The Warning

>>NARRATOR: Tonight on Frontline... Long before the economic meltdown, the story of one woman who tried to warn about the threat to the financial system.

>>She saw something that people either had not seen or refused to see, and she tried to sound the warning.

Nobody listened.

>>What are you trying to protect?

>>We're trying to protect the money of the American public.

>>I was told that she was irascible, difficult, stubborn, unreasonable.

>>NARRATOR: Before the toxic assets poisoned the economy, she warned of their danger.

>>And that made her the enemy of a very, very large number of people.

>>NARRATOR: She would fight an epic battle with one of the most powerful men in Washington.

>>He was, as George Bush put it at the time, a rock star.

>>And it got pretty nasty pretty quickly.

>>Greenspan turns to her, she turns to him, his face is red, and he's clearly quite upset.

>>NARRATOR: A story from inside the highest levels of the Clinton administration.

>>They were all part of a very concerted effort to shut her up and to shut her down.

And they did, in fact, shut her up and shut her down.

>>NARRATOR: Tonight on Frontline, Alan Greenspan, Brooksley Born and The Warning."

>>You need to get in the game.

>>NARRATOR: In 2005, economic cheerleaders dominated the airwaves.

>>I'm betting on Microsoft.

Boom, boom-- that stock is not done going up.

>>NARRATOR: Times were good.

Alan Greenspan ruled the economy.

>>When you can get a 3.7% yield with upside, that's a lot better than getting 3.7% yield... >>NARRATOR: Washington's hands- off attitude toward Wall Street seemed to be paying off.

>>So now it's all systems go between now and... >>I recommend a buy on it.

>>Ladies and gentlemen... >>NARRATOR: It was time for a celebration.

>>... the recipients of the Presidential Medal of Freedom... >>Alan Greenspan is one of the most admired and influential economists in our nation's history.

>>NARRATOR: The nation's highest civilian honor was bestowed on the man many called The Wizard."

>>More than one story was written about Alan Greenspan as the Wizard, the man behind the curtain, the Wizard of Oz.

>>Alan was a great wizard.

No one understood what he said, but he said it in such a way that everybody bought it.

>>What's going to happen when all of this stimulation starts to decline?

>>Everybody hung on every word.

>>Congressman, it depends on what is going on in the world generally.

>>The Wizard, the man behind the curtain who mumbled in ways that ordinary people couldn't understand, but who appeared to be controlling absolutely everything.

>>...then we're going to get an exceptionally large amount of fiscal stimulus, which we're not going to want.

>>Very few people wanted to take him on or challenge him because he knew so much more than they did, and if he didn't, he certainly appeared to.

>>In his 18 years as Fed Chairman, he applied... >>NARRATOR: Five presidents had watched Alan Greenspan work his magic.

It started back in the Ford Administration.

>>Alan Greenspan was a financial consultant who was hired by Gerry Ford, first to be head of his Council of Economic Advisors in the '70s.

>>NARRATOR: But Alan Greenspan was not your stereotypical economist.

>>He was also very charming and a man about Washington.

>>NARRATOR: He played jazz clarinet, had made himself rich on Wall Street.

And he had embraced an unusual political guru... >>I'm challenging the moral code of altruism.

>>NARRATOR: ...the libertarian philosopher Ayn Rand.

>>...is enslaved to every... >>Greenspan is a disciple.

She is the great champion of government is a destructive force that just gets in the way.

>>Mike Wallace, Ayn Rand, 2/25, batch one, take two.

>>Can I ask you to capsulize your philosophy?

>>I am opposed to all forms of controls.

I am for an absolute laissez- faire, free, unregulated economy.

Let me put it briefly-- I am for the separation of state and economics.

>>NARRATOR: Greenspan talked about Rand in his autobiography.

>>Ayn Rand became a stabilizing force in my life.

It hadn't taken long for us to have a meeting of the minds-- mostly my mind meeting hers.

>>NARRATOR: Rand stood in the Oval Office as her star pupil was sworn in.

>>Greenspan had a very clear ideology about regulation.

>>His philosophy was in the form of what was called Libertarianism.

And that meant those who do well prosper, those who do poorly fail, and the market clears the transactions.

>>I will faithfully execute the office of President of the United States.

>>NARRATOR: It was a philosophy made to order for Ronald Reagan.

>>Government is not the solution to our problem.

Government is the problem.

>>NARRATOR: In 1987, Reagan made Greenspan the most powerful banker in the world-- the chairman of the Federal Reserve.

>>Greenspan was a believer in Ayn Rand, a believer in free market.

Little bit curious for a central banker, because what is central banking?

It's a massive intervention in the market, setting interest rates.

>>NARRATOR: Greenspan worried about this contradiction in his autobiography.

>>I knew I would have to pledge to uphold not only the Constitution, but also the laws of the land, many of which I thought were wrong.

>>And now the vice-president will swear Alan Greenspan in.

>>NARRATOR: He swore the oath, and took the job.

>>I had long since decided to engage in efforts to advance free-market capitalism as an insider, rather than as a critical pamphleteer.

>>He understood that there were laws he had to enforce that he personally would not have passed.

But he intended to do as little as he could on regulation, and he proceeded to do just that.

>>NARRATOR: And by the time Bill Clinton took the White House, the antigovernment rhetoric had become so fashionable that even some Democrats embraced it.

>>Ronald Reagan had won.

Government was seen as the problem.

And even though Bill Clinton was someone who believed in government and wanted to use it, he was kind of forced into that Reaganesque ideology, because that was what people wanted to hear.

>>NARRATOR: From the beginning, Clinton aimed to reassure powerful forces on Wall Street.

And he did so with a key appointment.

>>I have asked Robert Rubin to serve as Assistant to the President for Economic Policy.

>>Rubin is the best known financier in the country at that point, because he had run the legendary Goldman Sachs.

>>Bob Rubin was Bill Clinton's emissary to Wall Street.

Clinton placed great trust in Bob Rubin and Bob Rubin's view of financial markets and financial regulation.

>>He had an enormous amount of credibility because he was a business success, and Democratic administrations always seem to worship people who can excel at business.

>>NARRATOR: At the White House, and as Treasury Secretary, Rubin found an unlikely ally.

Clinton had asked Alan Greenspan to stay on.

>>Bob Rubin and Alan Greenspan were very much in lockstep.

They had very similar views on Wall Street.

It boiled down to the less regulation, the better.

>>NARRATOR: And Rubin populated the Clinton administration with a network of free market true believers.

>>It wasn't just Rubin and Greenspan who were these free market acolytes.

That thinking pervaded the Treasury and the White House.

>>NARRATOR: Among Rubin's acolytes, 35-year-old Timothy Geithner and Rubin's top deputy, the outspoken Harvard economist Larry Summers.

>>Summers was tough.

Summers is very blunt spoken, doesn't suffer fools lightly, or anyone else, as the saying goes.

>>Bob Rubin is not a guy who likes confrontation.

He's confrontation-averse.

But he understands you need someone in there who can swing a heavy ax.

And that person was Larry Summers.

He was the enforcer.

>>NARRATOR: Together, Greenspan, Rubin and Summers formed their own pro-business, anti-regulation support group.

>>They're the committee to save the world, according to the Time magazine cover.

These are the people we turned to at that moment who, together, all three, in a way, say, Trust us."

>>They seemed to have things under control.

You know, the world trusted Rubin and Greenspan, so why wouldn't Clinton?

You know, and the market was doing great.

And the country seemed to be doing great.

>>This was a big day on Wall Street, as stock prices returned to territory... >>...the party on Wall Street today... >>Stock trading at five times its... >>For a total of 41,000... >>Active volume-- 55 million shares changing hands... >>2,500.

2,500.

>>NARRATOR: These were the euphoric go-go '90s.

>>Well, you know, the mid- to the late 1990s were a very ripe boom period.

It was the most robust portion of the tech boom.

>>Internet fever has not subsided... >>On the money tonight, Internet fever... >>eBay, up 700% since September.

>>The financial markets were zooming.

>>Priceline.com is the latest beneficiary of the Internet stock craze.

>>The market was rocking and rolling.

>>Shares of the Web technology company soared more than 250%... (cheers and applause) >>300 dollars a share... >>Santa Claus arrives early on Wall Street.

>>NARRATOR: But in Washington, there was one agency that looked at the bull market with some skepticism, buried deep in the bureaucracy-- the Commodities Futures Trading Commission, C.F.T.C.

>>It was a small fish in a... otherwise, a pretty big pond.

It was always viewed as kind of a sleeping, small, not terribly significant agency.

>>NARRATOR: The agency was authorized to regulate agriculture futures, and to oversee arcane, complex financial instruments known as derivatives.

>>You know, they're one of these little afterthought agencies that kind of get in the way of the big guys.

>>NARRATOR: The C.F.T.C.

started getting in the way" in 1996 when a new chairperson, Brooksley Born, took over.

>>My law practice was in the derivatives area.

I'd practiced derivatives law for more than 20 years.

>>Brooksley Born is a longtime securities lawyer.

She has a stellar reputation.

She's been around the block.

She knows her stuff.

>>NARRATOR: Born was 55, a veteran of the gender wars that had influenced many women of her age group.

In Born's case, the struggle had started early.

Born went to Stanford in the early 1960s.

Most women in her class got married; Brooksley went to law school.

>>There were very few women in law school at the time.

This was during the Vietnam War.

And a lot of men in the class saying, What are you doing here?

You're taking the place of somebody, a man who could be here and not have to go to the war.

The way she approached this was, Well, I got to show them I can do it.

>>NARRATOR: She did-- top of her class, the first female president of the Stanford Law Review.

>>You would think this would be a great moment of triumph for Brooksley Born.

Instead, she gets a phone call from one of the deans.

And he says, Brooksley, I just want to let you know that the faculty stands ready to step in if you're not able to pull this off.

It goes on like that, on and on and on, at each step of Brooksley Born's life and career.

>>NARRATOR: In Washington, she became a partner in a prestigious law firm, built an international reputation, formed alliances with other powerful female attorneys, including one who happened to be the wife of Arkansas's governor.

>>She had developed a very close relationship with Hillary Clinton, when Hillary Clinton was a very prominent lawyer in Little Rock, Arkansas.

>>NARRATOR: And then Bill Clinton won the presidency.

>>Brooksley Born found herself being invited down to Arkansas, during the transition, for a meeting with him to discuss possibly being the Attorney General of the United States.

>>She's very self-effacing.

You know, she's flattered, but she's going to see if it happens.

>>...seven of the Clinton transition... NBC's Andrea Mitchell tonight... >>For Attorney General, Clinton is considering Washington lawyer Brooksley Born.

>>Brooksley went in for an interview with Clinton.

The story that comes back was that Clinton found her boring, and that she was... it never went anywhere.

>>It didn't happen.

Janet Reno was chosen.

>>NARRATOR: And that's how Brooksley Born ended up running the obscure C.F.T.C.

>>I think, to some extent, you could view this as a consolation prize.

To the general world, people who knew Brooksley, the circle she traveled, the American Bar Association, the D.C. Bar, all the prestigious boards she served on, people were probably scratching their heads.

>>NARRATOR: An experienced financial litigator who'd seen the worst of the markets, Born was a believer in government regulation.

Given the political climate in Washington at the time, clashes with Greenspan, Rubin, and Summers were inevitable.

Almost right away she had one.

It began after she received an invitation to lunch at the Federal Reserve with the chairman himself.

>>How could you not have a little bit of butterflies in your stomach when you're going to go see Alan Greenspan at that moment in time?

>>NARRATOR: It didn't take long for Born to learn that she and the chairman were not going to see eye to eye.

>>He said something to the effect of, Well, Brooksley, we're never going to agree on fraud.

And she said, Well, what do you mean?"

And he said, You probably think there should be rules against it.

And she said, Well, yes, I do."

He said, you know, I think the market will figure it out and take care of the fraudsters.

>>The Alan Greenspan lunch, did it actually happen?

Where he says... >>I'm not going to talk about it.

I'm not going to talk about it on camera.

>>NARRATOR: Born is reluctant to speak about her meetings with Greenspan or others in the Clinton administration.

Greenspan refused to speak to Frontline at all.

But Born's advisors did.

>>Greenspan didn't believe that fraud was something that needed to be enforced.

And he assumed she probably did.

And of course she did.

I've never met a financial regulator who didn't feel that fraud was part of their mission.

>>And this is an absolute stunner for the new head of this tiny agency, who is charged with making sure people don't commit fraud.

>>Well, I think she was taken aback about how far he would go towards deregulation.

That even the notion that we should police fraudulent activity he didn't think was something that was a given.

>>That was her introduction to Alan Greenspan.

>>NARRATOR: The clash with Greenspan didn't intimidate Born.

She was determined that her agency would investigate fraud at the first opportunity.

One area that caught her attention was a new and highly lucrative market: over-the-counter derivatives.

>>She starts to realize that there's this whole world out there of what are called over-the-counter derivatives that are essentially unregulated.

It's not even that they're unregulated, it's that the government doesn't even know what is going on.

>>My staff began to say how big this was and how little information they had about it.

>>NARRATOR: On Wall Street, they described it as a black box.

Only the parties involved in a deal knew what was happening.

>>The derivatives market was a market that was not well understood, was growing rapidly, that had a few really smart, aggressive, innovative players.

>>NARRATOR: Derivatives, swaps, basically bets between companies and banks laying off risk.

>>Derivatives, in essence, are insurance policies that various players on Wall Street enter into to protect themselves from unforeseen calamities.

>>NARRATOR: It was a $27 trillion market happening out of sight, inside a black box.

>>We didn't truly know the dangers in the market because it was a dark market.

There was no transparency.

>>The conditions were very favorable for things to go wrong.

>>NARRATOR: As Born's investigators learned, there was also plenty of room for old-fashioned fraud.

>>There's this major scandal at Bankers Trust, where they have taken two of their customers," Proctor &Gamble and Gibson Greeting Cards, to the cleaners with these complex over-the-counter derivative products.

>>It was in derivatives.

>>Proctor &Gamble claim they've lost millions of dollars from derivative deals arranged by Bankers Trust.

>>NARRATOR: In 1993, Bankers Trust, one of the largest banks in the country at the time, had sold derivatives to Proctor &Gamble.

>>Proctor &Gamble sued Bankers Trust, claiming that they had been sold products that they didn't really understand and that blew up in their face.

>>NARRATOR: The lawsuit set the stage for a stunning revelation.

Bankers Trust employees took advantage of the fact that derivatives were too complicated to understand.

>>It opened a window onto what was really going on in the derivatives market.

(phone dialing) >>NARRATOR: As part of the case, Proctor &Gamble discovered secret audiotape recordings of telephone calls among Bankers Trust brokers.

>>There was one employee who described the business as a wet dream."

A Bankers Trust employee said, We set 'em up."

>>They had taped phone calls from people inside Bankers Trust who were sort of chuckling, saying, Ha, ha, these idiots really think that this is in their best interest, but ha, ha, it's not.

We're probably going to end up cleaning their clocks on these contracts.

>>NARRATOR: It had all happened in secret.

Even this blatant scam might never have been discovered by the government.

>>The only way the C.F.T.C.

found out about the Bankers Trust fraud was because Proctor &Gamble and others filed suit.

>>NARRATOR: Looking inside Wall Street's black box was impossible for Born, or indeed any other government regulator.

>>They're unregulated.

The contracts aren't traded on exchanges.

They're entered into between private parties.

>>There was no record keeping requirement imposed on participants in the market.

There was no reporting.

We had no information.

>>There's no way, really, for the government, or anyone else, to know how many of these are out there, know how big a market it is.

And know who owns them and who owes who money, because it's just a bunch of contracts in file cabinets in the lawyers' offices of banks and hedge funds all over the world.

>>NARRATOR: And that's what frightened Born more than anything: trillions of dollars and the biggest banks in the country operating in secret.

If something went terribly wrong, the high-stakes derivatives market could take down the entire financial system.

>>And that's what everybody's worried about.

You have one big institution that fails, it can't pay its obligations, it forces somebody else into a dangerous territory who can't pay their obligations.

Pretty soon, it's a falling domino effect through the economy.

>>NARRATOR: As the market grew and morphed, Born felt her agency would have to get involved.

But that would mean confronting Greenspan, Rubin and Summers.

>>She used to say she would lay awake at night turning in her bed because she could see, coming down the road, the crises kept building and building.

>>Federal Reserve Chairman Alan Greenspan told Congress today the U.S. economy is the best he's ever seen.

>>NARRATOR: By spring of 1998, the idea of tougher regulation seemed out of step with all the good news.

(gavel pounds) >>Current economic performance is as impressive as any I have witnessed in my near half century... >>Those Internet stocks continue their meteoric rise... >>Investors are hoping Alan Greenspan will give them another boost by lowering interest rates yet again.

>>You have to remember the context.

Companies are going public and doubling, and doubling every week of the year.

>>If you thought the Internet bubble was about to burst, think again.

>>Some weeks it was happening every day, and, you know, the idea of worrying about derivatives was just, you know, so 20th century.

>>We were on a path towards, Wow, markets can do great things.

Communism was dead.

Markets, capitalism was invincible.

>>NARRATOR: But at Treasury, things were about to change.

The carefully calibrated inner tranquility was being disturbed by a small tremor.

It quickly made its way up to Robert Rubin.

Brooksley Born was contemplating the regulation of O.T.C.

derivatives.

>>The pushback is visceral and immediate, and that's one of the striking things about this.

>>NARRATOR: This was a job for Larry Summers.

>>I walk into Brooksley's office one day, the blood has drained from her face.

She's hanging up the telephone, she says to me, That was Larry Summers."

>>Larry basically reads her the riot act.

He more or less tells her, my understanding is that, You don't get it."

>>He says, You're going to cause the worst financial crisis since the end of World War II.

That he has, my memory is, 13 bankers in his office who have informed him of this.

Stop, right away.

No more.

>>NARRATOR: In Washington, they say the financial sector has five lobbyists for every congressman.

>>Brooksley Born is stepping into the maw of the most well-oiled and highly financed lobby in the history of Washington, D.C.

It's the financial lobby.

>>Bankers just fall over themselves calling Summers and Rubin and Greenspan, and everybody, saying, Get this lady off our backs.

>>NARRATOR: But the harder they pushed, the more interested Born became.

>>They were totally opposed to it.

That puzzled me.

You know, what was it that was in this market that had to be hidden?

Why did it have to be a completely dark market?

So it made me very suspicious and troubled.

>>NARRATOR: Born's agency was legally independent.

She reported to the president.

Rubin had no authority over her.

To stop her, he would call upon his allies who sat with him on a secretive council known as The President's Working Group.

>>The President's Working Group was the most influential White House body on financial policy.

>>It was called at the discretion of the Secretary of the Treasury.

>>It was a committee hand picked by Bob Rubin, and it was a committee that he steered.

>>NARRATOR: Larry Summers attended.

So did Alan Greenspan, and the chairman of the S.E.C., Arthur Levitt.

>>Alan and Bob and I had known one another, and away from government, I think we all liked one another and respected one another.

>>NARRATOR: By executive order, the head of the C.F.T.C.

also attended the meetings.

>>I didn't know Brooksley Born.

I was told that she was irascible, difficult, stubborn, unreasonable.

>>Rubin, Summers and Greenspan had a great deal of faith in their own intellects.

And I think that they were not welcoming of somebody who looked at the world different and was kind of abrasive.

>>You know, they were used to dealing mainly with men and with people they knew.

And here was someone they didn't really know.

They didn't know that much about her.

And to boot, she was a woman.

So, you know, put it all together and you've got somebody that you can kind of flick off with the back of your hand, at least they thought.

>>NARRATOR: As Rubin was quietly preparing the Working Group, Born was taking the first steps toward regulating O.T.C.

derivatives, designing a document known as a concept release.

In response, Rubin acted, calling an emergency meeting of the Working Group.

>>We're driven there.

And we get out at the entrance of the Treasury, go up to the room, everybody assembles.

The Secretary walks in, the meeting is called to order.

And the subject of the meeting was to discuss the concept release, and the clear mission of it was to convince Brooksley that it shouldn't be issued.

>>What's amazing is that Rubin and Greenspan said, No, no, no.

You can't do that.

We just can't have this.

And it got pretty nasty pretty quickly.

>>Those on the other side were saying, Look, this deregulated market is part of what's brought us the boom times.

And so, we don't... we can't... we don't want to change that.

You know, the market will take care of everything.

And we really don't need regulation of these and in fact, it would be counterproductive.

>>Each of the principals in turn-- that is to say Rubin, Greenspan and Levitt-- take their shot at telling Brooksley that she shouldn't do what she's doing.

>>Rubin says to her, You don't have the legal authority to do this.

>>And Brooksley said, Well, that's interesting.

That's the first time I've ever heard that.

All my lawyers at the C.F.T.C.

have assured me that we have the exclusive jurisdiction to do this.

>>Rubin was condescending toward her.

He said he would get his lawyer in the Department to help her understand the laws better, or something like that.

>>NARRATOR: S.E.C.

chairman Arthur Levitt had been personally lobbied to join the effort to shut Born down.

>>This tight-knit group persuaded me that we really would face a situation of financial turmoil if we tried to undo these existing contracts.

>>NARRATOR: And then it was Alan Greenspan's turn.

>>I happened to be sitting behind Brooksley and behind Greenspan.

They're sitting next to each other.

Greenspan turns to her, she turns to him.

He's... his face is red, and he's clearly quite upset.

He was very adamant that this was a serious, serious mistake, that it would cause untold damages to the financial services market and that she should stop and not do this.

That it was unwise and... and would cause tremendous damage.

>>In a group of this kind there will be a disparity in power, and it would take an extraordinarily outspoken, knowledgeable, pugnacious person to fight the losing battle against the titans who led that group.

>>It's the education of Brooksley Born.

They decided that, Hey, she's not playing ball.

We're going to teach her a lesson.

And we're going to get this thing killed because we don't want it to happen.

>>NARRATOR: But two weeks later, Born told her staff to publish the concept release.

>>That creates an earthquake.

You're talking foundation of the building.

And she is literally in the crossfire of an amazing number of bullets.

>>NARRATOR: The response of the Working Group was immediate and unprecedented.

>>By the afternoon, Rubin, Greenspan, Levitt put out a statement saying, This is a very bad thing and Congress should act, with all deliberate speed, to block it.

>>We have grave concerns about this action and its possible consequences.

We are prepared to pursue, as appropriate, legislation that would provide greater certainty concerning the legal status of O.T.C.

derivatives.

>>The powers that be in Washington put out the word to the media, and they put out the word to Capitol Hill that her views were not to be trusted, they were not to be taken seriously, that she was running a podunk agency, this was power grab, and she didn't have a clear understanding of the products that she was going to regulate and shouldn't be entrusted with that kind of power, and it would be a great mistake if she were.

(gavel pounds) >>This hearing of the Senate Agriculture Committee is now called to order.

>>NARRATOR: Only Congress had the legal authority to stop Born.

Rubin, Greenspan, Summers, and Levitt lobbied hard.

>>Today we will receive testimony on over-the-counter derivatives.

>>NARRATOR: Hearings were held almost immediately in both the House and the Senate.

>>Brooksley is a lady, and the men were gentlemen, but the feelings were quite intense.

This was an enormous embarrassment to the executive branch because they couldn't coordinate with each other.

>>There are a ridiculous number of congressional hearings.

>>It is essential that the government not create uncertainty... >>C.F.T.C.

wants to come into somebody else's yard here.

>>She just gets pummeled on Capitol Hill.

>>I see no evidence whatsoever to suggest that this is a troubled market, that fraud is rampant in this market.

>>The release has cast a shadow of regulatory uncertainty.

>>The C.F.T.C.

's action has and will bring, I believe, significant disruption to this important global market.

>>...useful purpose hinders... >>All the regulators there testifying, and you know, all of them say, This is a bad idea.

This is a bad idea, this is a bad idea.

This is a bad idea.

And then she says, This is a good idea, and the senators and congressmen just, you know, beat her over the head.

>>I feel very strongly that we should not have one agency innovate in this area, and in doing so, create very substantial financial problems.

>>90% of the members of Congress couldn't have told you what a derivative was.

So all they knew was that these guys on Wall Street, some of whom make big campaign contributions, many of whom seem very smart, say, If we do this, it'll... it'll screw up the economy.

>>My question again is what are you trying to protect?

>>We are trying to protect the money of the American public, which is at risk in these markets.

>>NARRATOR: That summer of 1998, Born testified four times before hostile Congressional committees.

>>They were hearing from very respectable sources that there was no problem, and they chose to rely on those people.

And I think that was understandable.

I think it was unfortunate, but I think it was very understandable.

>>I thank each one of you for coming and for your testimony.

>>Thank you, Mr. Chairman.

>>Thank you.

>>Thank you.

>>The system wasn't set up to allow somebody like Brooksley Born to have a real impact.

>>She was running against the tide of very powerful forces, and powerful forces that were doing exceptionally well.

>>NARRATOR: As Congress headed for the summer recess, it seemed likely they would not heed Born's warning.

>>She had no support anywhere.

>>She wasn't a member.

She had no political capital.

She had no chance.

(phone ringing) >>NARRATOR: Then, Born's warning became a prophecy.

>>I was at home and I got a call, as I would often get, a call from the Treasury operator.

And it was Secretary Rubin on a Saturday.

And the Secretary of the Treasury wants to have a conversation with me about this hedge fund that apparently was about to go under.

>>NARRATOR: The hedge fund, Long Term Capital Management, was melting down.

A quiet panic had begun.

It looked exactly like what Brooksley Born had been warning about.

Known on the street as L.T.C.M., it was the trillion-dollar favorite of in-the-know investors.

>>L.T.C.M.

's a hedge fund.

It's run by John Meriwether, ex-Salomon Brothers.

He's considered one of the great geniuses of the bond market.

Tons of money flows his way from private investors who would like to make a killing via his smarts.

>>The firm also had the former vice chairman of the Fed, Alan Greenspan's number two.

>>NARRATOR: David Mullins and John Meriwether operated L.T.C.M.

outside government regulations.

>>They were the personification or the embodiment of Alan Greenspan's credo.

Credo was, Markets get it right."

>>NARRATOR: L.T.C.M invented complex mathematical formulas, and used derivatives to place their bets.

>>These guys are the rock stars.

The Long Term Capital Management team, they're sort of rock stars for the math clubs of America.

>>L.T.C.M.

is a case study in arrogance.

A lot of really, really smart people who thought they had a foolproof money machine, a number of them Nobel Prize winners.

>>NARRATOR: Neither the government nor investors knew anything about how L.T.C.M.

worked.

It was a completely secret process.

>>If you want to invest in Long Term Capital Management, you've got to walk into a conference room, abandon computers, abandon pencils, abandon yellow pads, no notes, and you're told there's a black box.

Look at these returns, 46%, 40%, 20%.

People are fighting to get in to invest, people are fighting to lend money.

>>NARRATOR: L.T.C.M.

did business with 15 of Wall Street's biggest banks, leveraging $5 billion into more than $1 trillion in derivatives.

>>All these big banks hadn't done their homework.

They didn't even know the extent of L.T.C.M.

's exposures in the market, or the fact that all of the other O.T.C.

derivatives dealers had been lending to them as well.

>>NARRATOR: Then, trouble.

L.T.C.M.

's complicated computer models were failing... >>In Russia the financial markets were hit hard today.

>>NARRATOR: ...rocked by a financial crisis in Russia.

>>The firm had all sorts of models that said, no matter what happened, based on history, they couldn't lose more than $35 million a day.

>>In Russia today, a grave financial situation grew... >>The side effects of the Russia crisis were evident everywhere.

>>They started dropping $300, $400, $500 million every day.

>>NARRATOR: Word of a pending collapse spread.

Many banks had invested in L.T.C.M.

's derivatives believing they alone were in a deal.

They weren't.

>>When L.T.C.M.

started to get stressed, and these guys said, I want to collect my collateral, they all discovered that a lot of other parties had the same claims on it.

>>NARRATOR: With Wall Street's banks in a panic, L.T.C.M.

was perilously close to collapse.

And that's when Washington first heard about the problem.

The Secretary of the Treasury began to contact members of the president's Working Group.

>>I got a call from the Treasury Department.

I thought that L.T.C.M.

was exactly what I had been worried about.

None of the regulators had known they were on the verge of collapse.

Why?

Because we didn't have any information about the market.

>>NARRATOR: That weekend the members of the Working Group were told the entire American economy was hanging in the balance.

>>Long Term Capital Management had very large positions in the over-the-counter derivatives marketplace.

And if it came down, the question is how would that affect the American public?

How would that reverberate through the system, and affect everybody's livelihood in the country?

>>The fear is that if it goes down, it would present what they call a systemic risk, something that could unwind the entire financial system.

>>NARRATOR: At Treasury, all they could do was watch and wait.

>>It was very scary.

Credit markets around the world just shut down.

There was a period of real panic.

People were very, very frightened.

These firms were worried about, in some cases, their future; in some cases, their survival.

It was... it was a real bloodletting.

>>NARRATOR: After four days the Fed acted, but not directly.

The Wall Street banks were pressured to bail out L.T.C.M.

themselves.

>>The government said, It is our belief that your financial stability is in jeopardy.

And the way to solve this problem is for you each to pony up $400 million and buy the fund, prevent it from collapsing, and try and work the thing out.

>>14 banks agree to put up a few hundred million each, about 3.5 billion total.

>>NARRATOR: It worked.

The crisis passed.

In Washington, a collective sigh of relief.

And then... (gavel pounds) ...a call to action.

>>The committee will come to order.

>>NARRATOR: Some in Congress began to clamor for regulation.

>>The United States government is obligated to be on top of the issues.

>>When and how did the concept of market self-regulation fail us?

>>Americans should be worried about the gambling of Wall Street elites.

>>That puts at risk every American.

It puts at risk democracy.

>>How many more failures do you think we'd have to have before some regulation in this area might be appropriate?

>>There was a strong sense that we ought to do something about these derivatives.

That they really were posing a risk to our national economy and to the global economy.

>>NARRATOR: But Alan Greenspan had no intention of yielding.

>>I know of no set of supervisory actions we can take that will prevent people from making dumb mistakes.

I know of no piece of legislation that can be passed by the Congress which would require us to prevent them from making dumb mistakes.

>>Congress was told that this was an anomaly, this was not indicative of dangers in the market.

>>I think it's very important for us not to introduce regulation for regulation's sake.

>>NARRATOR: In the end, Congress agreed with Alan Greenspan.

There would be no new regulations of over-the-counter derivatives.

>>So now this is an unregulated market.

No transparency, no capital reserve requirements, no prohibition on fraud, no prohibition on manipulation, no regulation of intermediaries.

All the fundamental templates that we learned from the Great Depression are needed to have markets function smoothly are gone.

>>NARRATOR: But within the next few weeks, Congress did decide to do something about Brooksley Born.

They stopped her entirely.

>>Essentially what you had was a very bald and brutal power play.

They defenestrate her entire agency.

They say, Because you haven't played ball, we are now declaring a regulatory freeze on anything you folks can do in this market.

Forget it, you're done.

And she was.

>>NARRATOR: Born resigned.

>>There was not anything effective that was going to happen in the over-the-counter derivatives area.

And I felt as though, because of that, I had done what I could to help protect the public and there wasn't much left for me to do.

>>NARRATOR: With Born out of the way, the last two years of the Clinton administration were a heyday of deregulation.

O.T.C.

derivatives were off-limits.

Banks were freed to make riskier investments.

Wall Street was largely left to regulate itself.

>>Again and again, during the Clinton administration, you see these examples of the top regulators basically saying, The market knows better than us and we're going to let the market do it.

>>NARRATOR: By 2007, the O.T.C.

derivatives market had grown to $595 trillion.

That's $595 trillion.

>>....higher, giving the Dow its best... >>NARRATOR: The hands-off approach seemed to be working.

Wall Street had bet heavily on the real estate boom.

>>The economy expanded at a robust 4.3% annual rate.

>>NARRATOR: Those derivatives were at the heart of that strategy.

>>You have derivatives insuring derivatives which are based on derivatives.

It's an almost an Alice in Wonderland kind of profitability.

>>What, in fact, you essentially had was a big, creaking time bomb that needed some sort of event to disrupt all of the assumptions everyone had.

(stock market bell rings) >>The stock market dropped by hundreds of points right from the open.

>>The jobless rate in America has now soared... >>NARRATOR: The time bomb exploded almost exactly ten years after the collapse of L.T.C.M.

>>Investors were shaken by Lehman's bankruptcy filing... >>You had the most raw panic the economy and the financial markets had seen since the 1930s.

It was ugly, it was broad-based, it was bringing huge institutions to their knees.

And a lot of that was tied into derivatives.

>>They're hidden like land mines in a battlefield, and nobody wants to give money to anybody else because they don't know.

>>A.I.G.

plunging, at one point they were down 70%... >>It was my worst nightmare coming true.

Nobody really knew what was going on in the market.

The toxic assets of many of our biggest banks are over-the-counter derivatives and caused the economic downturn that made us lose our savings, lose our jobs, lose our homes.

It was very frightening.

>>I think to understand the crisis, you have to understand that it had many, many factors that contributed to it.

But it's absolutely clear to me that if we had restricted the derivatives, some of the major problems would have been avoided.

>>Had Brooksley Born been enfranchised, had Brooksley Born been listened to, had Brooksley Born been made part of the process, would that have had a different ending for what subsequently happened in the derivatives market?

Certainly.

>>NARRATOR: In the aftermath, one former member of the Working Group has had a change of heart about Brooksley Born.

>>I've come to know her as one of the most capable, dedicated, intelligent and committed public servants that I have ever come to know.

I wish I knew her better in Washington.

I could have done much better.

I could have made a difference.

>>NARRATOR: And the others?

Robert Rubin left government to join top management at Citibank.

The taxpayers have pledged more than $100 billion to keep Citi afloat.

Rubin's former deputies Larry Summers and Timothy Geithner have become President Barack Obama's chief financial advisors.

Neither Rubin nor his former deputy, Larry Summers, would speak with Frontline about what happened to Brooksley Born.

And Rubin's other top deputy, Gary Gensler, now holds Brooksley Born's former post at the C.F.T.C.

It still lacks authority to regulate O.T.C.

derivatives.

Alan Greenspan retired from the Federal Reserve just before the crisis hit in 2006.

(gavel pounds) >>The committee will please come to order.

>>NARRATOR: Last year, he once again appeared before the Congress.

>>You see Greenspan at the hearing table after the collapse, and you see a crushed man, really.

>>He said that the premise that you could trust markets to regulate themselves was misplaced.

>>You have been a staunch advocate for letting markets regulate themselves.

And my question for you is simple.

Were you wrong?

>>Yes, I found a flaw, but I've been very distressed by that fact.

>>You found a flaw in the reality... >>Flaw, flaw in the model that I perceived as the critical functioning structure that defines how the world works, so to speak.

>>In other words you found that your... your view of the world, your ideology was not right.

>>Precisely.

No, that's precisely the reason I was shocked because I've been going for 40 years or more with very considerable evidence that it was working exceptionally well.

>>After almost two decades of public service, he realizes that the economic philosophy that he had pushed so hard-- resisting regulation of derivatives-- he realized that there were some fundamental flaws in that whole philosophy.

>>It was a pretty incredible moment that after a lifetime of faith in a certain way the world worked, that Greenspan would say, I was wrong."

>>It struck me as someone admitting that the core belief that had animated, you know, basically a 20-year, 18-year career as Fed chief was wrong.

It's stunning, but it doesn't undo the damage.

>>And President Obama visits New York today to deliver a major address to Wall Street.

>>NARRATOR: Last month, the president spoke on Wall Street.

>>We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis.

>>NARRATOR: Right now he is deciding how hard to push to regulate the O.T.C.

derivative market.

>>We've got to close the loopholes that were at the heart of the crisis.

Where there were gaps in the rules, regulators lacked the authority to take action.

>>NARRATOR: The president's point man, Larry Summers, now says he supports strong regulation of over-the-counter derivatives.

And Treasury has released a proposal outlining some of the same ideas Born had 11 years ago.

But the financial lobby is still against those ideas and is lobbying hard at the White House and in Congress.

The new regulations are stalled.

>>I was very hopeful that in the aftermath of the crisis we could see what had gone wrong and said, Let's fix it."

But it may be that we are passing that critical moment.

And in that case, the necessary reforms will be just much more difficult to come by.

>>NARRATOR: As for Brooksley Born, without new regulations, she's offering another warning.

>>I think we will have continuing danger from these markets, and that we will have repeats of the financial crisis.

May differ in details, but there will be significant financial downturns and disasters attributed to this regulatory gap, over and over, until we learn from experience.

>> Next time on Frontline, in a corner of New York City... >>The recession just hit.

>> Inside a shop down the street.

>>I sold the Porsche to pay my health insurance.

>> From people who could live next door.

>>I'm almost 40 years old.

Why should my mother have to give me money?

>> Are intimate stories... >>I was laid off eight months ago.

>> ...that hit... >>This is the Upper East Side.

This isn't supposed to happen here.

>> ...close to home.

Watch Frontline.

>>Frontline is made possible by contributions to your PBS station from viewers like you.

With major funding from the John D. and Catherine T. MacArthur Foundation, committed to building a more just, verdant and peaceful world.

With additional funding from the Park Foundation.