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(♪ Music playing throughout ♪)

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Fortunes are being accumulated in the U.K. on a scale we haven't seen for a hundred years!

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We've been told, that the wave of super-rich, create wealth that makes all of us, well, a bit better off.

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But does it?

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This time around they've used new and different financial techniques to enrich themselves.

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And right now, they're the big winners.

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And we seem to be the losers.

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I'm going to tell you, how the new super-rich are making their fortunes

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and why we're picking up the bill, in a global greed game.

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In the past few years, the City of London financial services, have contributed a third of all our economic growth.

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London is the capital, of capital.

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(Speaking Off Screen, Sir Richard Branson): London, for the international community, is a beautiful city,

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a lot of people are living in London that they might find interesting to meet.

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It's got the restaurants, it's got the clubs, it's got the bars.

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It's got the decent hotels, it's got the nice houses; it's safe, it's secure.

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There's a lot going for it.

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(Speaking off screen, Robert Peston): More than fifty billionaires call Britain home.

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Not since the 19th century have there been, such opportunities for so many to make quite so much money.

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At least 30,000 Brits now earn more than half a million pounds a year.

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In 2006 4,200 city executives took a bonus of a million or more.

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And among hedge-funds alone 150 people have been earning more than 20 million pounds a year.

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(Speaking off screen, Dr Philip Beresford): The only other period we have seen similar accumulation

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was during the industrial revolution in the Victorian age,

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when the whole raft of Victorian industrialists made massive fortunes, very quickly.

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But even that was over a period of forty or fifty years.

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This has been in the last 10 years.

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When you're coming here with several billion pounds, you travel around in armoured limos

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guarded by people who look after you, the idea of the congestion charge is wonderful to you because it clears the roads of the riff-raff.

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You can get out to a private airfield quickly, to get on your jet to go and see far-flung operations as part of your empire.

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(Speaking off screen, Robert Peston): And they've created ghettos of fabulously expensive property.

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This house in North London, recently sold for 50 million pounds.

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(Speaking off screen, Trevor Abrahamsohn): The new owner will be spending, probably, another-- up to thirty million pounds

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creating what will probably be the most desirable house

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in the world.

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(Speaking off screen, Robert Peston): And just outside London is this brand new 26 bedroom mansion.

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It's on the market now for over 70 million pounds,

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but it's the running costs of over a million a year

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that means that only proper billionaires need bother to view it.

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Even so, the developer, Leslie Alan Berker, tried his best with me.

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(Peston): So this is the private swimming pool. Is it simply for the owner of the house? (Laughs)

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(Berker): Unless, of course, the owner of the house wants to allow people to use it.

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The en-suite swimming pool.

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(Peston): Why would you want 5 pools?

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Because you've got 5 pools (Laughing) in this house.

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What family needs 5 pools?

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(Berker): You genuinely need to like swimming.

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This bathroom area is about 800 square feet.

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Putting it into perspective, it's about the size of the average 2-bedroom flat in London.

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(Peston): That's just for your towels, that room is it!?

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I feel rather disappointed that I haven't got one of those.

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It's the size of a decent sized kitchen for me.

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Jewel-encrusted gold taps (laughing)...very good, very nice!

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I think I'm going to have to have one of these in my home.

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So how have all of these people become super-rich in such a short time?

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Unlike the past, it's not been about finding new resources or exploiting new technology.

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The answer lies in how they conjured with money itself.

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(Speaking off screen, Robert Peston): And they were helped to become wealthy beyond anyone's wildest dreams,

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by a sharp fall in the cost of money,

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for them and all of us, engineered by the US Federal Reserve.

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It sets interest rates for America and, in a way, for the world.

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A clear September day. The American economy was already faltering after the

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bursting of the dot com bubble and then...

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the world's most powerful central banker, Alan Greenspan, feared that terrorist

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outrage would further undermine the confidence of businesses and consumers so he

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kept interest rates unusually low.

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(BBC News Footage): American interest rates were, tonight, cut by a half of one per cent.

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The Federal Reserve base rate now stands at just 1 and a quarter per cent, the lowest for 41 years.

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(Speaking off screen, Robert Peston): After the bursting of the dot come bubble and 9/11,

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Greenspan slashed rates to just 1%,

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and the supply of credit soared

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because the great exporting nations such as Japan, China and those in the Middle East

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were generating vast surpluses and lent much of their cash to us, in the West.

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Finance is global so it became cheap to borrow money anywhere,

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for private individuals and especially for businesses, tycoons and financial institutions.

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They went on the most frenetic borrowing spree,

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the world has seen. With so much money sloshing around,

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the price of assets, from paintings to houses to entire companies, soared.

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(Auctioneer) : £65,000. (Sound of Gavel) Sold!

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(Paul Myners): People borrowed more against the inflated value of their assets.

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The valuation of property, the valuation of shares, art, jewelry etc. was soaring;

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and the central banks on the whole said "This is not our business."

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"We don't manage assets, we only manage price inflation".

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(Speaking off screen Robert Peston): With markets rising, borrowing vast sums for investment, was the root

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to magnificent fortunes.

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It's what bankers call using leverage.

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(Alexander Batchvarov): Leverage is simply borrowing to invest.

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You're not investing your own money,--or you are investing part of your own money,

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but you borrow to invest more.--So that's simply--leverage is borrowing to invest.

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When we borrow for a mortgage we're leveraging. As simple as that.

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(Robert Peston): The power of leverage to multiply profits is a common experience

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for millions of us, who borrow to buy a house. If you put down a £10,000 deposit,

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when buying a £100,000 home, and borrow the other £90,000 and that house

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then rises in value to say, £110,000. Well your £10,000 doubles to £20,000.

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You make 100% profit. That's the magic of using the banks money to finance most of the purchase,

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and in a rising market, the more you borrow, the greater your profits.

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(Jon Moulton): The level of debt that became available for deals, became very, very high. And what

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was really uncomfortable was that not only was it a high level of debt, but every

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passing month you could get more and more debt.

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(Speaking off screen, Robert Peston): With debt so cheap, deal-makers were borrowing mind-boggling amounts.

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To invest in financial markets, in property and in commodities, or to buy entire companies.

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(Sir Tom Hunter): Banks were willing to lend in multiples that they'd never known before.

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The past 5,6 years have been unprecedented in terms of cheap debt, quite frankly,

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and have we --benefited from that? Absolutely, you know I would rather be lucky than clever

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everytime.--So we'll take every bit of luck that's going our way.

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(Speaking off screen, Robert Peston): And for Tom Hunter, Britain was a pretty good place to be,

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because since 1997, Labour has tried to make the United Kingdom a land

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fit for the new super-rich.

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(Sir Steve Robson): Well I think first of all you've got to thank your lucky stars

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if you are an economy which has the vibrant and successful industries, to a disproportionate degree;

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because, you know, that is generating wealth that you can do something with.

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So it's better to have the wealth generated that you can do something with,

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than not have the wealth generated at all.

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(Speaking off screen, Robert Peston): There was a time however, when our Prime Minister was explicitly hostile to the

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idea that tax rules should favour the super-rich.

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(Speaking off screen, Gordon Brown): The Labour chancellor and the Labour treasury will not permit tax reliefs to millionaires

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in off-shore havens. We will end the situation where millionaires can pay no tax.

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(Speaking off screen, Robert Peston): But in Government, Gordon Brown changed his mind. Labour feared that the

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super-rich would flee Britain if they had to pay the same rate of tax as the rest of us.

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And if enabling them to stay, meant a widening of the gap between the super-rich and

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the rest of us, well Gordon Brown believed that was a price worth paying,

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for the benefits that might accrue.

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(Sir Tom Hunter): We want the best people in the world, to come here because the spin-off and the clusters and the

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multiplier effect of, them building businesses within our country is phenomenal.

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And why not have the best in the world right here.

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(Jon Moulton): We've had the extreme case, there are --people in my industry who have literally lived in the country

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more than 40 years and claimed to be non-domiciled and pay very little tax.

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And that seems to me both politically and--indeed, some danger of the word morally,

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fairly repugnant.

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(Speaking off screen, Robert Peston):Even some of the super-rich began to question whether it's fair that

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they should be taxed at lower rates than their servants.

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(Jim Chanos): There's lots of things about my industry, I don't like quite frankly; but I think that broadly speaking,

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and I'm speaking personally now, not for my industry. The concept that hedge-fund managers

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pay a lower -- tax rate on earned income than, you know, -- maids that clean their office;

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I think is just palpably absurd.

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(Peston): By the start of the 21st Century, these two factors: the power of leverage and low taxes

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for enterprise, gave birth to a new set of business super-powers. Among them are the

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private equity firms who borrow huge sums of money to buy whole companies.

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( Speaking off screen, Sir Steve Robson): Private equity has demonstrated that if you go into--situations--in the company sector

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with clarity of purpose--strong drive, determination a willingness to pay people

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incentives to do the difficult things. You can make big returns and again you make big returns

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particularly when there's lots of cheap money around the place. And the fact that

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their success was over-amplified and magnified by the--macro-economic environment

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they were operating in which--made them very lucky--and I suspect made some of the

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rest of us rather jealous.

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(Speaking off screen, Robert Peston): Some of Britain's best known businesses have been taken over and sold on by private equity,

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for billions in profits. They include the AA, Saga, Homebase and Travelodge.

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The technique used by private equity of buying companies with borrowed money, is also

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employed by Philip Green. He owns much of the British high street.

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(Philip Green): I think we probably own about 12. Dorothy Perkins, Top Shop, Burton, Wallis, Top Man, BHS.

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(Green, pointing) That's a nice piece of Real Estate isn't it?

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We actually own that. It's probably worth in excess of 200 million.

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(Speaking off screen, Robert Peston): Sir Philip and his family pocketed a 1.2 billion dividend in 2005, the equivalent

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of the bay of 54,000 british workers on average earnings. And there was no tax to pay on it here, because

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it was received by his tax exile wife Lady Green.

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(Paul Myners): We'd had an extraordinary period of economic growth, and confidence this--is the critical factor

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-- confidence was very high. The masters of the universe seemed to be getting it right,

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they had been producing extraordinary high profits, great returns from their private equity funds.

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(Peston): It hasn't just been private equity making billions out of borrowed money.

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Hedge-funds have become the largest dealers in shares and securities across the globe.

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They make their money by betting on price variations however small, between what they

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can buy and how much they can sell for. And they too use borrowed money and leverage to

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generate spectacular profits.

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( Speaking off screen, Michael Hintze): Private equity will take control of a company.

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Hedge-funds will trade a company. It's a very different--they'll trade the shares of a company.

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So it's a--it is a very different beast.

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(Peston): And how much do you have under management at the moment?

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(Hintze): We've got about $10 billion.

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(Terry Smith): Hedge-funds are enormously powerful, now in the financial system.

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There's a lot of them--they manage a great deal of money, they're not regulated.

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by and large, they're usually in off-shore jurisdictions where they are not regulated

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I would say that the top 3 trading institutions in the US treasury market, which is the largest

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securities market in the world, are in fact hedge-funds, they're not banks.

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The only serious risk for a hedge-fund is that if it consistently loses money

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the backers will take their funds back.

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(Phillippe Jabre) You can lose money...you're allowed to make a mistake once.

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But if it's a bad one you--you're gone. I mean, it's a very fragile. I mean you're--

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there is high return in that industry yes, but you could also very quickly lose the appetite

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for risk that clients have in you, or the interests of clients.

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So no it's very, very severe, very...you--nothing is taken for granted because

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you are the ultimate risk taker.

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(Peston): And you, here manage how much money now?

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(Jabre): Now we have--around $4.2 billion.

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(Speaking off screen, Robert Peston): Using funds from wealthy investors and huge amounts of borrowed cash, colossal fortunes

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have been accumulated by hedge-fund managers.

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In 2006 an estimated 10 of them earned more than $500 million each. And 5 are thought to have

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trousered more than $900 million, in that single year.

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They included George Soros a consistent winner, who famously made a killing when

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he sold the pound on a colossal scale and helped to force sterling out of the european

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exchange rate mechanism in 1992.

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(George Soros): The average person did not get much benefit from the boom.

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The super-boom in the last 20 years. Its really the people like me who have really

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--earned enormous amounts of money.

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(♪Music playing♪)

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The spirit of an age can be captured in it's art. So perhaps this is the symbol of all that debt

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fueled financial excess: Damien Hirst's 'For the Love of God'.

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The glittering death's head, encrusted with 8,601 diamonds is said to have been sold to

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an investment consortium for £50 million. But the details of it's sale are shrouded in

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secrecy, as are so many of the transactions of the new super-rich. What's it's intrinsic value?

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There's quite an argument about that. Who actually owns it? No one seems quite sure.

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In many ways the glitter and the ambiguity seems to capture perfectly the spirit of this age

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of easy money.

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One reason why so much cash was pouring into the pockets of the stars of the new financial

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industries, was the pay structure they devised. They wrote the rules of the greed game

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so they couldn't lose; though it turned out that most of us could.

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The money making skills of private equity and hedge-fund stars, were considered so

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rare and precious, that they were able to charge their backers astonishing fees.

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(Speaking off screen, Hugo Dixon): These new breed of fund managers were performing extremely well for their clients.

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So if you gave them a billion pounds and they turned it into 2 billion pounds, that's a billion pounds profit.

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They'd take 20% of that as the success fee.

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(Peston): The tradition had been to take half a percent a year of the backers money

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for managing it; but private equity and hedge-funds charged much more, a basic fee of 2% a year

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on all funds under management plus 20% of all profits. This was jackpot capitalism.

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So long as that remuneration structure persists its an asymmetric bet, it's a one way bet,

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if he makes a great deal of money and he gets his 20% plus off it. If he loses money then it

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wasn't his. And I think once you've got that and that leads to earnings in some cases literally 100's of millions of dollars,

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in the hands of individuals. They're unlikely to change.

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If you've got a deal that you did for a billion, and sell for a billion and a half, made half

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a billion, you got a 20% carried interest on that, a 100 million, you'd probably have taken

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30 or 40 million of it in fees.

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(Sir Ronald Cohen): The reason private equity charges what are considered to be high levels of

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fees is there are relatively few people in the private equity world. And relatively few new entrants in to that world.

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Its quite a rare combination of skills, and the results, the financial results, that the industry is able to

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deliver to its investors means that the investors are continuing to pay those fees.

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(Speaking off screen, Peston): Not only were the rewards massive, but the bet was one way. Using borrowed money meant taking 20% of the gains

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but leaving all the losses for the original investor; and what began to motivate some

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wasn't pretty.

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(Peston): Do you think greed got the better of some people in that period?

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Well I don't know that it was greed. I think it might have been enthusiasm; and--I think in every cycle,

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it always works the same people who are doing something keep doing more and more of it.

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They lose--a little of their grounding, in terms of the amount of risk that they're taking.

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(Speaking off screen, Peston): Because the rewards on offer from hedge-funds and private equity funds were so huge

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the big banks saw much of their talent defect to them, so the banks too had to offer their more

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financially creative employees, the opportunity to pocket around 20% of the gains.

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Individual bankers now had the opportunity to play the greed game with their organisations money.

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( Speaking off screen): It's particularly awe inspiring when you get back to this central point,that the main things which

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have driven peoples ability to earn that remuneration, not every single case, but the majority

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of cases have been 2 things. A bull market and access to the banks' capital. It's not their own money they're risking.

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(Peston): What's the sort of minimum do you think in the last 2 or 3 years that a fairly mediocre,

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middle ranking, trader or investment banker at one of the bigger houses would have expected to take home?

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You're probably talking about a million dollar bonus, in those circumstances.

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(Peston): And how high does it go?

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--There isn't any limit.

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(Speaking off screen, Peston): And as the greed game intensified other professionals joined in. They were eager to

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facilitate the deals that would reward them rather than ask awkward questions about all that

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debt that was being heaped on the system.

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Everybody else joined in, the investment banks who are selling companies, the accountants

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who were increasingly doing less and less work to make deals happen quicker and easier; the lawyers

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who were finding their ways through difficulties by pretending they weren't there.

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Everybody contributed, it was a big bubble and people made a lot of money out of doing as many deals

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and as big a deal as quickly as they could.

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If you were a Wall Street investment banker making $3 million a year, you were on top of the world you

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were the master of the universe. Suddenly that banker making $3 million is looking at the

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hedge-fund guy, who he used to work with making $3 billion or maybe $1 billion a year.

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So it's created this big class warfare and envy between what I call, the 'haves' and the 'have mores'.

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(Speaking off screen, Peston): Many of the 'have mores' feel a visceral desire to prove their superiority over the mere 'haves'.

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So there's quite an industry catering to their needs for those little extras.

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Meet Charlie, who provides what they want however eccentric.

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(Peston): The people typically use you for stuff they want for themselves? Or as a present?

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(Charlie): Oh it varies, one of the members for his little son, asked for one of the premiership footballers

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to play with his son in his back garden. which..

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(Peston): And you were able to arrange that?

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(Charlie): We were able to arrange that.

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(Peston): A specific premiership footballer?

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(Charlie): Yes (Peston): (Laughing) And you were able to arrange that!

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(Charlie): And we were able to arrange that it was beautiful.

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(Charlie):Are you looking more for brown or black?

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(Peston): There's no price on it, (laughing) which is plainly the sign of a good bag! What do you think that costs?

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(Charlie): About 8 and a half thousand pounds.

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(Peston): I would have thought on my BBC salary that's more than affordable!

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(Charlie): We now have requests for submarines.

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(Peston): No! Really?

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(Charlie): Yes so they have their own submarines made You can speak to someone and

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create your own submarine which is definitely unique and different.

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(Peston):I think I'd find myself getting a little bit claustrophobic in there wouldn't you? (Laughs)

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(Charlie): Definitely. Couldn't sunbathe could you?

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(Charlie): One of our members called last week--asking for a jet fighter, for her garden.

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(Peston): What she just wanted a jet fighter ...just in her garden... (Charlie)--in her garden.

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(Peston):as an ornament? (Charlie): Yes that's what she wanted. (Peston): (laughing) Why?

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(Charlie): I don't know why. We don't ask, we just say: 'of course, Madam'.

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We have to come up with more and more extraordinary experiences, whether it be living with a tribe

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in the Sahara for 6 weeks, to challenge yourself and your mental state,-- through to climbing Everest.

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We have a Valentine's day extreme event, where you can have supper with your wife

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or your husband on an iceberg up in the arctic.

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((David Arnold): To walk onto boats that are...and boats probably isn't a great description of them. Vessels that are larger than

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most homes that I've been into. That are 200 feet long, that can only go into limited ports because

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only so many ports can handle them. But to walk into state rooms, that frankly, you would think you

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were in the palace of Versailles or Buckingham palace or the Whitehouse; is pretty amazing

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and every time I walk onto one of these--boats and have the opportunity to tour them it continues

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to take my breath away.

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With such a boom in full swing by 2006, it looked like nothing could stand int the way of the

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players in the greed game. And yet the very methods they used to make all that money contained

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flaws that would topple them, derail the world's biggest economy and cause mayhem for

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the banks on which we all depend.

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Low interest rates didn't just make it cheap to borrow, they gave little incentive to save.

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And this had significant consequences for the banks which needed to raise money to meet

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the inexhaustible appetite for loans.

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(Alexander Batchvarov):The first thing is that, we had--significant decline in savings rates,

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so the deposits fell. The banks could not necessarily provide all the funding for the products, they--

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got demand for, simply for the products. So they had to loook for other forms of funding

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And one of the forms of funding was to repackage some of the assets they have, sell them onto the market

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get cash for that because they're transferring the assets away, and in this way they have now

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more cash and the can start lending again.

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So in America, Wall street banks started by selling good quality loans to raise money

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and then looked at what else could be sold.

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There was this machine that Wall street created which was really remarkable. And they

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kept on pressing this technology, to the point where they said well prime mortgages work. How

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about we expand this technology to include less credit worthy home buyers.

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(Advertisment clip): With no income verification, no bank statements and no tax returns needed and with this no

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documentation loan, Greenlight Financial Services gives you the choice.

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Individuals, often those with the worst of credit histories were given the opportunity to

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borrow to own that cherished home.

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They were known as Sub-prime borrowers and there were truly frantic attempts to lend to them.

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The ads would be--literally, you know, just released from prison? Never had a job?

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Can't document that you are even a citizen? Please come down we would like to make a mortgage for you.

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In Cleveland, Ohio, the mortgage brokers wouldn't let any opportunity to earn a commission slip away.

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(Eleanor Hall): They came out to my job, it was a snowy day. And I was told if I wanted the house, I had to

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sign then, there on the spot, so I just signed hurriedly. I was looking for a place for my children

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and myself and it was like, either you sign or you don't have a home. So I just signed.

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The mortgage providers which supplied sub-prime loans to the like of Eleanor Hall didn't keep

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those loans on their books. The capital for those loans came from banks on Wall street and after the loans

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had been made, they were sold by the banks at a profit to investors who might be thousands of miles away

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in Europe or Asia.

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The new model says I make the loan I package it up, sell it on to somebody else, it's gone as

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quickly as possible and there is no--ongoing or continuing involvement or relationship or responsibility

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on behalf of the lending bank.

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Every time a mortgage was given, the broker took a commission. Every time those mortgage loans

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were sold on by the banks that extended the credit, the banks booked a profit and because the banks

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sold the risk of that loan going bad to someone else, there was little proper incentive to impose

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proper checks that the borrowers really had the means to repay their debts.

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Sub-prime you go from 4 times income, to 8 times income, you go from checking the incomes

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to not checking the income, from doing proper valuation to using Google Earth and postcodes to value

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houses. Which was done. So everything was driven far too far.

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(Advert): Do you own a house? Are you looking for lower mortgage payments? Yeah who can help me with that?

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Kal can.

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There was a torrent of cash for sub-prime loans thanks to a banking breakthrough called

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structured finance, which turned risky loans into supposedly safe investments.

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This is how it works. Here are 3 risky sub-prime borrowers. And over here are 3 investors who

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buy investments created from their (pointing to sub-prime borrowers) mortgages.

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1 investor loves risk, 1 likes a bit of risk and another hates taking risks and wouldn't normally lend to a sub-prime

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borrower. Now here's the great innovation known as structured finance which persuade the low risk investor

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who controls billions to lend to our sub-prime borrowers. I'm a clever banker, well let's pretend, and I'll mix

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these 3 mortgage loans together and create 3 new investment opportunities.

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So Mr. No risk the pension fund manager, I promise that he'll get first dibs on whatever cash is received

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from these 3 borrowers. And because he's getting first dibs on the cash he thinks the money he's investing or lending is

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as safe as can be; but Mr. Medium risk, the investment banker, I promise he'll get the 2nd bite..

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And the lover of risk who runs a hedge-fund she'll get whatever's left over.

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In the unlikely event all my borrowers pay on time, the 3 investors all do very nicely.

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If 1 borrower gets into difficulties well we sort of assumed that would happen and my investors

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are still pretty happy. But if none of them pay, then they (points to investors)are all facing losses

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and are pretty unhappy, especially Mr. No risk.

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Many hundereds of billions of dollars of low quality sub-prime loans were transformed in this way to

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investments that were labelled as good quality, and they were sold to investors all over the world.

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There was a world wide phenomenon, this risk really was taken out of Boston, out of

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Massachusetts, and really spread, atomized like a fine mist around the world.

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And what was the motivation for selling quite so much debt?

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Basically greed, (laughs) quite frankly. but by repackaging them into these more exotic

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vehicles we could then, yet again, front load the fees. And I can't stress how important it is

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the self interest being moved forward in this process.

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The market was booming, so if you go back to 2006, you'd probably be talking 1.7, 1.8 of trillion

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volume. Not only my bank but many banks, talking about the overall market. That's a significant amount.

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So, everything is positive, bullish there is fire going on. So the overall market gets into a frenzy.

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Most of the world's big banks from Citigroup and Merill Lynch in the U.S, to our own Royal Bank of Scotland

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and Barclays were stampeding to make profits by turning risky sub-prime loans into supposedly

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quality investments.

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A situation where a guy who's organizing bank debt, could take home a bonus of, quite literally,

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40 times his salary,--does bias behaviour. The guys wanted to do deals.

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Everybody has to get on board or they'll be left behind.

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They couldn't refuse to play because if they did they wouldn't have been bankers

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the banks would have lost clients and so on. The markets can't help, they have to go to excesses of

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--euphoria and despair.

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But the quality of the investments was not what the bankers thought it was, because more of the borrowers

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defaulted than they expected.

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(Deputy Sheriff): You guys ready? Lets start this, Lets get this eviction on the road here?

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(Knock on the door) Sheriff's office!

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(Jeff Sikora): When I started working we were getting 12 evictions a week.

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Now we're getting 90.

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(Ben Meder): Just goes to show you--neighbours are you know, going through the same sort

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of problems within weeks of each other literally.

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Sub-prime borrowers had been lured into taking on their mortgages, by special low teaser rates.

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With neither borrower nor lender worrying enough about what would happen when the low rates

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came to an end. And when rates rose, well for many default was inevitable.

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At the end of her introductory offer, Eleanor Hall's monthly payments went up by a painful

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75%. I was under the impression I had a fixed rate of 625 a month. I had no idea that I had a variable

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rate that would escalate every 3 to 6 months. So my mortgage went from $625 a month to $1098 a month.

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You could borrow a 100%--of the debt without any questions asked and with a teaser rate that--really got you sucked

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in. The very word teaser it gives the game away.

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The essence of good banking for millenia, that the lender is suppose to check whether the borrower

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can actually repay, had been lost.

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When I grew up and I looked at banking and, was in banking indeed, what used to happen was you went to see a bank

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manager to borrow money and he lent you the money and made sure that you paid it back,

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or tried to make sure that you pay it back. As soon as you divorce those 2 things you're in trouble.

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In the stampede to do deals, banking common sense had been abandoned. But for years the

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danger was ignored because all those dodgy loans had been converted into investments that

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had a triple A rating which in the past had always meant that they were ultra safe.

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When something is rated in the financial community, Triple A, the assumption of everyone is that

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it just can't go wrong. In all of my years in finance which is now getting pretty close to 40 years--I've never seen a

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Triple A default. Triple A's don't default. Triple A's are like Exxon and Royal Dutch Shell. There

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are very few Triple A's, and--they do not default.

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But just how partial were the agencies that awarded these Triple A ratings?

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After all they were paid by the banks which wanted to sell the investments as Triple A.

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None of us would hide the fact that we are paid by the issuers of the bonds. That does create a potential

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conflict of interest. What we would point out though is that, we have a number of ways

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of managing that conflict to ensure the integrity of the work that we do.

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But when giving the Triple A rating the agencies didn't actually go back to the sub-prime borrowers

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and check that they'd be able to repay their loans.

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We do not do underlying due diligence we do rely on information that is given to us, the investor community

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was aware or should have been aware of that because it is public fact.

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Eventually the simplest and oldest financial logic would reassert itself.

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(Sir Tom Hunter): The thing people forget about borrowing money is, you've got to pay it back. That's the golden rule that I learnt

410
00:38:46,767 --> 00:38:52,572
at my father's apron. And someday the bank's going to come back and say 'Can I have my money back'.

411
00:38:52,572 --> 00:38:59,653
And then you say well it's in this house which isn't quite valued what I paid for it and

412
00:38:59,653 --> 00:39:05,056
therefore I need to sell it and therefore, you know, it all unhinges.

413
00:39:05,056 --> 00:39:11,520
The bankers and rating agencies had been to clever for their own good. They based their Triple A ratings

414
00:39:11,520 --> 00:39:16,680
on historical data, they looked at how many sub-prime loans had gone bad when the market was tiny

415
00:39:16,680 --> 00:39:23,682
and used that information to calculate how many would default as the market grew and grew and gres.

416
00:39:23,682 --> 00:39:27,934
It turned out to be a catastrophic error.

417
00:39:27,934 --> 00:39:36,732
The red light was November 06, a bit more than a year ago, when what you call the first pay default a very important

418
00:39:36,732 --> 00:39:42,020
figure, i.e. people who have borrowed and at the first payment, 6 months after borrowing

419
00:39:42,020 --> 00:39:46,185
are not paying the first interest that's pretty significant.

420
00:39:46,185 --> 00:39:53,416
First pay default historically was 1 and a half percent. 1 to 2 percent. In a matter of a month that figure jumped to

421
00:39:53,416 --> 00:40:02,016
5, 6 percent. That was a clear sign when you have people not paying that you should be worried.

422
00:40:02,016 --> 00:40:09,374
Default rates were bound to rise as sub-prime loans shot up from being 1 in every 13 U.S mortgages

423
00:40:09,374 --> 00:40:18,765
in 2001 to 1 in every 4 by 2006.

424
00:40:18,765 --> 00:40:25,933
(Close up of Final Eviction Notice) I received this notice at the beginning of September. It was plastered to my door

425
00:40:25,933 --> 00:40:29,295
It was bad enough, it brought me down but I had to do everything to keep my children

426
00:40:29,295 --> 00:40:36,493
in control because I really didn't want them to know what was actually being done.

427
00:40:36,493 --> 00:40:42,536
Eleanor Hall like thousands of others can't pay and has been made homeless.

428
00:40:42,536 --> 00:40:49,352
I don't ever see myself owning another home. I just don't see it I don't trust. I'm always looking over my shoulder

429
00:40:49,352 --> 00:40:55,352
People I thought had my best interests, they was only out for a dollar.

430
00:40:55,352 --> 00:41:02,656
Here's what really shocked the bankers: sub-prime loans were going bad faster than any other kind of loan,

431
00:41:02,656 --> 00:41:05,961
in a holy unprecedented way.

432
00:41:05,961 --> 00:41:12,976
In the past decades,it was always the case that the general population would default on everything else

433
00:41:12,976 --> 00:41:18,098
in order to keep their house. Credit cards they default on, loan to buy their fridge they default on--on their

434
00:41:18,098 --> 00:41:23,772
car loans and finally they would default on their mortgage. They're keeping their credit card current and they're

435
00:41:23,772 --> 00:41:28,656
defaulting on their mortgage first. This has never been seen before.

436
00:41:28,656 --> 00:41:35,503
When the scale of losses from some prime- loans could no longer be ignored, the holders of all those

437
00:41:35,503 --> 00:41:43,103
Triple A investments made out of sub-prime loans had a horrible awakening.

438
00:41:43,103 --> 00:41:50,616
(peston): In August 2007, a big french bank BNP Paribas, spaked a global financial panic, when it

439
00:41:50,616 --> 00:41:57,896
announced that it couldn't value it's holdings of investments created from sub-prime loans.

440
00:41:57,896 --> 00:42:01,602
When BNP came out with that, you know this was a moment, they were saying its's time to go home.

441
00:42:01,602 --> 00:42:06,133
Children the party's over now.

442
00:42:06,133 --> 00:42:12,215
(Peston): Banks became reluctant to lend to each other, because they weren't sure which of them were holding

443
00:42:12,215 --> 00:42:17,737
the sub-prime poison, and whether they would ever get their money back. The multi-trillion dollar

444
00:42:17,737 --> 00:42:23,184
money markets that underpinned the global economy seized up.

445
00:42:23,184 --> 00:42:29,292
(Mervyn Davies): The speed at which it happened, the way in which financial institute-institutions just, you know,

446
00:42:29,292 --> 00:42:36,376
withdrew from the market because they were worried; I think that was unprecedented and it surprised politicians

447
00:42:36,376 --> 00:42:41,373
it surprised regulators and it certainly surprised the banks. So once you're in that vicious

448
00:42:41,373 --> 00:42:46,683
circle, lack of confidence a bit of lack of trust, you know, you don't know who's holding the problem,

449
00:42:46,683 --> 00:42:54,297
everybody then, like lemmings runs for cover.

450
00:42:54,297 --> 00:43:00,822
Once people got scared, they started being less happy to lend to each other. They started being less happy to

451
00:43:00,822 --> 00:43:07,296
work with each other and again, that in itself led to--all sorts of other activities specifically

452
00:43:07,296 --> 00:43:11,296
--securities going down in price.

453
00:43:11,296 --> 00:43:13,180
(Peston): Was that fear rational?

454
00:43:13,180 --> 00:43:22,334
Is fear ever rational? I don't know,but...is that fear rational? I'll give you a short answer. Yes.

455
00:43:22,334 --> 00:43:27,536
The fact that people did not know the full exposure to the sub-prime area or the sieve area or whatever

456
00:43:27,536 --> 00:43:32,656
yes of course, if you don't know something being fearful is rational.

457
00:43:32,656 --> 00:43:38,347
(Peston): Once the river of money stopped flowing with banks and financial institutions loathe to lend to each other,

458
00:43:38,347 --> 00:43:41,616
there was a very high profile casualty in Britain.

459
00:43:41,616 --> 00:43:47,599
(BBC News footage): One of Britain's biggest mortgage lenders needs emergency support from the Bank of England.

460
00:43:47,599 --> 00:43:52,773
Northern Rock has problems raising money because of the crisis in the financial markets.

461
00:43:52,773 --> 00:43:57,604
Be absolutely clear there is no suggestion this business is fundamentally bust, but merely running

462
00:43:57,604 --> 00:44:01,683
out of money in this way for a bank is extraordinarily serious.

463
00:44:01,683 --> 00:44:07,847
(Jon Moulton): The company was very successful, because it was taking a tremendous amount of risk.

464
00:44:07,847 --> 00:44:12,681
Northern Rock went the brink of insolvency because it's business was dependent on raising money

465
00:44:12,681 --> 00:44:18,493
selling it's mortgages to international investors. And when investors were burned by losses on

466
00:44:18,493 --> 00:44:25,054
sub-prime, they refused to buy any mortgages, Northern Rock's or anyone elses.

467
00:44:25,054 --> 00:44:33,457
They were actually possessed of enough capital to survive approximately a 1 week shut down in the

468
00:44:33,457 --> 00:44:37,018
capital market. That was all.

469
00:44:37,018 --> 00:44:42,493
(Peston): Banks across the world in Germany, France, Switzerland and the U.S have lost

470
00:44:42,493 --> 00:44:47,854
tens of billions of dollars and have had to been bailed out by governments or by investors with deep

471
00:44:47,854 --> 00:44:50,216
pockets.

472
00:44:50,216 --> 00:44:54,462
(BBC news footage): The Swiss bank UBS says it has suffered much bigger losses than anticipated

473
00:44:54,462 --> 00:44:58,849
because of its exposure to the sub-prime mortgage market in the United States.

474
00:44:58,849 --> 00:45:05,454
Today Barclays said it had written off 1.6 billion pounds of risky investments related to U.S mortgages.

475
00:45:05,454 --> 00:45:11,145
The global credit crisis has deepened with America's 5th largest investment bank asking for emergency funding.

476
00:45:11,145 --> 00:45:15,604
Bear Stearns which has been hit by the U.S. housing market slump, has been bailed out by another

477
00:45:15,604 --> 00:45:23,937
bank and the federal reserve.

478
00:45:23,937 --> 00:45:29,851
(Peston): Some of the bankers responsible for the financial losses are losing their jobs.

479
00:45:29,851 --> 00:45:34,096
(Sir Ronald Cohen):Bonuses of investment bankers are going to fall drastically now that

480
00:45:34,096 --> 00:45:40,432
you're discovering a lot of the banks, investment banks are taking billions of dollars worth of write offs.

481
00:45:40,432 --> 00:45:46,520
And these people are getting kicked out unceremoniously, out of their jobs.

482
00:45:46,520 --> 00:45:50,765
(Peston): As for those companies bought by private equity, well if they took on too much debt

483
00:45:50,765 --> 00:45:58,182
they'll experience difficulties, which would be bad news for their investors and employees.

484
00:45:58,182 --> 00:46:06,681
There are some clear examples of loans which are looking dreadful now, Fat Face the retailer,

485
00:46:06,681 --> 00:46:12,268
Countrywide the estate agent. The loans on those companies are being dealt with regularly now,

486
00:46:12,268 --> 00:46:18,294
at discounts of a quarter or more to their face value. So clearly there are some bad loans out there.

487
00:46:18,294 --> 00:46:28,334
(Peston): But many of the super-rich who helped create this unsustainable boom are sitting pretty.

488
00:46:28,334 --> 00:46:33,981
There are a lot of people who have made enormous amounts of money, created great mayhem and I'm afraid

489
00:46:33,981 --> 00:46:41,576
they're not going get hurt greatly by what's happening now. There is I understand at the moment quite a

490
00:46:41,576 --> 00:46:50,582
shortage of high-end hotel rooms in the Caribbean-- Mauritius and similar places,

491
00:46:50,582 --> 00:46:56,015
because these people have nothing to do at the moment and lots of money.

492
00:46:56,015 --> 00:47:05,100
(Peston): Having trousered so much the super-rich apparently have a problem many of us would love.

493
00:47:05,100 --> 00:47:10,936
(Aaron Simpson): Very top-end people are very liquid, have made a lot of money in the last 10 years,

494
00:47:10,936 --> 00:47:14,456
in fact would probably find it quite difficult to spend the money they have earned.

495
00:47:14,456 --> 00:47:22,616
And that's why companies like us are quite successful, because we help them spend their money.

496
00:47:22,616 --> 00:47:38,659
(David Arnold) :Frankly for companies that are producing such limited quantities of these very exclusive products

497
00:47:38,659 --> 00:47:45,596
they can't manufacture them quickly enough. There's a new Rolls Royce the drop head coupé that was launched last year.

498
00:47:45,596 --> 00:47:50,979
If you were to walk into your Rolls Royce dealer today, if you were lucky you would maybe get one in 2 years.

499
00:47:50,979 --> 00:47:57,270
They continue to indulge in their passions and I don't see that changing anytime soon.

500
00:47:57,270 --> 00:48:01,013
(Peston): And demand for the most expensive motoring experience on earth doesn't seem

501
00:48:01,013 --> 00:48:16,136
to have evaporated.

502
00:48:16,136 --> 00:48:23,892
(Julius Kruta): The car is not only the most expensive and fastest car on the planet, but it's also one of the most

503
00:48:23,892 --> 00:48:43,097
usable cars. The customer who pays 1.1 million Euros plus tax gets a car which is really second to none.

504
00:48:43,097 --> 00:48:48,812
The british have been the best European market and they still are the best European market,

505
00:48:48,812 --> 00:48:55,774
they are only second to the U.S. our best dealership in the world, our single dealership in the world,

506
00:48:55,774 --> 00:49:01,218
is Jack Barclay in London.

507
00:49:01,218 --> 00:49:08,494
(Peston): So for the super-lux. industry price cutting isn't on the agenda.

508
00:49:08,494 --> 00:49:19,574
The $1 million watch can not be affected by no crisis. That's the extreme. The extreme is safe.

509
00:49:19,574 --> 00:49:28,573
At the 1 billion-- There will always, always, always be demand for $1 billion watch.

510
00:49:28,573 --> 00:49:36,608
That is for sure and if you want to build a new watch and you want to go safe start with

511
00:49:36,608 --> 00:49:51,771
1 million. (laughs) Start with 1 million then you are safe.

512
00:49:51,771 --> 00:49:56,017
(Peston): The reason the super-rich can feel safe is that the gambles they've taken with other

513
00:49:56,017 --> 00:50:03,133
peoples money have been so huge that the authorities have to bail them out, or else the damage to

514
00:50:03,133 --> 00:50:06,522
the rest of us could be cripping.

515
00:50:06,522 --> 00:50:11,576
(Hugo Dixon): These people who operate in the financial markets they're smart, they know that they are too big

516
00:50:11,576 --> 00:50:19,525
to fail, they know that the authorities will rise to their rescue. So everywhere along the line

517
00:50:19,525 --> 00:50:29,822
there are one way bets; and this means that you are incentivised to take big risks, you're greedy

518
00:50:29,822 --> 00:50:37,272
the bigger the risk you take, the bigger the profit for yourself and if things go badly, oops! not our problem,

519
00:50:37,272 --> 00:50:40,852
your problem. You pick up the mess.

520
00:50:40,852 --> 00:50:49,940
(Peston): It's a mess they've landed all of us in. The losses incurred by banks, hedge-funds, insures and other financial

521
00:50:49,940 --> 00:50:57,136
businesses which could reach $3 trillion have reduced their willingness to lend to any of us; and badly

522
00:50:57,136 --> 00:51:04,434
damaged the global financial system. It's as though the mechanism for injecting fuel into the economy

523
00:51:04,434 --> 00:51:10,456
has broken down. And when that happens we all suffer.

524
00:51:10,456 --> 00:51:16,218
(Terry Smith): I think it's a mistake for people to think these events don't apply to them. You know that they don't earn any

525
00:51:16,218 --> 00:51:19,602
sub-prime mortgages or collateralized debt obligations, or even equities, so what does it matter to them.

526
00:51:19,602 --> 00:51:26,344
It affects us all The credit creation process is at the heart of everything in our economy

527
00:51:26,344 --> 00:51:33,740
and without that you can not get normal functioning. I think the damage that's been done to that is vast and it's

528
00:51:33,740 --> 00:51:42,002
persistent. So when you talk about the average home owner --and worker and its impact on them

529
00:51:42,002 --> 00:51:46,903
they probably will find that there mortgage costs more. Whatever the absolute level of interest rates,

530
00:51:46,903 --> 00:51:51,253
if they are unlucky, they may find their job is affected by this as well. I think there are some very

531
00:51:51,253 --> 00:51:54,747
real world effects on peoples abilty to borrow.

532
00:51:54,747 --> 00:52:00,523
Our banks have less money to lend to us and they're charging more for what they will lend.

533
00:52:00,523 --> 00:52:08,683
That's leading to falls in house and property prices, which makes us feel poorer. And it risks creating a vicious

534
00:52:08,683 --> 00:52:14,608
downward spiral as we spend less and the economy slows down.

535
00:52:14,608 --> 00:52:24,132
(peston): Just to translate that into what it means for ordinary people. If people are borrowing less, saving more,

536
00:52:24,132 --> 00:52:30,134
that will translate into slow growth. Does it translate into a serious recession in your view?

537
00:52:30,134 --> 00:52:38,356
I don't expect a worldwide -- recession. I do expect a recession in the United States

538
00:52:38,356 --> 00:52:43,518
the severity of which can not be predicted.

539
00:52:43,518 --> 00:52:49,023
(Peston): As a result of recent budget changes, the British tax system may no longer

540
00:52:49,023 --> 00:52:54,320
be quite so favourable to the new super-rich as it was.

541
00:52:54,320 --> 00:53:01,144
But what about the widening income and wealth gap between the super-rich and the rest of us?

542
00:53:01,144 --> 00:53:08,413
Some of the way that wealth is accumulated. If wealth is accumulated out of people growing

543
00:53:08,413 --> 00:53:12,359
successfully it's generally good it's hard to come up with a real negative on that.

544
00:53:12,359 --> 00:53:18,690
If on the other hand it's some guy who's made all of his money out of making 2 or 3 huge financial bets

545
00:53:18,690 --> 00:53:25,382
then the social implications are much wider, because those bets will go wrong as well as right; and when

546
00:53:25,382 --> 00:53:31,026
they go wrong there will be a lot of victims other than the guy. So ther's a social and political issue there.

547
00:53:31,026 --> 00:53:40,456
So the guy who's made a 100 million out of being the promoter of overloaded structures. That's a political

548
00:53:40,456 --> 00:53:43,892
issue he's caused a lot of damage and he's got very rich.

549
00:53:43,892 --> 00:53:52,372
I think it--an economy which is characterized by extremes of wealth is not a secure and safe economy

550
00:53:52,372 --> 00:54:01,101
any more than one economy versus another economy. Extremes of wealth and income, give rise

551
00:54:01,101 --> 00:54:05,253
I think to very serious moral risks.

552
00:54:05,253 --> 00:54:09,904
(Peston): That might not matter if we could be confident that lessons are being learned from the

553
00:54:09,904 --> 00:54:16,889
crisis. But what we see is that America's central bank the federal reserve is once again slashing interest

554
00:54:16,889 --> 00:54:23,377
rates and pumping cash into the system! Now didn't that start the whole poisonous process?

555
00:54:23,377 --> 00:54:34,277
You have a boom bust process similar to many that we have had in the last --decades, but it's also the end

556
00:54:34,277 --> 00:54:41,014
of a super-boom that has lasted since the end of the 2nd World War.

557
00:54:41,014 --> 00:54:46,103
From time to time, markets don't correct themselves we have a crisis and then the authorities

558
00:54:46,103 --> 00:54:54,746
have to intervene and inject liquidity and bail out the failing institutions and that creates

559
00:54:54,746 --> 00:55:07,216
a system of asymmetric incentives, where you are encouraged to leverage, but if things

560
00:55:07,216 --> 00:55:13,142
really go wrong, there is relief.

561
00:55:13,142 --> 00:55:18,972
If those in charge of the system can't be relied upon to change their ways what chance that

562
00:55:18,972 --> 00:55:22,216
those who play the greed game might actually mend their's?

563
00:55:22,216 --> 00:55:27,776
They've been incentivized to take dangerous risks with other peoples money in the hunt for big profits

564
00:55:27,776 --> 00:55:32,133
and vast rewards. Have those incentives been eliminated?

565
00:55:32,133 --> 00:55:40,732
No not really. I think that --if you set up a basic remuneration structure where people get paid 20% of the

566
00:55:40,732 --> 00:55:45,860
gains from playing with other peoples money. I'm not sure what possible event could occur to make them

567
00:55:45,860 --> 00:55:49,692
learn anything from it. You really just need to change the structure that's the only thing

568
00:55:49,692 --> 00:55:51,296
that will get their attention.

569
00:55:51,296 --> 00:55:52,852
(Peston): And who's going to change that structure?

570
00:55:52,852 --> 00:55:58,108
There's only really one group of people who ever can change any structure like that and that's the owners.

571
00:55:58,108 --> 00:56:03,653
This is matter so long as people are willing to be shareholders in banks where traders are

572
00:56:03,653 --> 00:56:09,360
allowed to play with the banks capital and walk off with 20 or 30% of the gains on it and none of the losses,

573
00:56:09,360 --> 00:56:13,443
and where people are willing to invest in private equity and hedge-funds and allow the same thing to occur

574
00:56:13,443 --> 00:56:17,222
it will occur.

575
00:56:17,222 --> 00:56:22,374
(Peston): If you're a hedge-fund, or a private equity firm there are fantastic opportunities to profit from

576
00:56:22,374 --> 00:56:28,858
the turmoil. A number of hedge-funds have already made billions from betting that all those

577
00:56:28,858 --> 00:56:34,768
sub-prime investments were over-valued, and some have done very nicely from speculating

578
00:56:34,768 --> 00:56:39,053
that the share prices of our leading banks would tumble.

579
00:56:39,053 --> 00:56:44,743
As for private equity well a recession would be just the most glorious time to buy businesses

580
00:56:44,743 --> 00:56:48,612
at knockdown prices.

581
00:56:48,612 --> 00:56:51,816
(Peston): Is this actually a period of tremendous opportunity for a firm like yours?

582
00:56:51,816 --> 00:56:59,687
Yes its-- its going to be a great opportunity. The real golden age comes when you have a mess. You have economies

583
00:56:59,687 --> 00:57:11,210
that are on their back, you know, capital --inadequate and when you start buying businesses at that part of the cycle

584
00:57:11,210 --> 00:57:19,336
you inevitably do extremely well unless you're too early and right now it's a little bit too early--

585
00:57:19,336 --> 00:57:29,893
but as you wait and it develops this will be a great time, to be buying businesses.

586
00:57:29,893 --> 00:57:36,189
(Peston): So there are still plenty of opportunities for the new super-rich to increase their fortunes.

587
00:57:36,189 --> 00:57:43,742
Even though the global financial system is in intensive care and our prosperity is threatened.

588
00:57:43,742 --> 00:57:49,652
With the greed game still being played, if we're not going to end up the losers again, the rules will

589
00:57:49,652 --> 00:57:52,655
need to be rewritten.

590
00:57:52,655 --> 99:59:59,999
(♪Music playing♪)