

functions in banking.

Some of the money of the depositors is kept behind

the great door of this vault.

For more than a century, JP Morgan has done what banks do -

taken money in as deposits and lent money out, as loans.

If the money coming in is greater than the money being lent out,

there is a surplus.

Part of the money that comes into a bank is kept in cash.

But the rest of it must be put to work to earn a profit for the bank.

At JP Morgan, the spare money was put to work

by the Chief Investment Office or CIO.

Banks are in the risk business. The CIO of JP Morgan was

part of the risk-taking machinery.

These investments must be safe investments

such as government bonds, municipal bonds and mortgages.

At first, the CIO stuck to safe investments like government bonds.

But it didn't stay that way.

After Jamie Dimon took over JP Morgan, it was decided

the CIO should boost its profits by investing in new areas.

The financial crash was a perfect opportunity.

Troubled banks began selling off their mortgage and loan assets.

And because frightened investors

were sheltering their money in JP Morgan, the CIO was flush with cash.

They were the bank to talk to if you had something to sell.

They helped RBS and Lloyds and some of the UK banks to offload

some of their...some of the assets they had on the balance sheet.

Buying billions of dollars of these assets meant taking on more risk.

But if any bank was confident it could handle it, it was JP Morgan.

After all, 30 years earlier the bank had embarked on a huge effort

to tame risk that would give all bankers confidence

they can control the gambles they take.

Saratoga, California.

High above the cauldron of hi-tech innovation, Silicon Valley.

And home to the man who defined the risk paradigm for JP Morgan

and the entire financial system for the last 30 years.

Till Guldimann's work has helped us believe we've harnessed

one of the forces driving civilisation forwards.

Capitalism is all about risk taking.

Whenever you want to make money or earn a return on capital,

you have to take risks.

Without risks there is no return.

Till was asked to measure the amount of risk

taken by traders at JP Morgan.

While they were guided by intuition, Till turned to maths.

The traders took the risks out of their gut feeling.

They were not very analytical, or not very numerical, but I was

at headquarters, at the centre,

we needed to understand what was going on in this network

of risk takers, so I was the policeman,

or the aggregator, the accountant,

so I, of course, needed the numbers.

So began his quest for a formula to measure the risks taken by banks.

The goal is to have as much return as possible

for the least amount of risk to take.

That's the Holy Grail.

Till's work at JP Morgan went hand in hand with the birth

of the complex global financial system we rely on today.

In the early 1980s, governments began deregulating their financial

markets so banks opened new trading operations across the world.

All of a sudden, you didn't have your daily coffee talk

with your traders anymore,

they were in a different time zone, a different location,

so it became important to have a good accounting system, not just

for the positions and the profits and losses, but also for risks.

To measure risk, Till first had to define it.

Risk is the potential change in value.

In other words, how much money did a trader stand to lose?

Till realised the only evidence he had, was how an investment

had performed before.

The only way to tell the future

is to think about what happened in the past.

By analysing the past performance of an investment,

Till came up with a formula

that converted the intangible idea of risk into a single number.

How many dollars could an investment lose most of the time?

It was a godsend for bosses

struggling to stay on top of what their trading teams were up to.

That number tells you that 95% of the time,

you will not lose more than that.

Every day, at four o'clock in the afternoon,

we had this report which said over the next 24 hours, Mr Chairman,

you could lose 2 million or 10 million or whatever.

Till Guldimann had found a way to predict financial risk

95% of the time.

But the story of how bankers embraced his Value at Risk

formula, or VaR, shows how attempts to measure risk can

encourage them to act as if they have mastered it.

It was developed at JP Morgan by a group of people who saw exactly what

it was and exactly what it wasn't.

In other words, they understood it was

a number that captured historical likelihoods, but that didn't

mean that that was truth with a capital T. But I think as

top executives became more and more divorced from the complicated nature

of what happened on trading floors, they began to see VaR as truth

with a capital T. It meant this was how much money you could lose.

During the 1990s, Value at Risk was adopted by regulators

as well as banks.

Value at Risk became

the all-pervasive model that every financial institution used.

It was seductive because you could create a model, so you'd run

a computer model, you'd plug a set of numbers in and something

would come out, which told you how much capital you needed to hold.

The executive in banks liked it

because it meant they had to hold less capital,

and they therefore could take bigger bets, if you like, with their bank,

and regulators like it, because it convinced us that all banks had

a system in place which was allowing the banks to understand risk.

From the late 1990s, banks lent around a trillion dollars

to Americans on low incomes to buy houses.

Even if your credit is less than perfect, Ameriquest can help!

Most bankers thought it wasn't risky

because that's what they thought Value at Risk was telling them.

People thought the future would look like the past.

So you could look over the last one or two years,

and just say, OK, we know what the risks look like and we'll just

manage going forward, as if the next period will play out with

the same types of risks and level of risk as we've seen in the past.

There was a sense that the future was predictable

and forecast-able and understandable.

There was this idea that

if you plugged enough numbers into a computer model or a spread sheet,

you could actually predict what was going to happen in the future.

The faith placed in models like Value at Risk before 2008

mirrored the economic optimism that swept across the West,

buoyed up by a rising tide of wealth.

In 2006 and 2007,

we were coming to the end of this fantastic boom period.

I'm sure many people will recognise the expression,

no more boom and bust.

There was a perception that the economic cycle had been managed

in some way that had never happened before,

and people were in quite a different mindset.

As it turned out, it was a fool's paradise,

but it was a fool's paradise with many fools in it.

But it wasn't obvious at the time.

Because the system seemed to work, the authorities believed risk

needed only the lightest touch of regulation.

The very, very strong view globally was that risk was

well managed, well diversified, that a light touch regulation

was appropriate, that banks could look after themselves

and frankly all of that was wrong.

In 2008, the financial crash hit the world like a natural disaster.

We are in the midst of a once-in-a-century credit tsunami.

Northern Rock's share price plunges

after it negotiates emergency funding.

Financial markets across the globe are in turmoil this afternoon.

TRADERS SHOUT

Lehman Brothers is now officially the largest corporate bankruptcy

in American history.

Nothing on this scale had been predicted by Value at Risk.

The crash essentially ripped apart the illusion that finance was

just a game about money and just a game about numbers.

Nearly three trillion dollars was lost.

It was the catastrophic end to an era

built on the global assumption that risk had been mastered.

It drove home a point that we made very starkly in the first edition

of the technical document,

and that said no amount of quantitative numbers

or quantitative methodology,

will allow you to abandon judgment.

Judgment is far more important than numbers.

One of the biggest failures of judgment was over

the historical data fed in to the Value at Risk models.

Banks relied mostly on statistics from the 1990s onwards,

when markets were on an upward path.

That meant the models had underestimated

the riskiness of lending money to people on low incomes.

It was very profitable in the short term.

But proved lethal in the end.

There were people who were benefiting

from the fact that the wrong models were in place.

There was a big flow of profit,

the system seemed to be working in the short term

and stopping a train that's going extremely well is not a happy job.

Although Value at Risk has taken a battering,

it remains at the heart of the financial system.

And what happened at JP Morgan

and MF Global suggests it is still providing false confidence.

New York. April 2010.

Jon Corzine, the new boss of MF Global, was about to take

the sort of gamble he used to on Wall Street in the 1990s.

He would act as if the risks were predictable,

just like bankers had before the crash.

But in the post-crash world, that miscalculation would prove costly.

Jon Corzine was kind of this figure out of the past.

He was out of it, for all intents and purposes,

as the financial system blew itself up,

so he was a Rip Van Winkle-ish figure

who woke up in the post crash world but still thought

he was back in the 1990s in the swashbuckling era of risk.

In the offices of MF Global, a battle was starting

between the Chief Executive and his supporters

and others who would try to stop him.

Back on Wall Street, Jon Corzine was in his element.

He was pretty excited. He liked that he was back in business

and that he was running a global, worldwide firm and that

you know, he thought that he could make a difference.

He made a difference straight away, becoming

chairman of the company's board, as well as Chief Executive.

He was an extremely strong-minded,

single-minded individual, who obviously enjoyed his power.

Taking gambles was at the heart of Jon Corzine's

vision of the firm's future.

He believed it would help MF Global become an investment bank

like the one he used to run.

He would say, I'm going to make this into the next Goldman Sachs,

he would say that the traders who work here don't take enough risk,

but Corzine was absolutely intent on ratcheting up the risk of MF Global.

Before long, every mechanism that could have controlled

the amount of risk Jon Corzine would take would fail.

Those sort of characters effectively can end up doing what they want.

In Canary Wharf, MF Global employed around 700 staff

under its own management.

One of their money-making strategies caught Jon Corzine's eye.

The chaos in the Eurozone was driving up the returns to investors

willing to lend to troubled governments.

MF Global in London was on the frontline,

buying around half a billion dollars of bonds, most of them Italian.

Over the summer of 2010,

Jon Corzine told staff in London to buy around a billion dollars more.

And it happened behind the back of the British chief executive.

That's disgraceful. I mean, what else can I say?

I mean, but equally, I can say that, you know, if Jon,

if Jon Corzine calls from New York and says, you know,

put on more Italian debt, and he's your boss,

ideally that person who receives that instruction,

in any better governed organisation, would report up to his boss.

And the culture should be that the senior management in the UK

ring him and say, "We're not prepared to do it,

"this, anyway, needs to be reported through to our regulator,

"because it's outside our sort of normal remit."

In normal companies, that sort of thing does not go on.

After the British chief executive found out about the bond purchases,

he went to Jon Corzine.

Soon after, he left the firm.

It tells us that he hadn't bought into

the Jon Corzine way of doing things.

Jon Corzine pressed on with his strategy.

Under his orders, MF Global bought more bonds from Italy

and other struggling countries, including Portugal and Spain.

The returns were high, because the market couldn't be sure these

governments would pay back their debt.

But Jon Corzine believed he was on top of the risk,

just as many bankers had before the crash.

His bet was that the European Central Bank or the IMF

or whatever the international financial structures,

were going to come to the rescue of these sovereign nations.

So this is, you know, was kind of a no-brainer bet.

As so often in our interconnected global financial system,

the risk was transferred across borders.

MF Global bought the bonds in London.

Then it used them as collateral to borrow money to buy more bonds.

And then the bonds were transferred to New York.

American accounting rules meant the profits could be booked

straight away, before the bonds had matured.

A kind of financial alchemy.

It inflates your profits in the short term.

It makes it look like you're doing much better than you actually are.

Accounting games are always a drug, because you start off saying,

"We're just going to do this for the short term."

And suddenly what was only supposed to be a short little bridge

to get you from here to there becomes this monstrous creation.

By March 2011,

MF Global had borrowed around 6 billion to buy European bonds.

He kept increasing that bet. Anybody who questioned him,

he eliminated. I mean, it is, you know, incredibly ruthless behaviour.

MF Global's strategy depended

on the market's perception of risk in the Eurozone.

The company had borrowed heavily to buy its bonds.

If MF Global's creditors thought the risk of default in the Eurozone was

rising, they could demand millions of dollars of extra collateral.

But with Jon Corzine at full tilt,

the board went along with his huge bet.

What was the board going to do?

Were they going to resign? They clearly couldn't persuade him.

They clearly sought as much information as they could -

very difficult.

There was one more control mechanism - Value at Risk.

Every financial firm is required to disclose its risks to the market.

The main tool to do so is publishing their Value at Risk figures.

But those figures don't always tell the whole story.

You have a number that stands for risk,

but the number is not really risk, it's a number, and so people

have an incentive to play with that number. That's just human nature.

You have to anticipate that this will happen.

Unusually, MF Global chose not to include its European bonds

in its published Value at Risk.

Anyone relying only on those figures to judge the firm's risks

would lack the complete picture.

But MF Global's risks wouldn't remain out of sight forever.

London. 2008.

At the bank that had pioneered Value at Risk,

a drama was unfolding that shows how bankers can become

desensitised to risk by the huge amounts of money they trade.

The road to JP Morgan's 6 billion London Whale losses

ironically began with a decision to try to reduce risk.

The Chief Investment Office was worried the mortgage assets

it had bought would lose money if the economy crashed again.

Could it use its vast cash reserves to play the markets

to try to offset that risk, to hedge it?

What the CIO was allegedly doing was taking steps

to reduce the risk that its firm was undertaking through the purchases of

that firm. This was supposed to be a risk-reducing operation.

That's the theory of this London firm.

The task fell to a French trader

who commuted from Paris each week to the CIO in London.

No photograph has ever been published of Bruno Iksil.

To build the hedge, he wouldn't trade simple stocks and shares.

Instead he would become a giant player in a shadowy global trade,

centred in London.

Bruno Iksil would buy billions of dollars of what bankers call

synthetic derivatives.

Derivatives in many cases, are just simply bets,

particularly what they call synthetic derivatives,

which mean instead of having an asset,

that they have to back something, for instance a mortgage.

They're simply betting that something else will go up or down in value

and that is a high risk deal because there's nothing to back it up.

Bruno Iksil gambled on the prospects of hundreds of major companies.

The Whale Trades would pay out

if there was another global financial shock.

But what began as a hedge would become one of the biggest bets

the world has ever seen.

We may never know what JP Morgan Chase's strategy was.

What they have said publicly

is that it was part of their portfolio hedging.

Hedging their overall risk of their business.

It's very hard to say where hedging stops and speculation starts.

The CIO gambled on whether some big companies would fail.

In September 2011, Bruno Iksil made a billion dollar bet for the CIO

that two companies listed on an index

would go bust by late December.

Sure enough, when American Airlines went bankrupt,

Christmas came early for the CIO, as it collected a cool 400 million.

The traders in London were rewarded to take big risks

with other peoples' money.

People are pretty simple, they do what they're rewarded to do.

The Whale Trades were making huge profits.

In 2011, Bruno Iksil

and his two managers in London were paid 32 million between them.

The bets grew until 51 billion was in play,

almost the size of the UK's annual defence budget.

That would bring about a risk no-one could control.

Complexity is a huge problem in the modern financial system,

I sometimes think of it as Frankenstein.

Something built by man, that man can no longer control.

Summer 2011. A torrid time in the Eurozone.

Greece tottered on the brink of plunging out of the Euro.

Fear stalked the markets.

But at MF Global in New York, there was no sense of crisis.

Even though the firm was holding 6 billion of risky European bonds.

But what happened when word got out shows how in the post-crash world,

the perception of risk can be the biggest risk of all.

In mid-September,

Anthony Abruzzo was among around a dozen new staff hired by MF Global.

He was welcomed aboard by Jon Corzine.

My impression was I just met the former Governor of New Jersey

and the president of the company. It wasn't that deep of a conversation,

but he did say, "We have a lot of things going on here,

"we are looking to become one of the big players."

It was exciting. It was very exciting.

But all that was to prove short lived.

Just a month later, the Wall Street Journal revealed

the regulators had finally got wind of MF Global's 6 billion risk.

It took a week for the markets to absorb the news.

Then all hell broke loose.

MF Global Holdings,

the firm run by former New Jersey Governor Jon Corzine, had its credit

rating cut to the lowest investment grade by Moody's Investors Service.

It was only when Anthony Abruzzo caught sight of an internal company

report that he realised how much trouble his new employers were in.

I said, "Holy shit, that's... What? You know, what is this?"

And then I looked up exactly what they were

and they were all Euro bonds and you had the big Euro crisis going on.

I was just, you know, I just put my head down and like, what do you say?

But the man at the top still believed he could control events.

He was taking the position that

if, working 24 hours a day could fix something,

he would work 24 hours a day.

He just sort of had a confidence

that if he worked hard enough at this, that he could solve things.

It was a nightmare. I mean, it was just

one note of bad news after the other.

MF Global Holdings recorded its largest quarterly loss ever.

Corzine is trying to turn...

That spooked the markets and MF Global's share price halved.

Investors have not forgotten the shock they had in 2008

and inevitably every time a new shock hits the markets of any sort

or the markets start to melt down a bit, investors start

to freeze and think, goodness me, what's going to happen next?

It's a bit like if you've been in a war zone

and you hear a car exhaust back-fire suddenly, you know,

part of you goes, ohh, could that be another gun?!

The death spiral began in London.

MF Global had always faced the threat of sudden demands for

extra collateral from those who had lent the firm money to buy bonds.

Millions of dollars were demanded by creditors in London,

anxious about their European bond holdings.

The firm was on the brink.

I knew it was the end unless somebody had bought them.

The brokerage MF Global has filed for bankruptcy in the United States

and called in the administrators in this country.

MF Global, that firm led by former New Jersey Governor Jon Corzine,

has been hit hard by its holdings of European sovereign debt.

Jon Corzine's bet helped bring about one of the biggest financial

bankruptcies since the crash.

You take a gamble and put us out of work? Why? Greed.

Jon Corzine, this is going to come and haunt you

for the rest of your life.

Despite everything,

Jon Corzine still believes his bet was a good one.

I think, in hindsight, he believed that had he had enough time,

that his positions were still the right positions,

that bonds were going to pay off, that he wasn't taking undue risk.

And yet obviously, the bankruptcy, you know, was sort of irrefutable

and as I understand it, the bonds ended up paying off.

So, you know, it was a little bit of having been proven right,

but not going to do him any good.

I mean this with all sincerity.

I apologise both personally and on behalf of the company.

MF Global's European bonds were sold by the firm's administrators

and ultimately paid off.

Jon Corzine's misjudgement was not that he took a big risk.

It was that he failed to understand how risk can be seen

in the post-crash world.

I don't think Corzine was wrong, essentially, about the risk

and this debt. What he was wrong about, is that it's not

always the real risk that does you in, it's the perception of risk.

What he failed to realise is actually, at the end of the day,

finance is a social game. It's not a mathematical game.

Human beings have a habit

of changing their behaviour radically when shocks occur

and that is precisely what's happened in the Eurozone.

March 2012.

Four years after the crash, nobody outside JP Morgan knew the bank

was holding dangerous levels of risk through its lucrative Whale Trades.

But that was about to change.

Just three blocks away, a newspaper reporter was

working on a story about the bank's secretive Chief Investment Office.

After a tip off,

Gregory Zuckerman was on the hunt for the London Whale.

JP Morgan Chase wasn't known for any kind of aggressive trading,

wasn't known for taking big positions, dominant positions

within markets,

and here it was, somebody senior on Wall Street telling me

that not only was JP Morgan doing it,

just a few years after the financial crisis, but it was one individual

in an office in London that no-one had ever heard of.

Bruno Iksil's luck was starting to run out.

The Whale Trades -

bets on the prospects of hundreds of companies - were vast.

But they were starting to lose money

because, overall, the trades were positioned to profit

if the economy got worse, and in fact it was improving.

They took some losses in the hedges and the hedges started to

look like just betting on the markets, possibly

in ways that even senior management didn't fully understand at the time.

As the losses hit 100 million,

Bruno Iksil advocated a new strategy to his bosses

to shore up the Whale Trades.

He said, "Sell the forward spread and buy protection on the

"tightening move. Use indices to add existing to position.

"Go long-risk on some belly tranches,

"especially where defaults may realise.

"And buy protection on HY," which means high yield, "and cross over

"in rallies and turn the position over to monetise volatility."

Now, it would probably take me a good hour to work out all

the different layers of trades that he is explaining there,

and even then I'm not quite sure I would completely understand it,

and I've spent 20 years in the financial industry.

The manager running the Chief Investment Office later said

she could not explain exactly what Iksil's presentation meant.

Despite that, he was allowed to expand the Whale Trades threefold.

There's a very well-known phenomenon

at the race track that at the last

race of the day, people bet on long shots. That is they try to catch up.

That's the mechanism - that is risk-taking when you're losing.

The Whale Trades grew until 157 billion was in play,

the same size as the UK's annual spending on the NHS.

But the losses kept on growing.

In the process of losing, people tend to take more risk,

rather than less, and they take more risk because they try to escape.

But there was no escape.

What finally brought the risky Whale Trades to an end

was not the oversight of regulators, but the vigilance of the media.

Once the trades were splashed by the Wall Street Journal,

the market turned against Bruno Iksil.

JP Morgan had little choice,

but to sell off the Whale Trades at a huge loss.

The financial world is still shaking today over JP Morgan's

2 billion bet gone wrong.

The boss of America's biggest bank, which saw one of its traders

lose over a billion pounds in just six weeks,

has admitted they were wrong

to ignore concerns over the bank's trading practices.

They just got too big, relative to the market

and I mean, that is lesson number one, it's not impossible to know

when you've become a very large chunk of the market.

So that was a real lapse at JP Morgan.

The bank's losses are yet another sobering moment

in the financial system's continuing attempt to tame risk.

The Value at Risk formula was invented by JP Morgan to help

avoid dangerous risk.

But the bank's CIO seemed to see it as a hurdle to overcome.

As the Whale Trades grew, they breached the bank's

Value at Risk limit.

But rather than reduce its risk, the CIO simply swapped

the model for another one that produced a lower risk number.

That allowed them to press on,

taking bigger bets in their pursuit of profits.

They changed the way that model worked

so that all of a sudden, overnight,

the Value at Risk was cut by about 50%.

Suddenly, instead of that particular limit being exceeded,

it was not. It was not exceeded.

So if suddenly it's half of what it was the day before,

that means they can continue on the course they were on,

which was making these very high-risk bets.

For the man who pioneered Value at Risk for JP Morgan,

the Whale losses show how the bank had come to mistake modelling risk,

for managing it.

What seems to have been absent is somebody at the top of the bank

who takes the opposite viewpoint of what the traders take.

The traders will always argue there's actually less risk

in what I have, that's how they get incented.

So you need somebody at the top,

a chief risk officer who says no,

we shall put higher risk number, and the top executive has to

listen to this dialogue and respect both sides. It's a very hard job,

but at least you have to have that opinion coming up.

It appears to me that this hadn't happened.

The storm over the losses

has engulfed JP Morgan's hugely admired Chief Executive.

Jamie Dimon's had his bonus cut in half...to 10 million.

And he's struck his own humble note.

This is a stupid thing that we should never have done.

But we're still going to earn a lot of money this quarter.

So it isn't like the company is jeopardised.

We hurt ourselves and our credibility yes

and you've got to fully expect to pay the price for that.

Bruno Iksil has now left JP Morgan along with his two managers.

The bank says it is learning lessons

and will never carry out this kind of trading in the CIO again.

But as the losses have grown to more than 6 billion,

there are new fears about dangerous risk infecting the financial system.

What's scary about the JP Morgan story is that most people

in the markets think that JP Morgan is one of the better-run

of the larger banks.

And yet if even a bank like JP Morgan can be tripped up this badly

and wrong-footed by the complexity,

what on earth are the other banks doing?

There's growing political pressure to stop vast multinational banks,

like JP Morgan, from taking reckless risks,

or at least to stop those risks affecting us all.

Because no other industry's failure has such power

to bring down nation states.

We have a choice.

We're either going to have to put the cop back on the beat,

get some regulations in place to reduce the risks to these banks,

or they've got to be broken up. It's one or the other.

We cannot allow them to be too big to fail or too big to manage.

The world has changed since the crash five years ago.

Then the fallout from dangerous risk hit us all.

That's not true of the risks that have gone wrong since.

But things may not stay that way.

We've had knocks to the financial system in the last five or six years

which have hurt individual institutions,

but not brought down the system. That's good news.

The big problem though is that as of today, there isn't really

a clear cut agreement or protocol in place for what would happen

if one or two really big banks started to run in to problems.

Risk remains at the heart of banking, the engine of its profits.

But the amount and type of risk in the financial system is

impossible to measure.

As the losses at MF Global and JP Morgan show,

many dangerous risks remain hidden until they go disastrously wrong.

It's an uncomfortable reality for regulators in Britain and America.

There's no question whatsoever we won't spot everything.

There will be failures and scandals in the future,

hopefully somewhat less than in the past,

but it's a feature of a market as complex as financial services.

What we have to ensure, as regulators,

is that failure doesn't spill out

to the rest of the economy, that the customers aren't hurt

and also that no institution is so large that it's not allowed to fail.

The relentless pursuit of profits means bankers will always

find new ways to take risk.

Something happens, regulation comes in,

and you think, now this is going to be the end.

It's not the end, it's just new opportunities

to create new businesses outside that regulation and start afresh.

And the stakes will rise again for all of us.

I have to live with my mistake, you don't. Buckle up.

Next time, how a cultural revolution inside Britain's

high street banks helped them

make billions by ripping off their own customers.

How has the banking crisis affected you? Get your voice heard

and join the debate at The Open University.

Go to bbc.co.uk/bankers

and follow the links to The Open University.

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