Title: Inside Job
Andrew Sheng: They were having massive private gains at public loss.
Lee Hsien Loong: When you start thinking that you can create something out of nothing, it's very difficult to resist.
Christine Lagarde: I'm concerned that a lot of people want to go back to the old way; the way they were operating prior to the crisis.
Narrator: This crisis was not an accident. It was caused by an out-of-control industry. Since the 1980s, the rise of the U.S. financial sector has led to a series of increasingly severe financial crises. Each crisis has caused more damage, while the industry has made more and more money.
Narrator: After the Great Depression, the United States had 40 years of economic growth, without a single financial crisis. The financial industry was tightly regulated. Most regular banks were local businesses, and they were prohibited from speculating with depositors' savings. Investment banks, which handled stock and bond trading, were small, private partnerships.
Samuel Hayes: In the traditional, uh, investment-banking-partnership model, the partners put the money up. And obviously, the partners watched that money very carefully. They wanted to live well, but they didn't want to bet the ranch on anything.
Willem Buiter: Why do you have big banks? Well, because banks like monopoly power; because banks like lobbying power; because banks know that when they're too big, they will be bailed.
George Soros: Markets are inherently unstable, or at least potentially unstable. An appropriate metaphor is the oil tankers. They are very big; and therefore, you have to put in compartments to prevent the sloshing around of oil from capsizing the boat. The design of the boat has to take that into account. And after the Depression, the regulations actually introduced these very watertight compartments. And deregulation has led to the end of compartmentalization.
Narrator: Since deregulation began, the world's biggest financial firms have been caught laundering money, defrauding customers, and cooking their books; again and again and again.
Text: JP Morgan - bribed government officials
Text: Riggs Bank - laundered money for Chilean dictator Augusto Punochet
Text: Credit Suisse - laundered money for Iran in violation of US sanctions
Narrator: Between 1998 and 2003, Fannie Mae overstated its earnings by more than US$10 billion.
Franklin Raines: These accounting standards are highly complex, and require determinations over which experts often disagree.
Narrator: Beginning in the 1990s, deregulation and advances in technology led to an explosion of complex financial products, called derivatives. Economists and bankers claimed they made markets safer. But instead, they made them unstable.
Narrator: Using derivatives, bankers could gamble on virtually anything. They could bet on the rise or fall of oil prices, the bankruptcy of a company; even the weather. By the late 1990s, derivatives were a US$50 trillion unregulated market.
Narrator: In the old system, when a homeowner paid their mortgage every month, the money went to their local lender. And since mortgages took decades to repay, lenders were careful.
Narrator: In the new system, lenders sold the mortgages to investment banks. The investment banks combined thousands of mortgages and other loans -- including car loans, student loans, and credit card debt -- to create complex derivatives, called collateralized debt obligations, or CDOs. The investment banks then sold the CDOs to investors. Now, when homeowners paid their mortgages, the money went to investors all over the world.
Narrator: The investment banks paid rating agencies to evaluate the CDOs, and many of them were given a AAA rating, which is the highest possible investment grade. This made CDOs popular with retirement funds, which could only purchase highly rated securities.
Narrator: This system was a ticking time bomb. Lenders didn't care anymore about whether a borrower could repay, so they started making riskier loans. The investment banks didn't care, either; the more CDOs they sold, the higher their profits. And the rating agencies, which were paid by the investment banks, had no liability if their ratings of CDOs proved wrong.
Narrator: It wasn't real profits, it wasn't real income; it was just money that was being created by the system, and booked as income two, three years down the road. There's a default; it's all wiped out.
Narrator: During the bubble, the investment banks were borrowing heavily, to buy more loans, and create more CDOs.
Narrator: The ratio between borrowed money and the banks' own money was called leverage. The more the banks borrowed, the higher their leverage.
Daniel Alpert: The degree of leverage in the financial system became absolutely frightening; investment banks leveraging up to the level of, you know, 33 to 1, which means that a tiny 3% decrease in the value of their asset base would leave them insolvent.
Narrator: There was another ticking time bomb in the financial system: AIG, the world's largest insurance company, was selling huge quantities of derivatives, called credit default swaps.
Narrator: For investors who owned CDOs, credit default swaps worked like an insurance policy. An investor who purchased a credit default swap paid AIG a quarterly premium. If the CDO went bad, AIG promised to pay the investor for their losses.
Narrator: But unlike regular insurance, speculators could also buy credit default swaps from AIG in order to bet against CDOs they didn't own.
Narrator: In 2005, Raghuram Rajan, then the chief economist of the International Monetary Fund, delivered a paper at the annual Jackson Hole Symposium, the most elite banking conference in the world.
Raghuram Rajan: The title of the paper was, essentially: Is Financial Development Making the World Riskier? And the conclusion was, it is.
Narrator: Rajan's paper focused on incentive structures that generated huge cash bonuses based on short-term profits, but which imposed no penalties for later losses. Rajan argued that these incentives encouraged bankers to take risks that might eventually destroy their own firms, or even the entire financial system.
Raghuram Rajan: It's very easy to generate performance by taking on more risk. And so what you need to do is compensate for risk-adjusted performance...
Kenneth Rogoff: Rajan, you know, hit the nail on the head. What he particularly said was, you guys have claimed you have found a way to make more profits with less risk. I say you've found a way to make more profits with more risk, and there's a big difference.
Narrator: The three rating agencies -- Moody's, S&P, and Fitch -- made billions of dollars giving high ratings to risky securities. Moody's, the largest rating agency, quadrupled its profits between 2000 and 2007.
Bill Ackman: Moody's and S&P get compensated based on putting out ratings reports. And the more structured securities they gave a AAA rating to, the higher their earnings were gonna be for the quarter.
Frank Partnoy: I’ve now testified before both houses of Congress on the credit rating agency issue. And both times, they trot out very prominent First Amendment lawyers, and argue that when we say something is rated AAA, that is merely our opinion; you shouldn't rely on it.
Deven Sharma: S&P's ratings express our opinion.
Stephen Joynt: Our ratings are are our opinions. But they're opinions.
Raymond McDaniel: Opinions, and those are, they are just opinions.
Stephen Joynt: I think we are emphasizing the fact that our ratings are... are opinions.
Deven Sharma: They do not speak to the market value of a security, the volatility of its price, or its suitability as an investment.
Narrator: (Hank) Paulson and (Ben) Bernanke had not consulted with other governments, and didn't understand the consequences of foreign bankruptcy laws.
Charles Fergurson: Isn't there a problem when the person in charge of dealing with this crisis is the former CEO of Goldman Sachs; someone who had a major role in causing it?
David McCormick: Well, I think it's fair to say that the financial markets today are incredibly complicated.
Dominique Strauss-Kahn: At the end of the day, the poorest, as always, pay the most.
Lee Hsien Loong: Even as the crisis unfolded, we didn't know how wide it was going to spread, or how severe it was going to be. And we were still hoping that there would be some way for us to have a shelter, and be less battered by the storm. But it is not possible. It's a very globalized world; the economies are all linked together.
Bill Ackman: Ultimately, I hold the board accountable when a business fails because the board is responsible for hiring and firing the CEO and overseeing big strategic decisions. The problem with board composition in America is the way boards are elected. You know, the boards are pretty much, in many cases, picked by the CEO.
Narrator: Between 1998 and 2008, the financial industry spent over 5 billion dollars on lobbying and campaign contributions. And since the crisis, they're spending even more money.
Narrator: The financial industry also exerts its influence in a more subtle way; one that most Americans don't know about. It has corrupted the study of economics itself.
Narrator: Since the 1980s, academic economists have been major advocates of deregulation, and played powerful roles in shaping U.S. government policy. Very few of these economic experts warned about the crisis. And even after the crisis, many of them opposed reform.
Narrator: Many prominent academics quietly make fortunes while helping the financial industry shape public debate and government policy. The Analysis Group, Charles River Associates, Compass Lexecon, and the Law and Economics Consulting Group manage a multi-billion-dollar industry that provides academic experts for hire.
Narrator: Two bankers who used these services were Ralph Ciofi and Matthew Tannin, Bear Stearns hedge fund managers prosecuted for securities fraud. After hiring The Analysis Group, both were acquitted. Glenn Hubbard was paid US$100,000 to testify in their defense.
Narrator: Increasingly, the most important determinant of whether Americans go to college is whether they can find the money to pay for it.
Narrator: Meanwhile, American tax policy shifted to favor the wealthy.
Narrator: The most dramatic change was a series of tax cuts designed by Glenn Hubbard, who at the time was serving as President Bush's chief economic advisor. The Bush administration sharply reduced taxes on investment gains, stock dividends, and eliminated the estate tax.
Narrator: Most of the benefits of these tax cuts went to the wealthiest 1% of Americans.
Narrator: Inequality of wealth in the United States is now higher than in any other developed country.
Narrator: American families responded to these changes in two ways: by working longer hours, and by going into debt.
Narrator: For decades, the American financial system was stable and safe. But then something changed. The financial industry turned its back on society, corrupted our political system, and plunged the world economy into crisis.
Narrator: At enormous cost, we've avoided disaster, and are recovering. But the men and institutions that caused the crisis are still in power; and that needs to change.
Narrator: They will tell us that we need them, and that what they do is too complicated for us to understand. They will tell us it won't happen again. They will spend billions fighting reform.
Narrator: It won't be easy. But some things are worth fighting for.