(sleigh bells ringing) >> NARRATOR: Every year in December, bankers find out if the bets they've made that year have paid off.

It's Christmastime on Wall Street.

("Jingle Bells" playing) By some measures, 2011 was a dismal year to be a banker.

Their stocks took a nose dive.

But this season, New York banks set aside $20 billion in bonuses.

Since the crash of '08, banks have paid out more than $80 billion in bonuses.

While officials in Washington focus on rule-making, nothing seems to have really changed the culture of Wall Street... a culture some feel has simply lost its bearings.

>> I think it's probably not an over-exaggeration to sa Wall Street kind of lost its senses.

>> NARRATOR: John Fullerton is a former banker who says it all began when banks started trading for their own gain and not for their customers.

>> It was the rise of trading that shifted the culture.

And with that came this much more short-term, profit-generating, competitive mentality.

There was just this kind of cult of more, more, more, grow, grow, grow.

And I think now the culture on Wall Street is fundamentally unhealthy.

>> ...commodity prices rising... >> I grew less happy about my work and what I was doing every day.

Candidly, I felt it was beginning to change my own values-- you know, how I looked at myself and how I valued myself.

>> ...managed to finish with a triple-digit gain today, but behind the scenes, another nail-biter.

>> I never really cared about money per se.

I never really wanted to become a rich person.

I knew that the people I was working with wanted to be rich.

So I wasn't offended by that idea.

It seemed like a pretty typical American goal, in fact.

>> NARRATOR: Cathy O'Neil, a mathematician, came to Wall Street in 2007 after beginning her career in academia.

>> I went to U.C.

Berkeley as an undergrad.

I went to Harvard for grad school.

And then I was a postdoc for five years at MIT.

And I applied to work at a hedge fund, D.E.

Shaw, and I got the job.

And I thought, "This was great."

I was a quant.

A quant uses statistical methods to try to predict patterns in the market.

>> NARRATOR: Her work was used to predict when big pension funds would buy or sell so the firm could jump in ahead of their trades.

>> I just felt like I was doing something immoral.

I was taking advantage of people I don't even know whose retirements were in these funds.

We all put money into our 401(k)s. And Wall Street takes this money and just skims off, like, a certain percentage every quarter.

At the very end of somebody's career, they retire and they get some of that back.

This is this person's money, and it's just basically going to... to Wall Street.

Just doesn't seem right.

>> Everybody kind of knows in their heart that something's not right.

But once you are making money for a while, you don't ever want to stop making money.

>> NARRATOR: Caitlin Kline came to Wall Street in 2004.

She says it was all very seductive.

>> Your whole first summer is taken up with things like golf lessons and negotiation classes, wine tastings, things to make sure you know how to handle yourself in a business environment.

>> NARRATOR: Kline was a math major at New York Universit and considered becoming a teacher.

But she remained on Wall Street for six years.

>> You have the sneaking suspicion that you're not contributing to society.

But it was always really easy to say, "I know the risks.

"They know the risks.

"None of this is our money.

"So, you know, we can kind of do these things, and it's all fair game."

>> I don't think I at any point thought I was doing anything harmful.

I just didn't think I was doing something necessarily positive.

>> NARRATOR: Alexis Goldstein graduated from Columbia with a degree in computer science.

She then designed trading software for Deutsche Bank and Merrill Lynch.

>> There's an incentive to make as much money as you can for the firm.

And in some senses, I think, for the traders, they think, "Hey, I earned a billion dollars this year.

I deserve some small percentage of that."

What I think is incorrect about that is the behavior that that incentivizes is, "I'm gonna go for broke.

"I'm gonna try and make as much money as I can.

"And if it blows up three years from now, that's not gonna affect the bonus I make today."

>> Yahoo, 250 to buy, and I'm selling Hewlett-Packard about 200... >> NARRATOR: The incentives are powerful.

A young trader at a big Wall Street bank can make around $150,000 a year.

>> All right, let's put all hands on deck.

I'm tempin' up these MUs... >> NARRATOR: But based on performance, that number can rise quickly.

Star traders make huge sums.

>> MARTIN SMITH: How much are you making if you're a star trader?

>> For a star trader, you could, after ten years, reach pay above $5 million or $10 million for the star performers.

That wasn't the average.

>> SMITH: $10 million a year.

How much did you make as a trader?

>> I think I was a star performer, so I probably followed the pay curve of the star performers, yeah.

>> SMITH: So, between $5 million to $10 million a year.

>> I mean, I guess so.

>> SMITH: Is that... is it a secret?

>> (chuckling) Well, it... it was a secret, in fact.

I mean, compensations were not public, for all the obvious reasons.

>> I'd really rather not say.

If that's okay, 'cause I...

I just don't know if that's publicly available information.

But it's certainly like more than you would get at most first-time jobs.

>> I shouldn't talk about that.

That's in... that's in the contract.

I can't talk about any salaries or bonuses or anything like that.

But it was a lot of money.

Especially for young people, you know.

>> NARRATOR: It wasn't always this way.

For most of the last century, bankers made the same salaries as lawyers, doctors and engineers.

The last time Wall Street saw extravagant compensation was in the run-up to the crash of 1929.

>> The 1920s, of course, were a period of financial frenz and and a big stock market boom.

And there was a lot of innovating, risk-taking banking at that time.

>> NARRATOR: At the time, it wasn't uncommon for bankers to take home paychecks that, when adjusted for inflation, rival those earned by bankers today.

But it didn't last.

>> From the 1930s we got a period of reform and constraints placed on banks.

They became much more regulated.

And many of the banks were forced to do what you might call plain vanilla business.

Take in deposits, lend it out.

>> By looking in on Frank Hamilton, we'll learn the meaning of credit.

>> You could make good money, don't get me wrong.

But it was boring.

It was very straightforward.

It was about being in the community.

It was about understanding who was a good credit risk.

That's the history of American banking.

>> When I started life in banking, it was basically a simple profession, very much like being an executive at an electrical company, or some sort of utility.

You provided some essential services.

>> In the old days, Wall Street and the finance industr financed things that got done, be they the railroads, or the interstate system... all of that has to be financed.

That's what finance is supposed to be about.

What has entirely changed is that they're in the business of making money for themselves.

If it happens that they can also finance something along the way, okay.

But that's really no longer part of the core business.

(applause) >> Now it gives me great pleasure to introduce the president of the United States, William Jefferson Clinton.

(applause) >> NARRATOR: The changes were formalized in the late '90s, as the last of the Depression- era reforms were lifted.

>> The Glass-Steagall law is no longer appropriate... >> NARRATOR: And traditional commercial banks could merge with trading-oriented investment banks.

Trading activity and bank profits rose quickly.

>> The trading side became overwhelming-- three, four, five times bigger than the banking side.

But the banking side grew as well, but not as much as the trading side.

>> This is very much the beginning of the brain drain, when Wall Street looked at people who had technical, scientific training, and it said, "We'll pay you double, triple, five times what you could make in any other field."

And if you're looking at those kinds of incentives, you're trained as an engineer, why wouldn't you want to make three times more money?

>> Two and a quarter points at five million.

>> NARRATOR: So they came.

And many ended up doing what is called proprietary trading-- trading for the bank's own account.

Some bankers were uncomfortable.

>> I think that sometimes we weren't really serving the interests of the clients.

But we were serving our interests.

And I didn't like that.

>> NARRATOR: Claudio Costamagna was the co-head of European investment banking for Goldman Sachs.

>> Everybody was making money.

Everybody jumped in.

It's sort of, you know, human nature.

You see your neighbor making tons of money in that activity.

Even if you don't understand it, you just walk in.

>> SMITH: By "that activity," you mean what exactly?

>> Yeah, you know, selling derivatives, making proprietary bets and so forth and so on.

>> NARRATOR: Derivatives.

It's where the really big money is made.

>> I'm going to propose here a micron swap.

>> NARRATOR: Derivatives can be many things but are basically contracts or bets that derive their value from the performance of something else: an interest rate, a bond or stock, a loan, a currency, a commodity... virtually anything.

For traders, derivatives are a perfect product.

>> SMITH: A derivative is something can be made up, crafted right on the trading floor and sold the next day?

>> Absolutely.

Most derivatives you don't need to have them in warehouses, you don't need to find them to sell them.

You just can create them.

>> NARRATOR: They are also very profitable.

>> If you take the trading revenues, I would say they would probably be easily two-third of the trading revenues was directly or indirectl associated with derivatives.

>> SMITH: So, it's not exaggeration to sa that trading of derivatives was really the lifeblood of the banks.

>> Yes, I think it's fair to say.

>> Hey, listen, I'd buy ten million of these things at 6 3/8 points, and I'll show you 10 million of the As here.

>> NARRATOR: The problem with derivatives is that they can be very dangerous for unsophisticated customers.

>> They come out at 10.33, versus 9.99.

>> NARRATOR: They often involve highly leveraged bets.

A small change in market conditions can mean huge losses.

>> The credit spread in here is about six fifty.

>> NARRATOR: And traders are incentivized to get the deals done, even if it's at the customer's expense.

>> There was a phrase, "ripping someone's face off," that was used on the trading floor to describe when you sold something to a client who didn't understand it and you were able to extract a massive fee because they didn't understand it.

And the idea was that this was a good thing, because what you were doing was making more money for the bank.

And that sort of spirit of being antagonistic to your client actually took on significant life on Wall Street.

>> Guys, Halliburton the better side's the buy side here.

We pay 85 for any part of 150 right now Halliburton.

>> NARRATOR: Banks want to do business where there is less regulation.

>> And this week's program hears from some of the people who are being called "the new kings of capitalism."

>> NARRATOR: Beginning in the '90s, many American banks found London preferable to New York.

>> The two big markets that rival each other are New York, with Wall Street, and London-- the city of London.

And in some instances, the key risk-taking activities were in London.

They were outside the purview of American regulators.

>> NARRATOR: Hundreds of young bankers moved here from Wall Street to pursue careers in derivative trading.

As the economy boomed, British and American bankers became the toast of the town.

>> These are the rock stars of London at the time.

People being paid, you know, $10 to $15 million a year.

And you saw them in their expensive shirts and in these VIP places where there's like a £500 bottle of vodka, and there were all these girls in miniskirts flocking to these VIP rooms, enjoying this, you know, once-in-a-lifetime opportunity, people in their 20s making this kind of money.

>> You lived and breathed for the firm.

I mean, the hours were insane.

You never questioned it.

And on a relative basis, you were making so much mone and you felt grateful.

You felt indebted to the bank.

>> NARRATOR: Desiree Fixler, a graduate of the London School of Economics, sold derivatives for Deutsche Bank and J.P. Morgan.

>> I didn't think for myself.

You know, I was so desperate to perform for the bank.

I mean, for so many of us, if you slit our wrists, corporate logos would jump out.

>> NARRATOR: Fixler was part of a small army of bankers pushing derivatives to European markets.

(phones ring) On the trading floor, they were known as F9 monkeys.

>> SMITH: You were an F9 monkey?

>> Half of me was an F9 monkey.

And the other half would be out on the road, marketing to accounts.

>> SMITH: So what was an F9 monkey?

>> Well, just somebody who's just simply pricing all of these structures.

>> SMITH: These are on the computer.

>> Exactly right.

So you just had to put in a few inputs and press F9 and it would determine the price of the instrument and, in fact, your hedge as well.

>> SMITH: And who did you... who did you sell to?

>> Hedge funds, to pension funds, to insurance companies, to all sorts of different types of banks.

And there were many uses to the product.

So it just... it naturally grew.

>> NARRATOR: After pricing the derivatives, teams of investment bankers hit the road.

>> They're called investment bankers, but they're effectively salesmen.

Their job is to go out and sell the stuff that the bank is creating.

Just in the same way a pharmaceuticals compan would have a very large sales force who go around selling their latest version of whatever the particular drug of the moment is.

>> What sticks out in my mind is going to a group of Italian companies and local governments and even convents that had been sold derivatives to try and make their accounts look better.

And the theory was that these were sophisticated financial investors who could tell the risks.

In reality, you had a bunch of nuns who knew nothing about this, but basically had bought it, hoping that this would somehow be financial alchem that would solve their problems.

>> These bankers were fanning out across Europe, finding all of these clients that were... they were lapping up these deals.

It's what you might call a form of governance arbitrage.

Where the bankers will find the... the type of client that doesn't understand the product in order to sell the product that the client shouldn't be buying.

>> SMITH: How many of these deals were being done?

>> We don't know.

These deals are confidential.

We only know about them when the... when they go wrong.

>> NARRATOR: Take, for instance, this small town, Cassino, an hour south of Rome.

In 2003 a team of investment bankers from Bear Stearns arrived at Cassino's city hall and met with officials.

>> They went to Cassino and they said, "We can lower your borrowing."

They'd be saying, "You're paying 5% a year on your debt.

"We can reduce it to 1% or 2%.

"But you have to enter into a derivative with us-- "an interest rate swap or an option, "some kind of derivative "where as long as something doesn't happen in the market, your rates will stay low."

So they signed this contract with Bear Stearns, now J.P. Morgan, and they got a benefit from it in terms of lower borrowing costs.

>> NARRATOR: But it didn't work out that way.

Soon after the deal was signed, the interest rate the deal was pegged to began to rise.

Cassino found itself paying hundreds of thousands of dollars more in interest than it bargained for.

(speaking Italian): >> NARRATOR: Carmelo Palombo is a former city councilman.

>> SMITH: How well do these people understand the deals that they're buying?

>> They had very little understanding of them at all.

They should never have been allowed to have been even talking to these investment banks.

It was... it was a crazy idea for them even to get into these kind of conversations.

>> SMITH: And when you talk to bankers, what justification do they offer for selling to rubes out there these complex financial instruments that they know they don't understand?

>> They'd be saying, "Well, they might win."

You know?

I can tell you...

I can tell you a client who's done that bet and did very well out of it.

>> I think very few people knew what they were buying.

>> SMITH: But if they don't know what they're buying, then somebody's failing to do their job, aren't they?

>> But in a way, I think that it's more on the investor's side that the due diligence has to be done.

I mean, you know, it's-it's-it's... it's an open market.

And so I'd put more blame on investors than on the banks that were selling them.

>> SMITH: But who could understand these products besides the bankers?

>> Even the bankers didn't understand them.

>> NARRATOR: Cassino ended up paying Bear Stearns over a million dollars in interest.

The town sued the bank now owned by J.P. Morgan and received a half-million dollar settlement.

But it was still left in the red.

>> SMITH: You bought Bear Stearns in 2008.

And they had done some deals in the town of Cassino outside of Rome?

>> Mm-hmm.

>> SMITH: Which... are you familiar with those?

>> Yeah.

>> SMITH: Was that a clean deal?

>> I don't know.

At the time that the deals were entered into... hard to tell.

Would J.P. Morgan have done those deals?

No.

No.

Too complicated, too small a counterparty.

>> SMITH: So in this case, I mean, you're holding banks responsible for leading less sophisticated municipal officials, you know, down the... down the wrong path?

>> Yeah, I would hold banks responsible for that.

>> SMITH: That was the abuse of derivatives, right?

>> There were abuses.

In every market, there are abuses.

There were abuses in the derivative markets.

Because of the opaqueness of derivatives, it was probably easier to abuse in some cases.

>> SMITH: And what does that say about the profession?

>> It obviously doesn't cover the profession in glory.

When you go through a period-- like we all did-- where really large amounts of money were available to individuals-- we're talking bonuses-- the incentive to cheat is very high.

It's very high.

>> NARRATOR: By last count, over 1,000 municipalities and institutions across Europe entered into similar deals with other banks like Merrill Lynch, UBS and Deutsche Bank.

Potential losses are estimated to be in the billions.

Scores of lawsuits have been filed.

And it wasn't just in Europe.

The banks did deals in America, too, in places like Birmingham, Alabama, seat of Jefferson County.

>> They came down here like sharks to raw meat in the water and... took advantage, full advantage of the opportunity that was here to make a lot of money.

>> NARRATOR: Jefferson County had a problem.

In 1996, it had squandered $2 billion to build a state-of-the-art sewage system.

People were left with sewers to nowhere and huge monthly bills.

>> If my bill is $30, I now have to pay $90.

Most of the people in this neighborhood are on fixed income.

So even if you're paying $70 a month for water and sewage, and that $700 a year, that's pretty much the sum of their checks for the month.

>> NARRATOR: In 2002, the county was looking to refinance their sewer debt by issuing $3 billion worth of bonds.

Wall Street bankers came knocking.

>> The Jefferson County sewer financing in $3 billion worth of borrowing over a two- or three-year period would be a huge financing at that time in the marketplace.

It would be a huge financing today in the marketplace.

Those numbers gets Wall Street's attention.

>> NARRATOR: One banker who called was Charles LeCroy.

>> He was the leading producer at J.P. Morgan, and supposedly, street talk is he was the largest profit center that J.P. Morgan had for several years running.

So he was hustling this product not just in Jefferson County, but all over the country.

>> NARRATOR: One of the products LeCroy was pitching to Jefferson County was an interest rate swap similar to the one Cassino had entered into.

>> He says, "Have I got a deal for you.

"We've got this new product, it's called a swap.

"And we know how to work this swap program to help write off, where you don't have to raise rates on your citizens."

>> He said, with the refinancing, it would hold the sewer rate increases to single digits, and it would also, over the long run, save the county $300 to $400 million.

>> NARRATOR: In late 2002, a former local TV reporter turned politician named Larry Langford took charge of the county's finances.

>> I think the bankers in New York with Larry Langford sitting across from them had to stifle the laugh.

Because you had a guy here who had no idea about swaps, had no idea about auction rate securities, had no idea about the financial market.

>> NARRATOR: Langford decided to consult a friend, Birmingham financial advisor Bill Blount.

>> Blount looks at it.

Says, "Yeah, it's a pretty good deal, Larry.

"We just swap this debt, you won't have to raise rates, everything looks great, here we go."

They didn't just do it once.

They did it several times.

They were swapping low to high, or variable to fixed, and they were swapping fixed back-- back to variable.

"Where's the market going?

"If it goes up, we do this.

If it goes down, we do this."

Very sophisticated transactions.

I mean it was just basically commodity trading, because they were just literally betting against the market.

>> Today Wall Street had one of its worst days on record.

>> NARRATOR: But what the county didn't account for was a big change in the markets.

In 2008, it all went horribly wrong.

>> It was the day we were afraid to wake up to... >> Financial institutions are in trouble.

Lehman Brothers filed for bankruptcy.

The worst financial crisis in modern times, and perhaps the end of an era in American... >> Then in 2008, when the music stopped, in the fall, they pull out the chairs, they're several chairs short.

>> NARRATOR: The county suddenly owed hundreds of millions of dollars in fees and penalties to its debt holders, including J.P. Morgan.

>> We knew we could not pay the warrants.

You know, we knew we could not sustain the debt that we had amassed when the derivatives and the variable rates shot up.

And so we just put off the fact that we were in bankruptcy, just like an alcoholic who never admits that they're alcoholic.

>> NARRATOR: And there was more.

It turns out LeCroy had paid mone to Langford's friend Bill Blount.

>> If you didn't pay Blount, you weren't in the deal.

If you look at the timing of the transactions between Langford and Blount, you'll see that they correspond closely with the timing of the Jefferson County financial transactions.

>> NARRATOR: According to federal prosecutors, the money was for bribes.

$3 million from J.P. Morgan to Blount, who in turn passed money and gifts to Langford.

>> I can't say that J.P. Morgan paid bribes.

Certainly didn't pay any bribes to... to Larry.

Now, what J.P. Morgan did is they paid some benefits to Bill Blount.

Is it bribery, is it undue influence, is it good or is it not good?

It depends on the situation.

But certainly it's at least got the potential for corruption.

>> NARRATOR: In 2010, Langford went to jail on charges of bribery and fraud.

He is currently serving a 15-year sentence.

Langford's friend Bill Blount cooperated with authorities and is serving four and a half years.

J.P. Morgan settled with the SEC for $25 million and was ordered to forgive the county fees totaling $697 million.

Charles LeCroy was sentenced to three months in jail after a similar deal in Philadelphia.

>> Jefferson County, Alabama, was going to teach America how to use swaps and derivatives.

Now it's running out of money.

>> NARRATOR: In November 2011, after years of corruption and mismanagement, Jefferson County filed the largest municipal bankruptc in U.S. history.

Across the country, over a hundred school districts and hospitals, as well as scores of state and local governments, bought interest rate swaps.

Over the last five years, banks earned an estimated $20 billion on these kinds of swaps.

On Wall Street, the derivatives business is sometimes called the solutions business.

Traders are constantly looking for big problems to solve.

>> For a derivative person-- trader, marketer for the business-- naturally, you tend to focus your... attention to big problems.

Usually, big problems become a big source of opportunities and... and business.

>> NARRATOR: And some of the biggest problems and opportunities were in Europe, when, starting in the '90s, countries were bidding to join the euro club.

>> It became very clear that the question of who was going to be let into the club or not was going to rel very heavily on statistics.

It's a bit like your SAT scores for university.

The question of how those are calculated is absolutely key.

And what happened, as so often in finance, was that bankers bought it, a similarly dull geeky area that was incredibly important, that almost no one understood, and the politicians certainly weren't looking at and thought, "Aha, here is a chance for arbitrage."

>> Regulatory arbitrage.

This is a kind of esoteric term.

But basically what it means is figuring out a wa to get around the law.

And Wall Street has become very good at regulatory arbitrage.

They're very good at figuring out a complicated financial structure that achieves some objective that you couldn't achieve otherwise in a legal way.

>> Your job was to find a solution, a legal solution, to selling these derivative products.

And the more of this-- if you want to say regulatory accounting arbitrage-- that happened, um, the more you got promoted and the more you were paid.

>> SMITH: So violating the spirit of... >> Absolutely, yes.

>> ...of regulations.

>> Yes, that... >> SMITH: That was very much the game?

>> Absolutely.

>> NARRATOR: So bankers descended on European capitals offering derivative solutions.

>> Derivatives became the name of the game, became some kind of magic formula through which you could readjust macroeconomic imbalances across the border by speculating.

It almost became something that you had to do, or you had to try.

>> Everybody was using derivatives.

All agencies were looking somewhere else.

All statutory auditors were looking somewhere else, all supervisors were looking somewhere else.

Many shareholders were looking somewhere else.

>> NARRATOR: Countries also used other tricks.

>> The French were cooking their books by reclassifying their pensions.

The Germans were cooking their books with gold transactions.

This was a time when... when Europeans were generally cooking their books.

>> NARRATOR: The first known case of a countr using a derivative to window-dress its accounts was in Italy.

Officials in Rome had been struggling.

>> In Italy, the fear was that if we are not going to get hooked to Europe, we are going to get hooked to North Africa.

And so there was not much of a chance, there was not much of a choice about what to do about this.

We had to be in Europe, period.

>> NARRATOR: They turned to J.P. Morgan for help.

The bank sent the head of derivatives for Italy, Bertrand des Pallieres.

>> SMITH: You went to Rome.

You helped them enter a derivative contract.

Did it effectively lower their deficit?

>> This transaction?

Did it lower their deficit?

It's... this transaction probably had... yeah, this transaction lowered the deficit, absolutely.

But... it's probably inappropriate for me to discuss, you know, too specific details.

Because I think I have duty towards clients.

I have duty towards my employer.

>> NARRATOR: Not all the details are known.

But Italy and J.P. Morgan entered into a currency swap, a commonly used derivative.

Except in this case, the swap was more complex.

It had a built-in loan.

>> This was done with J.P. Morgan and Ital as a derivative rather than as a traditional loan.

It was not put on the financial statements.

It potentially deceives the other countries in the euro zone into thinking that they are cleaning up their books more than they really are.

(crowd cheering) >> NARRATOR: In 1999, Italy was allowed into the euro zone.

>> The euro is the beginning of a strong European Union.

We shall be the best in the world.

The best in the world.

>> NARRATOR: Italy said derivative deals had little effect on their acceptance.

But nobody really knows how many deals they entered into.

>> Derivatives are opaque.

They're not publicly listed.

No one knows who has what.

Even the central bankers don't know who holds what in many cases.

And so we don't know how many more of these trades J.P. Morgan did with the government of Italy.

>> NARRATOR: J.P. Morgan declined to discuss the deal, but Des Pallieres says the bank did nothing to fool regulators or other European countries about Italy's financial health.

>> SMITH: Did the deal with Italy change the perception of the nation?

>> Absolutely not, absolutely not.

And, furthermore, every transaction that we were involved in Europe-- every transaction we were involved in Europe-- were not hidden to the other European partners.

>> NARRATOR: Des Pallieres insists that his deals for J.P. Morgan were all aboveboard.

He won't vouch for other banks.

But in 2003, Nick Dunbar published a stor in Risk magazine uncovering a secret deal between Goldman Sachs and Greece.

The article revealed that Goldman had sold Greece several giant swaps to help Greece meet its targets.

>> SMITH: What was the reaction when your story came out?

>> What happened was complete silence.

I think I did one radio appearance and the story was just buried.

Nothing happened at all.

>> NARRATOR: The silence was surprising.

This was the largest sovereign derivative deal ever reported.

The deal cut Greece's debt by around 2%.

What other deals there were is not known.

>> It was a secret off-balance-sheet loan.

Legal within the rules of the time, as Goldman would say, but it was an off-balance-sheet loan.

It's a very expensive form of borrowing for Greece.

By going through Goldman, Greece ended up paying something like 16% a year.

It's a bit like a subprime mortgage or something like that.

It's a crazy borrowing rate for someone that's desperate to borrow money.

>> SMITH: And how much did Goldman make in the deal?

>> I think you can safely say that Goldman earned hundreds of millions on that deal.

>> NARRATOR: Desiree Fixler was working at J.P. Morgan when the news hit.

>> SMITH: When Nick Dunbar's story came out in 2003, what was the reaction inside the bank?

>> The reaction wasn't... scandal-- "My goodness, I can't believe Goldman Sachs has pushed it this far and clearly has broken the spirit of the law."

The reaction was, "You better go down to Athens and find out "if there's any more to do.

How did you miss this?"

So, most banks were trying to see if they could replicate it.

>> I can tell you it's absolutely false.

I was in charge.

And I... you know, extremely knowledgeable in that domain.

The position didn't make much sense.

For Greece, the transaction was disguised from Greece's partners and a number of other... and I think the margins didn't really make sense.

>> SMITH: Because it was too much dressing of the books.

>> Absolutely.

>> SMITH: So you were leaving a lot of bonus on the table.

>> Oh, yes.

When you drop... and when I speak about, you know, several hundred million transaction, it's several people around the table leaving several million of personal money.

That's absolutely right.

>> NARRATOR: With its books dressed, Greece had kicked their problems down the road.

For the next several years, Greece would also go on a massive spending spree.

>> Credit was easy, and big global investment banks such as Goldman Sachs were eager to lend to relatively risky places such as Greece.

And they were eager to tell their customers that these risks were not very big.

>> Banks considered Greece almost as safe as Germany.

So Greece could borrow on German interest rates, and they were very low indeed.

>> There was a bubble, a consumption bubble, I would say.

Banks were intermediating that.

So we had an increase in expenditures way above our means.

>> Citizens of the world, welcome to Athens!

>> It has a special twist in Greece because of the Olympic Games.

There was a euphoria that led to irresponsibility.

>> No one was thinking, you know, "The money's available, but we're borrowing it.

"And this is very expensive.

"And at some stage, we're gonna have to pay it back.

Well, how is that going to work out?"

Greece being such a small country, being a small econom and one that wasn't really going anywhere, it was a disastrous mix.

>> NARRATOR: Between 2001 and 2008, Greece's debt had doubled.

No one, it seemed, wanted to ask any hard questions, including the European regulator Eurostat.

>> I find it hard to believe that a continent that can figure out, you know, pretty precisel how many centrifuges Iran is running at this moment enriching plutonium and uranium couldn't figure out that the Greeks were cooking their books doing currency transactions with Goldman Sachs.

I think they knew.

In fact, I know they knew.

And they just didn't care.

>> SMITH: How do you know they knew?

>> Because I talked to them.

They knew.

The Greeks had a constant dialogue with Eurostat.

Now, doesn't mean that they didn't play a few tricks along the way that Eurostat didn't know about, but Eurostat knew the big ones.

>> I would put it cynically as follows.

For several years, Greek governments pretended that to keep their public finances in order.

And their European partners pretended to believe them.

>> NARRATOR: The reckoning came in 2009.

The newly elected government of George Papandreou would arrive in office claiming to have no idea what the true size of the debt was or what tricks had been used to hide it.

George Papakonstantinou was the Minister of Finance.

>> Not until we sat down in the general accounting office and sort of slowly stripped the layers of expenditures that were due, but not really being recorded or declared... Not until that time did we realize that what we had was a very, very serious problem.

>> NARRATOR: Papakonstantinou had to deliver the bad news to his fellow European finance ministers.

>> Our deficit for this year is going to be double the one previously projected.

In double digits, around 12.5%.

This means...

I showed up and I had to tell them that the deficit was twice as big as they thought, twice as big as the previous government had told them, and six times as big as was originally planned.

>> We felt betrayed, to be fair.

Because, you know, all of a sudden the public deficit that had been reported by the Greek authorities at the time suddenly, you know, ballooned.

And then it went, you know, sort of downhill from there on, because there were successive revisions of those numbers, on several occasions.

>> Some creative accounting is used by virtually every self-respecting government that I can think of, right?

But here again the Greeks went a bit beyond the pale.

>> There could be extensive foreign exchange volatilit at the risk... >> A decade of frantic overspending has left... >> They will default... >> Investors are ignoring Greece at their own risk.

>> Yeah, I bid 35 for 50, so... >> NARRATOR: Bond traders from New York to London started dumping Greek sovereign bonds.

The very same institutions that had happily fueled the euro spending spree pulled back.

>> And in 2009, this whole thing fell apart.

And what you're seeing at the moment is this sort of crumbling edifice that was built over the last few decades.

>> NARRATOR: With the markets no longer willing to provide Greece cheap credit, the country had to cut spending.

People took to the streets in protest.

Other European countries had no plan in place to deal with the situation.

>> I think everybody knew that the construction of the euro was not a finished construction-- because, you know, when you don't have a real, common economic policy and fiscal policy, clearly, you know, a common currenc theoretically doesn't work.

>> NARRATOR: In 2010, the value of the euro dropped precipitously.

Ireland, Portugal and Italy started their own downward spirals.

Today it's Spain, an economy four and a half times larger than that of Greece.

>> It became apparent that Greece was not alone, that this was not just a Greek issue, that there were other countries that had similar problems.

So what was originally perceived as an isolated problem quickly became a systemic problem for the rest of the euro zone.

>> Could this affect the United States?

Absolutely.

Of course.

Our banks would be the obvious conduit for any... any shock.

They lend a lot to Europe.

They transact a lot with European banks.

And we in the United States have not sufficiently prepared for those difficulties.

>> The debt crisis and economic chaos could have a dangerous ripple effect around the world... >> NARRATOR: If difficulties in Europe lead to the failure of a big American bank, it could be catastrophic.

>> How palpable is the fear?

How much of an impact could this have in the U.S.?

>> NARRATOR: Since 2007, the five biggest banks in America have become larger.

Today, they control assets equal to 56% of the American economy.

(protestors chanting) >> NARRATOR: Last fall as the European debt crisis worsened, Occupy Wall Street launched its protests in New York.

>> I remember sending e-mail to my boss asking, "Is anybody watching?

Does anybody care about this?"

"What?

The protests?

No."

That was the response, you know?

I mean, just wasn't an issue.

They didn't seem to care down on Wall Street.

>> When I first saw Occupy Wall Street, I was highly skeptical.

And I just thought it would be shut down on day one, like I think most people did.

And then they had this momentum.

And then there was the pepper spray incident.

(protestors screaming) >> Those three girls were kettled in the orange netting and sprayed in the face.

And that was the moment where I said, "I have to get down there.

And I have to be involved in this."

>> People took to the streets to express their anger.

But what exactly is their message?

>> I don't think they know what it is.

What do these people want?

>> You know, Occupy Wall Street from the very beginning was being criticized for not really knowing how the system works.

And what I realized was, you know what?

Nobody knows how the system works.

Even the people in finance don't understand the system.

>> The yields come down, the prices go up... >> Go from bonds into stocks... (mixed voices of TV commentators) >> They understand their little corner of the system.

But very few people would come forward and say, "I'm an expert on the financial system.

I know how everything works."

>> We are Occupy Wall Street!

>> We are Occupy Wall Street!

>> The occupiers, they know that the result of this system is not working for them.

That's enough.

The system is a huge black box, and they are seeing the output of that black box.

You know, a lot of them are college educated, they have enormous student loans, and they don't have a job.

And that is the output-- them and all the people around them don't have jobs and are in huge debt.

(protestors shouting) >> They don't have the power, in fact, to address the system and to question it.

And I feel like the occupiers should be appreciated.

That in spite of the fact that they don't understand it, they're willing to come out and say, "This isn't working.

The system isn't working."

>> Occupy everything!

>> Occupy everything!

(crowd cheering) >> NARRATOR: In Washington, other battles are being fought.

On one side are the 12 federal agencies responsible for protecting the public interest.

On the other, the bank lobby.

Ever since the passage of the Dodd-Frank financial reform act in 2010, the two groups have been in a virtual deadlock over what kind of rules are acceptable.

The industry has spent over $320 million lobbying lawmakers.

The regulators face an uphill battle.

>> Generally speaking, it's not a level playing field.

The banks have got vast resources.

They have very highly paid inside counsels whose job it is to outwit the regulators.

It's a game.

And over time what we've seen is that the winners of this game are usually the banks rather than regulators.

>> NARRATOR: To date, the rule-writing process has been slow.

Few rules have been finalized.

>> I'd like to call this meeting of our advisory committee to order and begin by thanking you all for agreeing... >> NARRATOR: At the Federal Deposit Insurance Corporation, regulators are meeting to discuss banks that are "too big to fail."

>> I think this is the most important part of Dodd-Frank.

>> NARRATOR: They've pulled together a group of financial heavyweights, among them former Citigroup CEO John Reed, Wall Street super-lawyer Rodgin Cohen.

Former SEC chairman William Donaldson and former Fed chief Paul Volcker.

Across the table are officials from the FDIC's Office of Complex Financial Institutions.

It is their job to plan for a big bank failure.

>> ...mitigate systemic risk.

>> So the scenario is sort of everything but Title II.

>> NARRATOR: There are many questions.

>> Non-bank operations... >> NARRATOR: How to unwind derivative contracts?

>> Billions of dollars notional value of derivative trades... >> NARRATOR: How to protect customers' money?

>> The funding is provided by a line of credit provided... >> NARRATOR: How to deal with foreign subsidiaries?

>> The subsidiaries went into the solvency, value was eliminated... >> NARRATOR: How to prevent catastrophe?

>> This is a problem for the entire strategy.

You continue to have mega-banks.

Because from a market point of view, surely what you're looking through to how disruptive would that be, what kind of systemic knock-on effects could it create?

>> I don't know how this ends.

We like to think that we live in unique times, but during the 1920s, we had a tremendous amount of financial innovation.

And when we had the great crash and we came out of it, we had a series of investigations that led to the securities laws.

My hope is that we'll learn the lessons that we learned from 1929.

Maybe it'll take longer for us to learn the lessons of 2007 and 2008.

Maybe we'll need another several crises to get us there.

>> You got two main business lines-- good old commercial banking and capital markets.

>> NARRATOR: Some believe the answer is to roll back time.

Former Fed chief Volcker has proposed a rule that would in effect reinstate a cornerstone of the Depression- era Glass-Steagall act: separating proprietary trading from traditional customer-oriented banking.

>> You're in a big mess if they're in the same legal entity.

>> Well, we aren't going to be instructing the companies what to do.

They're going to be telling us how they're going... >> There seems to be no willingness to address the conflict of interest inherent in modern banking, because that would mean essentially pulling apart the two parts of the bank, the proprietary trading and the client-focused businesses.

And there is no real energy or traction for dealing with that issue.

>> And then a year down the road, you have 37 different offsetting trades just to hedge this one stock buy that you made.

>> I mean, it makes sense in as much as the rule is supposed to prevent... P&L due to prop trading, right?

>> NARRATOR: In New York, Occupy Wall Street has formed its own group to review the Volcker Rule.

>> You know, this would be a good question to just straight-up ask the SEC.

>> NARRATOR: After extensive industry lobbying, the rule has ballooned from ten pages to almost 300 of exemptions and loopholes.

>> What are they going to say specifically about funds that are not risky... >> The risk section of the Volcker Rule is really vague-- really vague.

And, you know, I worked in risk.

I mean, if I'm a bank, I can game this.

We need people who are experts, who have gamed the system.

>> When things like Lehman happen, the unwind process is just mind-boggling, and nobody can handle it.

>> We decided we would read through the rule and figure out what the rule was trying to do and then sit and try and figure out how we would get around it.

If we were still working on Wall Street, what are the ways that we would try and evade it?

>> I have no faith that it will ever make it through into the final rule under any circumstances, but we can make a very, very strong case for continuity.

>> NARRATOR: Recently they submitted their proposal to the SEC, the FDIC and the Fed in the hope that the Volcker Rule would be tightened up.

>> Normally the only people that comment on these regulations are the industries that are about to be regulated.

And you can probably guess what they say, right?

They say, "This is too harsh.

"You have to take this out.

This is going to ruin our business."

They'll say, "This will ruin the economy."

>> The cynic in me will sa that even under the best circumstances, if this law went through and all speculative proprietary trading was cut from the banks, and they just couldn't do it anymore, they will find something else.

They always do.

>> We can absolutely reform banks.

We just have to care enough about it and we have to... we have to trust that the world won't collapse in the meantime.

Banks were reformed after the Great Depression.

They absolutely were.

It was a political will issue and it continues to be.

And the question isn't, "Are we going to create something perfect?"

The question is, "Are we going to create something better than this?"

It's actually a pretty low bar.

So I think it's... it's definitely achievable.

>> NARRATOR: Recently, the government tried to create tougher rules for banks that trade more than $100 million of swaps annually.

The bank lobby swung into action.

The outcome: only banks trading more than $8 billion will be subject to oversight, leaving 85% of all derivative players outside the reach of regulators.

>> We now somehow believe that finance sort of drives everything.

The crisis was an opportunity to change that.

To ask questions like, "What is the role of finance in our economy?

What is the role of banks?"

But I suspect it's very hard.

Because it's very difficult to change gods.

And in the modern age, our god is finance.

Except it's turned out to be a very cruel and destructive god.

>> "Money, Power and Wall Street" continues online with a dynamic oral history.

>> Rotting in the system... >> 20 original interviews, including seven to watch at length.

>> Incredibly new stuff.

>> First-hand testimony from deep inside the crisis.

>> To the president's credit... >> Navigate by theme or person.

>> Cool head in a crisis.

>> Explore the personal experiences that shape current events and make history.

At pbs.org/frontline.

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