(♪ Music playing throughout ♪)
Fortunes are being accumulated in the U.K. on a scale we haven't seen for a hundred years!
We've been told, that the wave of super-rich, create wealth that makes all of us, well, a bit better off.
But does it?
This time around they've used new and different financial techniques to enrich themselves.
And right now, they're the big winners.
And we seem to be the losers.
I'm going to tell you, how the new super-rich are making their fortunes
and why we're picking up the bill, in a global greed game.
In the past few years, the City of London financial services, have contributed a third of all our economic growth.
London is the capital, of capital.
(Speaking Off Screen, Sir Richard Branson): London, for the international community, is a beautiful city,
a lot of people are living in London that they might find interesting to meet.
It's got the restaurants, it's got the clubs, it's got the bars.
It's got the decent hotels, it's got the nice houses; it's safe, it's secure.
There's a lot going for it.
(Speaking off screen, Robert Peston): More than fifty billionaires call Britain home.
Not since the 19th century have there been, such opportunities for so many to make quite so much money.
At least 30,000 Brits now earn more than half a million pounds a year.
In 2006 4,200 city executives took a bonus of a million or more.
And among hedge-funds alone 150 people have been earning more than 20 million pounds a year.
(Speaking off screen, Dr Philip Beresford): The only other period we have seen similar accumulation
was during the industrial revolution in the Victorian age,
when the whole raft of Victorian industrialists made massive fortunes, very quickly.
But even that was over a period of forty or fifty years.
This has been in the last 10 years.
When you're coming here with several billion pounds, you travel around in armoured limos
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.
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.
(Speaking off screen, Robert Peston): And they've created ghettos of fabulously expensive property.
This house in North London, recently sold for 50 million pounds.
(Speaking off screen, Trevor Abrahamsohn): The new owner will be spending, probably, another-- up to thirty million pounds
creating what will probably be the most desirable house
in the world.
(Speaking off screen, Robert Peston): And just outside London is this brand new 26 bedroom mansion.
It's on the market now for over 70 million pounds,
but it's the running costs of over a million a year
that means that only proper billionaires need bother to view it.
Even so, the developer, Leslie Alan Berker, tried his best with me.
(Peston): So this is the private swimming pool. Is it simply for the owner of the house? (Laughs)
(Berker): Unless, of course, the owner of the house wants to allow people to use it.
The en-suite swimming pool.
(Peston): Why would you want 5 pools?
Because you've got 5 pools (Laughing) in this house.
What family needs 5 pools?
(Berker): You genuinely need to like swimming.
This bathroom area is about 800 square feet.
Putting it into perspective, it's about the size of the average 2-bedroom flat in London.
(Peston): That's just for your towels, that room is it!?
I feel rather disappointed that I haven't got one of those.
It's the size of a decent sized kitchen for me.
Jewel-encrusted gold taps (laughing)...very good, very nice!
I think I'm going to have to have one of these in my home.
So how have all of these people become super-rich in such a short time?
Unlike the past, it's not been about finding new resources or exploiting new technology.
The answer lies in how they conjured with money itself.
(Speaking off screen, Robert Peston): And they were helped to become wealthy beyond anyone's wildest dreams,
by a sharp fall in the cost of money,
for them and all of us, engineered by the US Federal Reserve.
It sets interest rates for America and, in a way, for the world.
A clear September day. The American economy was already faltering after the
bursting of the dot com bubble and then...
the world's most powerful central banker, Alan Greenspan, feared that terrorist
outrage would further undermine the confidence of businesses and consumers so he
kept interest rates unusually low.
(BBC News Footage): American interest rates were, tonight, cut by a half of one per cent.
The Federal Reserve base rate now stands at just 1 and a quarter per cent, the lowest for 41 years.
(Speaking off screen, Robert Peston): After the bursting of the dot come bubble and 9/11,
Greenspan slashed rates to just 1%,
and the supply of credit soared
because the great exporting nations such as Japan, China and those in the Middle East
were generating vast surpluses and lent much of their cash to us, in the West.
Finance is global so it became cheap to borrow money anywhere,
for private individuals and especially for businesses, tycoons and financial institutions.
They went on the most frenetic borrowing spree,
the world has seen. With so much money sloshing around,
the price of assets, from paintings to houses to entire companies, soared.
(Auctioneer) : £65,000. (Sound of Gavel) Sold!
(Paul Myners): People borrowed more against the inflated value of their assets.
The valuation of property, the valuation of shares, art, jewelry etc. was soaring;
and the central banks on the whole said "This is not our business."
"We don't manage assets, we only manage price inflation".
(Speaking off screen Robert Peston): With markets rising, borrowing vast sums for investment, was the root
to magnificent fortunes.
It's what bankers call using leverage.
(Alexander Batchvarov): Leverage is simply borrowing to invest.
You're not investing your own money,--or you are investing part of your own money,
but you borrow to invest more.--So that's simply--leverage is borrowing to invest.
When we borrow for a mortgage we're leveraging. As simple as that.
(Robert Peston): The power of leverage to multiply profits is a common experience
for millions of us, who borrow to buy a house. If you put down a £10,000 deposit,
when buying a £100,000 home, and borrow the other £90,000 and that house
then rises in value to say, £110,000. Well your £10,000 doubles to £20,000.
You make 100% profit. That's the magic of using the banks money to finance most of the purchase,
and in a rising market, the more you borrow, the greater your profits.
(Jon Moulton): The level of debt that became available for deals, became very, very high. And what
was really uncomfortable was that not only was it a high level of debt, but every
passing month you could get more and more debt.
(Speaking off screen, Robert Peston): With debt so cheap, deal-makers were borrowing mind-boggling amounts.
To invest in financial markets, in property and in commodities, or to buy entire companies.
(Sir Tom Hunter): Banks were willing to lend in multiples that they'd never known before.
The past 5,6 years have been unprecedented in terms of cheap debt, quite frankly,
and have we --benefited from that? Absolutely, you know I would rather be lucky than clever
everytime.--So we'll take every bit of luck that's going our way.
(Speaking off screen, Robert Peston): And for Tom Hunter, Britain was a pretty good place to be,
because since 1997, Labour has tried to make the United Kingdom a land
fit for the new super-rich.
(Sir Steve Robson): Well I think first of all you've got to thank your lucky stars
if you are an economy which has the vibrant and successful industries, to a disproportionate degree;
because, you know, that is generating wealth that you can do something with.
So it's better to have the wealth generated that you can do something with,
than not have the wealth generated at all.
(Speaking off screen, Robert Peston): There was a time however, when our Prime Minister was explicitly hostile to the
idea that tax rules should favour the super-rich.
(Speaking off screen, Gordon Brown): The Labour chancellor and the Labour treasury will not permit tax reliefs to millionaires
in off-shore havens. We will end the situation where millionaires can pay no tax.
(Speaking off screen, Robert Peston): But in Government, Gordon Brown changed his mind. Labour feared that the
super-rich would flee Britain if they had to pay the same rate of tax as the rest of us.
And if enabling them to stay, meant a widening of the gap between the super-rich and
the rest of us, well Gordon Brown believed that was a price worth paying,
for the benefits that might accrue.
(Sir Tom Hunter): We want the best people in the world, to come here because the spin-off and the clusters and the
multiplier effect of, them building businesses within our country is phenomenal.
And why not have the best in the world right here.
(Jon Moulton): We've had the extreme case, there are --people in my industry who have literally lived in the country
more than 40 years and claimed to be non-domiciled and pay very little tax.
And that seems to me both politically and--indeed, some danger of the word morally,
fairly repugnant.
(Speaking off screen, Robert Peston):Even some of the super-rich began to question whether it's fair that
they should be taxed at lower rates than their servants.
(Jim Chanos): There's lots of things about my industry, I don't like quite frankly; but I think that broadly speaking,
and I'm speaking personally now, not for my industry. The concept that hedge-fund managers
pay a lower -- tax rate on earned income than, you know, -- maids that clean their office;
I think is just palpably absurd.
(Peston): By the start of the 21st Century, these two factors: the power of leverage and low taxes
for enterprise, gave birth to a new set of business super-powers. Among them are the
private equity firms who borrow huge sums of money to buy whole companies.
( Speaking off screen, Sir Steve Robson): Private equity has demonstrated that if you go into--situations--in the company sector
with clarity of purpose--strong drive, determination a willingness to pay people
incentives to do the difficult things. You can make big returns and again you make big returns
particularly when there's lots of cheap money around the place. And the fact that
their success was over-amplified and magnified by the--macro-economic environment
they were operating in which--made them very lucky--and I suspect made some of the
rest of us rather jealous.
(Speaking off screen, Robert Peston): Some of Britain's best known businesses have been taken over and sold on by private equity,
for billions in profits. They include the AA, Saga, Homebase and Travelodge.
The technique used by private equity of buying companies with borrowed money, is also
employed by Philip Green. He owns much of the British high street.
(Philip Green): I think we probably own about 12. Dorothy Perkins, Top Shop, Burton, Wallis, Top Man, BHS.
(Green, pointing) That's a nice piece of Real Estate isn't it?
We actually own that. It's probably worth in excess of 200 million.
(Speaking off screen, Robert Peston): Sir Philip and his family pocketed a 1.2 billion dividend in 2005, the equivalent
of the bay of 54,000 british workers on average earnings. And there was no tax to pay on it here, because
it was received by his tax exile wife Lady Green.
(Paul Myners): We'd had an extraordinary period of economic growth, and confidence this--is the critical factor
-- confidence was very high. The masters of the universe seemed to be getting it right,
they had been producing extraordinary high profits, great returns from their private equity funds.
(Peston): It hasn't just been private equity making billions out of borrowed money.
Hedge-funds have become the largest dealers in shares and securities across the globe.
They make their money by betting on price variations however small, between what they
can buy and how much they can sell for. And they too use borrowed money and leverage to
generate spectacular profits.
( Speaking off screen, Michael Hintze): Private equity will take control of a company.
Hedge-funds will trade a company. It's a very different--they'll trade the shares of a company.
So it's a--it is a very different beast.
(Peston): And how much do you have under management at the moment?
(Hintze): We've got about $10 billion.
(Terry Smith): Hedge-funds are enormously powerful, now in the financial system.
There's a lot of them--they manage a great deal of money, they're not regulated.
by and large, they're usually in off-shore jurisdictions where they are not regulated
I would say that the top 3 trading institutions in the US treasury market, which is the largest
securities market in the world, are in fact hedge-funds, they're not banks.
The only serious risk for a hedge-fund is that if it consistently loses money
the backers will take their funds back.
(Phillippe Jabre) You can lose money...you're allowed to make a mistake once.
But if it's a bad one you--you're gone. I mean, it's a very fragile. I mean you're--
there is high return in that industry yes, but you could also very quickly lose the appetite
for risk that clients have in you, or the interests of clients.
So no it's very, very severe, very...you--nothing is taken for granted because
you are the ultimate risk taker.
(Peston): And you, here manage how much money now?
(Jabre): Now we have--around $4.2 billion.
(Speaking off screen, Robert Peston): Using funds from wealthy investors and huge amounts of borrowed cash, colossal fortunes
have been accumulated by hedge-fund managers.
In 2006 an estimated 10 of them earned more than $500 million each. And 5 are thought to have
trousered more than $900 million, in that single year.
They included George Soros a consistent winner, who famously made a killing when
he sold the pound on a colossal scale and helped to force sterling out of the european
exchange rate mechanism in 1992.
(George Soros): The average person did not get much benefit from the boom.
The super-boom in the last 20 years. Its really the people like me who have really
--earned enormous amounts of money.
(♪Music playing♪)
The spirit of an age can be captured in it's art. So perhaps this is the symbol of all that debt
fueled financial excess: Damien Hirst's 'For the Love of God'.
The glittering death's head, encrusted with 8,601 diamonds is said to have been sold to
an investment consortium for £50 million. But the details of it's sale are shrouded in
secrecy, as are so many of the transactions of the new super-rich. What's it's intrinsic value?
There's quite an argument about that. Who actually owns it? No one seems quite sure.
In many ways the glitter and the ambiguity seems to capture perfectly the spirit of this age
of easy money.
One reason why so much cash was pouring into the pockets of the stars of the new financial
industries, was the pay structure they devised. They wrote the rules of the greed game
so they couldn't lose; though it turned out that most of us could.
The money making skills of private equity and hedge-fund stars, were considered so
rare and precious, that they were able to charge their backers astonishing fees.
(Speaking off screen, Hugo Dixon): These new breed of fund managers were performing extremely well for their clients.
So if you gave them a billion pounds and they turned it into 2 billion pounds, that's a billion pounds profit.
They'd take 20% of that as the success fee.
(Peston): The tradition had been to take half a percent a year of the backers money
for managing it; but private equity and hedge-funds charged much more, a basic fee of 2% a year
on all funds under management plus 20% of all profits. This was jackpot capitalism.
So long as that remuneration structure persists its an asymmetric bet, it's a one way bet,
if he makes a great deal of money and he gets his 20% plus off it. If he loses money then it
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,
in the hands of individuals. They're unlikely to change.
If you've got a deal that you did for a billion, and sell for a billion and a half, made half
a billion, you got a 20% carried interest on that, a 100 million, you'd probably have taken
30 or 40 million of it in fees.
(Sir Ronald Cohen): The reason private equity charges what are considered to be high levels of
fees is there are relatively few people in the private equity world. And relatively few new entrants in to that world.
Its quite a rare combination of skills, and the results, the financial results, that the industry is able to
deliver to its investors means that the investors are continuing to pay those fees.
(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
but leaving all the losses for the original investor; and what began to motivate some
wasn't pretty.
(Peston): Do you think greed got the better of some people in that period?
Well I don't know that it was greed. I think it might have been enthusiasm; and--I think in every cycle,
it always works the same people who are doing something keep doing more and more of it.
They lose--a little of their grounding, in terms of the amount of risk that they're taking.
(Speaking off screen, Peston): Because the rewards on offer from hedge-funds and private equity funds were so huge
the big banks saw much of their talent defect to them, so the banks too had to offer their more
financially creative employees, the opportunity to pocket around 20% of the gains.
Individual bankers now had the opportunity to play the greed game with their organisations money.
( Speaking off screen): It's particularly awe inspiring when you get back to this central point,that the main things which
have driven peoples ability to earn that remuneration, not every single case, but the majority
of cases have been 2 things. A bull market and access to the banks' capital. It's not their own money they're risking.
(Peston): What's the sort of minimum do you think in the last 2 or 3 years that a fairly mediocre,
middle ranking, trader or investment banker at one of the bigger houses would have expected to take home?
You're probably talking about a million dollar bonus, in those circumstances.
(Peston): And how high does it go?
--There isn't any limit.
(Speaking off screen, Peston): And as the greed game intensified other professionals joined in. They were eager to
facilitate the deals that would reward them rather than ask awkward questions about all that
debt that was being heaped on the system.
Everybody else joined in, the investment banks who are selling companies, the accountants
who were increasingly doing less and less work to make deals happen quicker and easier; the lawyers
who were finding their ways through difficulties by pretending they weren't there.
Everybody contributed, it was a big bubble and people made a lot of money out of doing as many deals
and as big a deal as quickly as they could.
If you were a Wall Street investment banker making $3 million a year, you were on top of the world you
were the master of the universe. Suddenly that banker making $3 million is looking at the
hedge-fund guy, who he used to work with making $3 billion or maybe $1 billion a year.
So it's created this big class warfare and envy between what I call, the 'haves' and the 'have mores'.
(Speaking off screen, Peston): Many of the 'have mores' feel a visceral desire to prove their superiority over the mere 'haves'.
So there's quite an industry catering to their needs for those little extras.
Meet Charlie, who provides what they want however eccentric.
(Peston): The people typically use you for stuff they want for themselves? Or as a present?
(Charlie): Oh it varies, one of the members for his little son, asked for one of the premiership footballers
to play with his son in his back garden. which..
(Peston): And you were able to arrange that?
(Charlie): We were able to arrange that.
(Peston): A specific premiership footballer?
(Charlie): Yes (Peston): (Laughing) And you were able to arrange that!
(Charlie): And we were able to arrange that it was beautiful.
(Charlie):Are you looking more for brown or black?
(Peston): There's no price on it, (laughing) which is plainly the sign of a good bag! What do you think that costs?
(Charlie): About 8 and a half thousand pounds.
(Peston): I would have thought on my BBC salary that's more than affordable!
(Charlie): We now have requests for submarines.
(Peston): No! Really?
(Charlie): Yes so they have their own submarines made You can speak to someone and
create your own submarine which is definitely unique and different.
(Peston):I think I'd find myself getting a little bit claustrophobic in there wouldn't you? (Laughs)
(Charlie): Definitely. Couldn't sunbathe could you?
(Charlie): One of our members called last week--asking for a jet fighter, for her garden.
(Peston): What she just wanted a jet fighter ...just in her garden... (Charlie)--in her garden.
(Peston):as an ornament? (Charlie): Yes that's what she wanted. (Peston): (laughing) Why?
(Charlie): I don't know why. We don't ask, we just say: 'of course, Madam'.
We have to come up with more and more extraordinary experiences, whether it be living with a tribe
in the Sahara for 6 weeks, to challenge yourself and your mental state,-- through to climbing Everest.
We have a Valentine's day extreme event, where you can have supper with your wife
or your husband on an iceberg up in the arctic.
((David Arnold): To walk onto boats that are...and boats probably isn't a great description of them. Vessels that are larger than
most homes that I've been into. That are 200 feet long, that can only go into limited ports because
only so many ports can handle them. But to walk into state rooms, that frankly, you would think you
were in the palace of Versailles or Buckingham palace or the Whitehouse; is pretty amazing
and every time I walk onto one of these--boats and have the opportunity to tour them it continues
to take my breath away.
With such a boom in full swing by 2006, it looked like nothing could stand int the way of the
players in the greed game. And yet the very methods they used to make all that money contained
flaws that would topple them, derail the world's biggest economy and cause mayhem for
the banks on which we all depend.
Low interest rates didn't just make it cheap to borrow, they gave little incentive to save.
And this had significant consequences for the banks which needed to raise money to meet
the inexhaustible appetite for loans.
(Alexander Batchvarov):The first thing is that, we had--significant decline in savings rates,
so the deposits fell. The banks could not necessarily provide all the funding for the products, they--
got demand for, simply for the products. So they had to loook for other forms of funding
And one of the forms of funding was to repackage some of the assets they have, sell them onto the market
get cash for that because they're transferring the assets away, and in this way they have now
more cash and the can start lending again.
So in America, Wall street banks started by selling good quality loans to raise money
and then looked at what else could be sold.
There was this machine that Wall street created which was really remarkable. And they
kept on pressing this technology, to the point where they said well prime mortgages work. How
about we expand this technology to include less credit worthy home buyers.
(Advertisment clip): With no income verification, no bank statements and no tax returns needed and with this no
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Individuals, often those with the worst of credit histories were given the opportunity to
borrow to own that cherished home.
They were known as Sub-prime borrowers and there were truly frantic attempts to lend to them.
The ads would be--literally, you know, just released from prison? Never had a job?
Can't document that you are even a citizen? Please come down we would like to make a mortgage for you.
In Cleveland, Ohio, the mortgage brokers wouldn't let any opportunity to earn a commission slip away.
(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
sign then, there on the spot, so I just signed hurriedly. I was looking for a place for my children
and myself and it was like, either you sign or you don't have a home. So I just signed.
The mortgage providers which supplied sub-prime loans to the like of Eleanor Hall didn't keep
those loans on their books. The capital for those loans came from banks on Wall street and after the loans
had been made, they were sold by the banks at a profit to investors who might be thousands of miles away
in Europe or Asia.
The new model says I make the loan I package it up, sell it on to somebody else, it's gone as
quickly as possible and there is no--ongoing or continuing involvement or relationship or responsibility
on behalf of the lending bank.
Every time a mortgage was given, the broker took a commission. Every time those mortgage loans
were sold on by the banks that extended the credit, the banks booked a profit and because the banks
sold the risk of that loan going bad to someone else, there was little proper incentive to impose
proper checks that the borrowers really had the means to repay their debts.
Sub-prime you go from 4 times income, to 8 times income, you go from checking the incomes
to not checking the income, from doing proper valuation to using Google Earth and postcodes to value
houses. Which was done. So everything was driven far too far.
(Advert): Do you own a house? Are you looking for lower mortgage payments? Yeah who can help me with that?
Kal can.
There was a torrent of cash for sub-prime loans thanks to a banking breakthrough called
structured finance, which turned risky loans into supposedly safe investments.
This is how it works. Here are 3 risky sub-prime borrowers. And over here are 3 investors who
buy investments created from their (pointing to sub-prime borrowers) mortgages.
1 investor loves risk, 1 likes a bit of risk and another hates taking risks and wouldn't normally lend to a sub-prime
borrower. Now here's the great innovation known as structured finance which persuade the low risk investor
who controls billions to lend to our sub-prime borrowers. I'm a clever banker, well let's pretend, and I'll mix
these 3 mortgage loans together and create 3 new investment opportunities.
So Mr. No risk the pension fund manager, I promise that he'll get first dibs on whatever cash is received
from these 3 borrowers. And because he's getting first dibs on the cash he thinks the money he's investing or lending is
as safe as can be; but Mr. Medium risk, the investment banker, I promise he'll get the 2nd bite..
And the lover of risk who runs a hedge-fund she'll get whatever's left over.
In the unlikely event all my borrowers pay on time, the 3 investors all do very nicely.
If 1 borrower gets into difficulties well we sort of assumed that would happen and my investors
are still pretty happy. But if none of them pay, then they (points to investors)are all facing losses
and are pretty unhappy, especially Mr. No risk.
Many hundereds of billions of dollars of low quality sub-prime loans were transformed in this way to
investments that were labelled as good quality, and they were sold to investors all over the world.
There was a world wide phenomenon, this risk really was taken out of Boston, out of
Massachusetts, and really spread, atomized like a fine mist around the world.
And what was the motivation for selling quite so much debt?
Basically greed, (laughs) quite frankly. but by repackaging them into these more exotic
vehicles we could then, yet again, front load the fees. And I can't stress how important it is
the self interest being moved forward in this process.
The market was booming, so if you go back to 2006, you'd probably be talking 1.7, 1.8 of trillion
volume. Not only my bank but many banks, talking about the overall market. That's a significant amount.
So, everything is positive, bullish there is fire going on. So the overall market gets into a frenzy.
Most of the world's big banks from Citigroup and Merill Lynch in the U.S, to our own Royal Bank of Scotland
and Barclays were stampeding to make profits by turning risky sub-prime loans into supposedly
quality investments.
A situation where a guy who's organizing bank debt, could take home a bonus of, quite literally,
40 times his salary,--does bias behaviour. The guys wanted to do deals.
Everybody has to get on board or they'll be left behind.
They couldn't refuse to play because if they did they wouldn't have been bankers
the banks would have lost clients and so on. The markets can't help, they have to go to excesses of
--euphoria and despair.
But the quality of the investments was not what the bankers thought it was, because more of the borrowers
defaulted than they expected.
(Deputy Sheriff): You guys ready? Lets start this, Lets get this eviction on the road here?
(Knock on the door) Sheriff's office!
(Jeff Sikora): When I started working we were getting 12 evictions a week.
Now we're getting 90.
(Ben Meder): Just goes to show you--neighbours are you know, going through the same sort
of problems within weeks of each other literally.
Sub-prime borrowers had been lured into taking on their mortgages, by special low teaser rates.
With neither borrower nor lender worrying enough about what would happen when the low rates
came to an end. And when rates rose, well for many default was inevitable.
At the end of her introductory offer, Eleanor Hall's monthly payments went up by a painful
75%. I was under the impression I had a fixed rate of 625 a month. I had no idea that I had a variable
rate that would escalate every 3 to 6 months. So my mortgage went from $625 a month to $1098 a month.
You could borrow a 100%--of the debt without any questions asked and with a teaser rate that--really got you sucked
in. The very word teaser it gives the game away.
The essence of good banking for millenia, that the lender is suppose to check whether the borrower
can actually repay, had been lost.
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
manager to borrow money and he lent you the money and made sure that you paid it back,
or tried to make sure that you pay it back. As soon as you divorce those 2 things you're in trouble.
In the stampede to do deals, banking common sense had been abandoned. But for years the
danger was ignored because all those dodgy loans had been converted into investments that
had a triple A rating which in the past had always meant that they were ultra safe.
When something is rated in the financial community, Triple A, the assumption of everyone is that
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
Triple A default. Triple A's don't default. Triple A's are like Exxon and Royal Dutch Shell. There
are very few Triple A's, and--they do not default.
But just how partial were the agencies that awarded these Triple A ratings?
After all they were paid by the banks which wanted to sell the investments as Triple A.
None of us would hide the fact that we are paid by the issuers of the bonds. That does create a potential
conflict of interest. What we would point out though is that, we have a number of ways
of managing that conflict to ensure the integrity of the work that we do.
But when giving the Triple A rating the agencies didn't actually go back to the sub-prime borrowers
and check that they'd be able to repay their loans.
We do not do underlying due diligence we do rely on information that is given to us, the investor community
was aware or should have been aware of that because it is public fact.
Eventually the simplest and oldest financial logic would reassert itself.
(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
at my father's apron. And someday the bank's going to come back and say 'Can I have my money back'.
And then you say well it's in this house which isn't quite valued what I paid for it and
therefore I need to sell it and therefore, you know, it all unhinges.
The bankers and rating agencies had been to clever for their own good. They based their Triple A ratings
on historical data, they looked at how many sub-prime loans had gone bad when the market was tiny
and used that information to calculate how many would default as the market grew and grew and gres.
It turned out to be a catastrophic error.
The red light was November 06, a bit more than a year ago, when what you call the first pay default a very important
figure, i.e. people who have borrowed and at the first payment, 6 months after borrowing
are not paying the first interest that's pretty significant.
First pay default historically was 1 and a half percent. 1 to 2 percent. In a matter of a month that figure jumped to
5, 6 percent. That was a clear sign when you have people not paying that you should be worried.
Default rates were bound to rise as sub-prime loans shot up from being 1 in every 13 U.S mortgages
in 2001 to 1 in every 4 by 2006.
(Close up of Final Eviction Notice) I received this notice at the beginning of September. It was plastered to my door
It was bad enough, it brought me down but I had to do everything to keep my children
in control because I really didn't want them to know what was actually being done.
Eleanor Hall like thousands of others can't pay and has been made homeless.
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
People I thought had my best interests, they was only out for a dollar.
Here's what really shocked the bankers: sub-prime loans were going bad faster than any other kind of loan,
in a holy unprecedented way.
In the past decades,it was always the case that the general population would default on everything else
in order to keep their house. Credit cards they default on, loan to buy their fridge they default on--on their
car loans and finally they would default on their mortgage. They're keeping their credit card current and they're
defaulting on their mortgage first. This has never been seen before.
When the scale of losses from some prime- loans could no longer be ignored, the holders of all those
Triple A investments made out of sub-prime loans had a horrible awakening.
(peston): In August 2007, a big french bank BNP Paribas, spaked a global financial panic, when it
announced that it couldn't value it's holdings of investments created from sub-prime loans.
When BNP came out with that, you know this was a moment, they were saying its's time to go home.
Children the party's over now.
(Peston): Banks became reluctant to lend to each other, because they weren't sure which of them were holding
the sub-prime poison, and whether they would ever get their money back. The multi-trillion dollar
money markets that underpinned the global economy seized up.
(Mervyn Davies): The speed at which it happened, the way in which financial institute-institutions just, you know,
withdrew from the market because they were worried; I think that was unprecedented and it surprised politicians
it surprised regulators and it certainly surprised the banks. So once you're in that vicious
circle, lack of confidence a bit of lack of trust, you know, you don't know who's holding the problem,
everybody then, like lemmings runs for cover.
Once people got scared, they started being less happy to lend to each other. They started being less happy to
work with each other and again, that in itself led to--all sorts of other activities specifically
--securities going down in price.
(Peston): Was that fear rational?
Is fear ever rational? I don't know,but...is that fear rational? I'll give you a short answer. Yes.
The fact that people did not know the full exposure to the sub-prime area or the sieve area or whatever
yes of course, if you don't know something being fearful is rational.
(Peston): Once the river of money stopped flowing with banks and financial institutions loathe to lend to each other,
there was a very high profile casualty in Britain.
(BBC News footage): One of Britain's biggest mortgage lenders needs emergency support from the Bank of England.
Northern Rock has problems raising money because of the crisis in the financial markets.
Be absolutely clear there is no suggestion this business is fundamentally bust, but merely running
out of money in this way for a bank is extraordinarily serious.
(Jon Moulton): The company was very successful, because it was taking a tremendous amount of risk.
Northern Rock went the brink of insolvency because it's business was dependent on raising money
selling it's mortgages to international investors. And when investors were burned by losses on
sub-prime, they refused to buy any mortgages, Northern Rock's or anyone elses.
They were actually possessed of enough capital to survive approximately a 1 week shut down in the
capital market. That was all.
(Peston): Banks across the world in Germany, France, Switzerland and the U.S have lost
tens of billions of dollars and have had to been bailed out by governments or by investors with deep
pockets.
(BBC news footage): The Swiss bank UBS says it has suffered much bigger losses than anticipated
because of its exposure to the sub-prime mortgage market in the United States.
Today Barclays said it had written off 1.6 billion pounds of risky investments related to U.S mortgages.
The global credit crisis has deepened with America's 5th largest investment bank asking for emergency funding.
Bear Stearns which has been hit by the U.S. housing market slump, has been bailed out by another
bank and the federal reserve.
(Peston): Some of the bankers responsible for the financial losses are losing their jobs.
(Sir Ronald Cohen):Bonuses of investment bankers are going to fall drastically now that
you're discovering a lot of the banks, investment banks are taking billions of dollars worth of write offs.
And these people are getting kicked out unceremoniously, out of their jobs.
(Peston): As for those companies bought by private equity, well if they took on too much debt
they'll experience difficulties, which would be bad news for their investors and employees.
There are some clear examples of loans which are looking dreadful now, Fat Face the retailer,
Countrywide the estate agent. The loans on those companies are being dealt with regularly now,
at discounts of a quarter or more to their face value. So clearly there are some bad loans out there.
(Peston): But many of the super-rich who helped create this unsustainable boom are sitting pretty.
There are a lot of people who have made enormous amounts of money, created great mayhem and I'm afraid
they're not going get hurt greatly by what's happening now. There is I understand at the moment quite a
shortage of high-end hotel rooms in the Caribbean-- Mauritius and similar places,
because these people have nothing to do at the moment and lots of money.
(Peston): Having trousered so much the super-rich apparently have a problem many of us would love.
(Aaron Simpson): Very top-end people are very liquid, have made a lot of money in the last 10 years,
in fact would probably find it quite difficult to spend the money they have earned.
And that's why companies like us are quite successful, because we help them spend their money.
(David Arnold) :Frankly for companies that are producing such limited quantities of these very exclusive products
they can't manufacture them quickly enough. There's a new Rolls Royce the drop head coupé that was launched last year.
If you were to walk into your Rolls Royce dealer today, if you were lucky you would maybe get one in 2 years.
They continue to indulge in their passions and I don't see that changing anytime soon.
(Peston): And demand for the most expensive motoring experience on earth doesn't seem
to have evaporated.
(Julius Kruta): The car is not only the most expensive and fastest car on the planet, but it's also one of the most
usable cars. The customer who pays 1.1 million Euros plus tax gets a car which is really second to none.
The british have been the best European market and they still are the best European market,
they are only second to the U.S. our best dealership in the world, our single dealership in the world,
is Jack Barclay in London.
(Peston): So for the super-lux. industry price cutting isn't on the agenda.
The $1 million watch can not be affected by no crisis. That's the extreme. The extreme is safe.
At the 1 billion-- There will always, always, always be demand for $1 billion watch.
That is for sure and if you want to build a new watch and you want to go safe start with
1 million. (laughs) Start with 1 million then you are safe.
(Peston): The reason the super-rich can feel safe is that the gambles they've taken with other
peoples money have been so huge that the authorities have to bail them out, or else the damage to
the rest of us could be cripping.
(Hugo Dixon): These people who operate in the financial markets they're smart, they know that they are too big
to fail, they know that the authorities will rise to their rescue. So everywhere along the line
there are one way bets; and this means that you are incentivised to take big risks, you're greedy
the bigger the risk you take, the bigger the profit for yourself and if things go badly, oops! not our problem,
your problem. You pick up the mess.
(Peston): It's a mess they've landed all of us in. The losses incurred by banks, hedge-funds, insures and other financial
businesses which could reach $3 trillion have reduced their willingness to lend to any of us; and badly
damaged the global financial system. It's as though the mechanism for injecting fuel into the economy
has broken down. And when that happens we all suffer.
(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
sub-prime mortgages or collateralized debt obligations, or even equities, so what does it matter to them.
It affects us all The credit creation process is at the heart of everything in our economy
and without that you can not get normal functioning. I think the damage that's been done to that is vast and it's
persistent. So when you talk about the average home owner --and worker and its impact on them
they probably will find that there mortgage costs more. Whatever the absolute level of interest rates,
if they are unlucky, they may find their job is affected by this as well. I think there are some very
real world effects on peoples abilty to borrow.
Our banks have less money to lend to us and they're charging more for what they will lend.
That's leading to falls in house and property prices, which makes us feel poorer. And it risks creating a vicious
downward spiral as we spend less and the economy slows down.
(peston): Just to translate that into what it means for ordinary people. If people are borrowing less, saving more,
that will translate into slow growth. Does it translate into a serious recession in your view?
I don't expect a worldwide -- recession. I do expect a recession in the United States
the severity of which can not be predicted.
(Peston): As a result of recent budget changes, the British tax system may no longer
be quite so favourable to the new super-rich as it was.
But what about the widening income and wealth gap between the super-rich and the rest of us?
Some of the way that wealth is accumulated. If wealth is accumulated out of people growing
successfully it's generally good it's hard to come up with a real negative on that.
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
then the social implications are much wider, because those bets will go wrong as well as right; and when
they go wrong there will be a lot of victims other than the guy. So ther's a social and political issue there.
So the guy who's made a 100 million out of being the promoter of overloaded structures. That's a political
issue he's caused a lot of damage and he's got very rich.
I think it--an economy which is characterized by extremes of wealth is not a secure and safe economy
any more than one economy versus another economy. Extremes of wealth and income, give rise
I think to very serious moral risks.
(Peston): That might not matter if we could be confident that lessons are being learned from the
crisis. But what we see is that America's central bank the federal reserve is once again slashing interest
rates and pumping cash into the system! Now didn't that start the whole poisonous process?
You have a boom bust process similar to many that we have had in the last --decades, but it's also the end
of a super-boom that has lasted since the end of the 2nd World War.
From time to time, markets don't correct themselves we have a crisis and then the authorities
have to intervene and inject liquidity and bail out the failing institutions and that creates
a system of asymmetric incentives, where you are encouraged to leverage, but if things
really go wrong, there is relief.
If those in charge of the system can't be relied upon to change their ways what chance that
those who play the greed game might actually mend their's?
They've been incentivized to take dangerous risks with other peoples money in the hunt for big profits
and vast rewards. Have those incentives been eliminated?
No not really. I think that --if you set up a basic remuneration structure where people get paid 20% of the
gains from playing with other peoples money. I'm not sure what possible event could occur to make them
learn anything from it. You really just need to change the structure that's the only thing
that will get their attention.
(Peston): And who's going to change that structure?
There's only really one group of people who ever can change any structure like that and that's the owners.
This is matter so long as people are willing to be shareholders in banks where traders are
allowed to play with the banks capital and walk off with 20 or 30% of the gains on it and none of the losses,
and where people are willing to invest in private equity and hedge-funds and allow the same thing to occur
it will occur.
(Peston): If you're a hedge-fund, or a private equity firm there are fantastic opportunities to profit from
the turmoil. A number of hedge-funds have already made billions from betting that all those
sub-prime investments were over-valued, and some have done very nicely from speculating
that the share prices of our leading banks would tumble.
As for private equity well a recession would be just the most glorious time to buy businesses
at knockdown prices.
(Peston): Is this actually a period of tremendous opportunity for a firm like yours?
Yes its-- its going to be a great opportunity. The real golden age comes when you have a mess. You have economies
that are on their back, you know, capital --inadequate and when you start buying businesses at that part of the cycle
you inevitably do extremely well unless you're too early and right now it's a little bit too early--
but as you wait and it develops this will be a great time, to be buying businesses.
(Peston): So there are still plenty of opportunities for the new super-rich to increase their fortunes.
Even though the global financial system is in intensive care and our prosperity is threatened.
With the greed game still being played, if we're not going to end up the losers again, the rules will
need to be rewritten.
(♪Music playing♪)