Phil Angelides

Why do you think no one, in the end, no bankers ever went to jail for this?

Well, I hope it is not the end of the story. Let me be clear: We don't want revenge. We don't want hangman justice in this country. But if wrongs were committed, they need to be righted. If people broke the law, they need to be fully investigated and prosecuted, and if they are found guilty, appropriately sentenced or punished for that behavior. And it is the question I get most often from people: Why is it that no one has paid the price? Because I think what is striking to people is there seems to be no correlation between those who drove the crisis and who has paid the price.

And think about it for a minute. Here we are, some three years after the meltdown, and what do we see? We see in 2011 that banks had record profits. The 10 biggest banks in this country now control 77 percent of the banking assets of this country -- bigger, fewer banks. The 10 biggest banks had $62 billion in profits. And we see Wall Street compensation in 2010 rising to record levels, $135 billion of publicly traded Wall Street firms.

Meanwhile, 24 million people out of work can't find full-time work, have stopped looking for work. Nine trillion dollars in wealth of American families wiped away, like a day trade gone bad. Four million folks have lost their homes to foreclosure, and estimates are it is going to rise to 8 to 13 million people before this is over, families out of their homes. And I think there is a great sense of injustice.

And then we see a whole set of civil suits that are settled for pennies on the dollar and generally with no admission of wrongdoing. It's very much akin to someone who robbed a 7-Eleven for $1,000 being settled for $25 with no admission of wrongdoing. If that happens, you know they are going to be back at it. So we do want justice. We want people to know that there's one justice system in this country, not two.

And we want to make sure we have deterrents. And I think the most disturbing aspects of what's happened in the wake of this crisis is no real prosecutions, no real deterrents, no real payments of penalties. Take, for example, the instance of Citigroup, which was charged by the SEC [U.S. Securities and Exchange Commission] for misleading the investing public about its exposure to subprime lending. They claimed all the way through 2007 that their exposure to subprime loans, to the subprime market was about $13 billion, and in fact, it was $55 billion.

At the end of the day, the CFO, the chief financial officer, who made $7 million that year, was fined $100,000. The deputy CFO who made $3 million was fined $75,000. And the company paid a fine of $75 million, but of course that's paid by the shareholders. And time and again we've seen the lack of aggressive investigation and prosecution. Now, my hope is that the wheels of justice turn slow and that there is still vigorous pursuit of the cases, both that we referred and that have been referred to others.

But time will tell. I'm still of the hope and belief that we'll see some justice in the wake of this crisis, but to date, not yet.

And what was your role, actually? What kind of cases did you refer to DOJ [Department of Justice]?

Well, we had three mandates that were given to us. The first was to investigate the causes of the crisis and then to look at the causes of the collapse of the major financial institutions that collapsed or would have collapsed but for the extraordinary assistance from the taxpayers of this country, and then if we found potential violations of law, to refer those matters to the appropriate authorities. Now, we did make referrals. But in the interest of justice and a fair adjudication of the matters, we haven't commented on those specific referrals, and we won't. It's really up to the investigative authorities.

But you can read our report. And when you read our report, what you see are many instances of breaches of ethics and accountability. You see many instances where companies did not forthrightly lay out to the public what their conditions were. You see instances where companies that bundled and securitized and sold to investors tens of billions of dollars of mortgages knew the defective nature of those mortgages and didn't disclose them to the investors to whom they were selling them.

So it's pretty clear from reading the historical accounts of this crisis and the years leading up to it that there were many breaches of accountability, of ethics. And now it falls to the prosecutors to dive in, to dig deep, and if there have been violations of law, to bring those cases to court. And I would hope that we'll see less of the settlements with no admission of wrongdoing and more cases that go fully to court.

What kind of numbers are we talking about, the referrals that you guys made?

Well, we made a number of referrals. Again, if you read our report, you will see many instances where companies had information, didn't disclose it to the investing public -- didn't disclose it. You'll see many instances where companies appear to have gone over the line. We, of course, were not a jury. In the end we're not a judge. So we referred potential violations of law, and we sent those over to the appropriate authorities.

How prepared were our Treasury and the Fed -- [then-Treasury Secretary Hank] Paulson, [Chairman of the Federal Reserve Ben] Bernanke, [then-President of the Federal Reserve Bank of New York Tim] Geithner in New York -- before this crisis? What did you guys find?

Woefully unprepared. I think that was for me one of the biggest revelations of the year-and-a-half investigation that we undertook. What became clear as you look at the record is the extent to which the people who were charged with overseeing our financial system really didn't have a sense of the risks that were embedded in that system that could collapse our financial system and, ultimately, our economy.

And there's instance after instance where the folks who were in charge, who were charged with protecting the public, are caught completely by surprise. Of course, in 2007, in the spring and summer of 2007, Hank Paulson and Ben Bernanke reassure the public consistently that there is really no chance that the problems in the subprime market will spill over into the larger economy. And of course that turned out to be wholly wrong.

A good example is in July of 2007, when one of the first real signals of trouble to come happens, and that is the hedge funds that are run by Bear Stearns blow up. And then there is a meeting at the Fed about the implications of that. And what you read when you see what happened in that meeting is the view is that Bear Stearns is relatively unique, when, in fact, now we know that the holdings of major investment firms in these toxic subprime securities was pervasive.

You see that it's only in August of 2008 the Treasury claims that it fully understands the depth of the problems at Fannie Mae and Freddie Mac, literally weeks before the government decides to seize those entities. It is only a month before Lehman collapses that the New York Federal Reserve, the Federal Reserve Board of New York, decides that it had better look into the derivatives positions of Lehman Brothers, who had 900,000 derivatives contracts, and only one month before they said, "We'd better get a handle on this."

And of course then they're afraid to ask for the information from Lehman, lest they set off panic in the marketplace.

They want to look at the master contracts for the derivatives. And you guys find e-mails that define what? What is the fear of asking for those contracts?

The fear is the mere asking [for] those contracts will set off panic and will set off panic that there is a view that Lehman is in trouble, which of course people in the marketplace know. And it is really quite telling, because what's striking about it is, here we are a month out from the deluge, the implosion, and we don't even have, as a country, in our regulators and our policy-makers the basic knowledge that they need about how our financial system operates.

You know, there had been a dramatic transformation of the financial system from the 1980s…

I'm going to stop you there, because the other thing you said about the way the Treasury and the Fed handled the crisis was that it showed unclear understanding of the financial system. What do you mean by that?

Well, it's striking, because you would think that the people who were in charge of our financial system would have a grip on the key risks that were in it. And if they did, they would have moved, in a sense, to get a handle on those. So take the derivatives market, which exploded in size from the time it was deregulated -- you know, by 2007 there's over $600 trillion nominal value of over-the-counter derivatives contracts. Our regulators, because that market had been deregulated, had really no sense of the magnitude of risks that were embedded in that system. In a sense they had deliberately turned a blind eye to those problems.

That's one example. Another example is just not fully understanding how the risk in the subprime market could metastasize to the rest of the financial system through derivatives, through the creation of synthetic securities and these exotic instruments like collateralized debt obligations and CDO-squared; not much understanding of the risk embedded in something called the repo market, which was a $2.8 trillion market of overnight lending, which really sustained most of these major financial institutions.

There had been a deliberate decision to leave unfettered, unregulated huge expanses of our financial marketplace. And even --

By who?

Oh, it was a collective decision, but it clearly accelerated through the 2000s. But look, it began in the 1980s. It began with the deregulation of the savings and loan industry. It happened in the 1990s with the deregulation of over-the-counter derivatives, a clear and definitive policy statement that this part of our marketplace would be left in the dark. There were changes that happened as part of the Glass-Steagall Act reforms or repeal in 1999, when, in fact, in many ways, the light hand of regulation was embedded in the practices of regulators.

And, of course, through the 2000s you had instance after instance where regulators failed to spot problems or repeatedly assured the public that things were OK. For example, the Securities and Exchange Commission had the full authority to control leverage at the major investment banks. This is how much they were borrowing on thin capital. Yet they chose not to act.

And is part of the reason for that because of something you said before we started the interview, of the power and the sway of the financial industry that you didn't understand before you got involved in this research?

Well, I understood that it was a very powerful industry. I was struck by the extent of their power and how at every turn they exercised that power to make sure that either big swaths of the financial industry weren't regulated or even the most basic of information wasn't provided to policy-makers or regulators so they could understand what was happening in the marketplace. The best example is, of course, the derivatives marketplace, where there was a decision deliberately to deregulate that market, and in the course of doing that, deprive policy-makers of the fundamental information that they needed. But ... I think it was both the power of the financial industry plus the ascendancy of an ideology, an ideology that held that there was an intersection between the self-preservation instincts of these big financial institutions and the public interest. The view was that they would always, in the end, protect themselves and therefore protect the public. And we found, of course, that that was a completely flawed ideology.

But it was bought into, and bought into widely.

And Alan Greenspan eventually apologized for that?

Well, apologized and then quickly recanted and began a very steady course of revisionism. But the fact is that it was ascribed to fairly broadly. Here is just kind of one piece of information. On the eve of the crisis by 2007, the shadow banking industry, which is essentially the lightly or not regulated parts of our financial markets, had grown to have about $13 trillion of assets. The traditional banking sector -- you know, the commercial banks and thrifts that were regulated for the public interest -- had about $11 trillion.

What had grown up alongside our traditional regulated banking sector was a largely unregulated financial system with many dark pockets unseen by the public and by regulators. And in the end it was the risk in those systems that overwhelmed the system itself. …

Going back to Bear, when Geithner, who is really handling that one, sees the hole in Bear, how surprised is he, and how extraordinary [is it] that he was surprised?

Well, I think it's extraordinary that he should have been surprised, given how many assets they had in mortgages, in subprime and what's called Alt-A mortgages. And, you know, when things go at Bear, they go fast. They start the week of their collapse with about $18 billion in cash, which is less than the other institutions. But within five days it's gone, as essentially there is a run on that institution.

In a sense, runs happen very quickly. So when they start, they gather tremendous velocity. As I noted earlier and I will just repeat, right after Lehman, Morgan Stanley goes into meltdown. They go from $130 billion on hand to about 55 billion. Goldman Sachs within one week goes from 120 billion to 57 billion.

Some could argue, hey, when runs happen, they happen fast, so the policy-makers had to act quickly. But I think what's most troubling is the extent to which they didn't see the fundamental rotting in the system that had manifested itself for years. And it was clear, I think, and evident to many people in the marketplace by the end of 2006.

And remember, this didn't happen in a vacuum. By the end of 2006, many of the biggest subprime lenders in this country are beginning to go out of business. At the beginning of 2007 New Century blows up, so, you know, there is lead time here. Now, I think the real story of this financial crisis is probably not so much whether the bailout was the right thing to do or the wrong thing to do. The real question is, how did it come to be that this nation found itself with two stark, painful choices, one of which was to wade in and commit trillions of dollars to save the financial system, where we still end up losing millions of jobs, millions of people lose their homes, trillions of dollars of wealth is wiped away, and the other choice is to face the risk of total collapse? I mean, that's the real story. How did the policy-makers, our government leaders, the financial sector maneuver this country into that kind of corner?

Is there an irony in your mind that the fact that who Obama brings onboard as his economic team -- [former Director of the National Economic Council Larry] Summers, [Chairman of the U.S. Commodity Futures Trading Commission Gary] Gensler is involved, Geithner -- were all in the Clinton White House, were there during the later years when they decided to deregulate derivatives, that these are the people that he relies on?

One of the things that's most striking is the extent to which in the wake of this crisis there hasn't been a fundamental rethinking of our financial system and its role in our economy. If you look at the arc of what happened, from the 1980s, 1990s through the eve of the crisis, what you see is a financial system and sector that is more and more dominant in our economy, that's taking more and more risks; in a sense, an economy that is more about money making money than capital being deployed to create goods and value and jobs for the American people.

In 1980, the financial sector represents 15 percent of the corporate profits in this country. By the mid-2000s, that has risen to over 30 percent. The amount of debt in the financial sector in 1978 is $3 trillion. By 2007 that soared to $36 trillion, very much an economy now being driven by the financial sector and by the risky practices it's undertaking.

You would think in the wake of this crisis we'd have a rethinking fundamentally. And I think one of the things that's most troubling is that here we are three years-plus after, and very little has changed. Now, Dodd-Frank [Wall Street Reform and Consumer Protection Act] has made a number of significant changes. But of course there is a fierce rearguard action by Wall Street, by its political allies, to inhibit its implementation. But here we are, three years later, and the over-the-counter derivatives market is still unregulated.

We don't know today the risks that we have in this country from the euro zone crisis. It could be that banks in this country have $100 billion of risk. It could be that it has a trillion dollars of risk. In many respects nothing has really changed in the credit rating agencies. If you look across the board, very little has changed in the nature and operation of Wall Street, and I think that is one of the more stunning aspects of this episode.

Did this administration miss its opportunity when they had the leverage, they had the power to make bigger changes? Did they lose that opportunity? And if so, why? Was it simply fear that we were in such a crisis that they couldn't move too radically or else the whole thing could come down?

Well, I can't look into other people's decision making, but I do think that there was an extraordinary opportunity to remake the financial system in a dramatic way in the immediate wake of this crisis. I don't [think] the opportunity is fully lost because the country is still suffering greatly. I'd like to view it as dramatic change delayed, not forever lost as an opportunity. But clearly, in the wake of the crisis, when banks only survived through the kindness and the willingness of the American people to [for pay] trillions of dollars to support them, clearly in that context there is greater opportunity to change.

And make no mistake about it, no matter what you hear from revisionists today, almost every financial institution was on the precipice of collapse in the fall of 2008. There are those who now say, for example, at Goldman, "Oh, we would have probably made it anyway." If you listen to Ben Bernanke, he's pretty clear that of the 13 biggest financial institutions in the country, perhaps only one would have survived.

I think Secretary Geithner himself has admitted that every major financial institution was on the way to collapse. You know, it's interesting. In the week after Lehman, Morgan Stanley goes from having about $130 billion in liquidity, cash, in one week to about $55 billion. Goldman Sachs -- supposedly bold, strong investment bank -- goes from $120 billion cash on hand to $57 billion. All these institutions were about to collapse, and they never would have survived but for the trillions of dollars afforded them by the taxpayers.

So let's go to the basics.

Sure.

"Too big to fail." Number one, what does it mean? And why is it the danger that you define?

Well, "too big to fail" means an institution that, if it falls, essentially sets off a domino effect. And the fact is that leading into this crisis, we had a set of very large institutions that were woven together, interconnected very closely, so that if one of those major institutions fell, it ran the risk of creating ripples throughout the whole system, through its derivatives contracts, through the repo lending, which is that massive overnight lending market. So these institutions were very woven together and very concentrated in terms of these assets and power within the financial system.

Now, where we are today? In worse shape. Ten biggest banks in this country control 77 percent of the banking assets in this country today. Fewer banks that are even bigger, and I think that presents a real challenge for this country going forward.

So we have a problem again. What does the federal government have to do?

Well, for all the rhetoric that there won't be bailouts again -- and Dodd-Frank has changed the law so as to not allow emergency loans to specific institutions -- it's hard to imagine that we won't face the same kind of dilemma as we did in 2008 unless we make fundamental changes, unless we perhaps break apart the largest banks in this country, unless we really do move away from a system that's crippled by too-big-to-fail“too big to fail” institutions in the critical moments.

Dodd-Frank is supposed to do a big piece. But again, a big rearguard action being waged by Wall Street and by political allies on the Hill who keep, for example, trying to strip away money from the Securities and Exchange Commission, strip away money from the Commodity Futures Trading Commission so they can't succeed, blocking appointments to key positions -- Wall Street, in the first quarter of 2011, after Dodd-Frank was signed, spent about $52 million on lobbying to try to thwart the implementation of that law and its regulations.

Let's go back to the Lehman moment and break it down a little bit more.

Sure.

The report is very good at defining exactly what happens when Lehman goes down. What are the consequences?

Well, the consequences of Lehman going down, I think it goes back to what we were talking about earlier, which is that there are two consequences. First of all, there are the direct consequences from Lehman going down, the direct consequences, which is they have 900,000 derivatives contracts with other parties; they have relationships with other institutions. But more than that, the policy-makers have sent inconsistent signals. They saved Bear; they didn't save Lehman. So the marketplace doesn't know what to expect.

And there's no doubt, in the wake of Lehman, there is real panic in the marketplace. But I will say this, that whether or not Lehman went down or not, the marketplace was so infected with toxic assets that whether or not Lehman itself goes down, this country still faces a dramatic, dramatic financial crisis.

What did you find the reason was for why Paulson and Geithner decided that they would let Lehman fail?

Right after Lehman goes down, Ben Bernanke goes up to the Capitol Hill to testify about why the decision was made to let that happen. And what Chairman Bernanke says is that the judgment was that in the wake of the Bear collapse, they had sent clear signals that they wouldn't do that again, and the market therefore had time to adjust. So their judgment was the market could absorb the Lehman collapse. That's what Chairman Bernanke said right after the collapse.

But soon thereafter the story changed. And the story of policy-makers, whether it was Tim Geithner or Ben Bernanke or Hank Paulson, becomes that we didn't save Lehman because we didn't have the legal authority to do so. We looked at all the facts, and what we really found was, there was a decision to let Lehman go. And as it turned out, it was a decision that was a miscalculation in the sense they undersized the effect of letting Lehman go down.

We really found that they made it on the basis of political considerations. There was clearly concern about the backlash of another bailout. We determined that they made it on the basis that they couldn't find a buyer and had doubts about whether they really could, absent a buyer, save Lehman. And they made the decision because, in a sense, they did miscalculate the impact of Lehman. But our conclusion was that it really wasn't the lack of legal authority. It was a decision to let Lehman go for a variety of reasons, political, financial, their sense of the market.

I think what happened is, when they saw the reaction to Lehman's collapse and the looming and pending problems at AIG which were coming at the same time, they reversed course again and, of course, moved in to save AIG.

So tell us about AIG. When do they figure out, "Oh, my God, we've got a problem with AIG as well," and how [do] they react?

Well, it's again quite stunning, and it really goes to the slow response, the slow-footedness of the response. It's really the weekend of the Lehman collapse that they become fully aware of the depth of AIG's problem. I believe it's the Friday night before Lehman collapses, Lehman files for bankruptcy, the beginning of Monday morning effectively, at the end of a very long and tortuous Sunday. And it's really that Friday, while problems at AIG had been on the screen, where the problems of AIG burst fully on the scene.

Here's this mammoth institution that turns out to have an enormous hole in it. And again, policy-makers just come to grips with the extent of the challenges and the problems days before its imminent collapse. And of course in the wake of Lehman, a decision is made to inject over $80 billion in AIG, which, of course, ultimately grows to $180 billion.

So Paulson creates this TARP [Troubled Asset Relief Program] plan. And I guess the way it is written out is he writes it on three pages, and then he goes to Congress and has to sell them on the disaster that is about to happen. What's your take on that moment?

Well, that moment was the result of everything that had preceded it, you know. And Hank Paulson came before a commission. He said that by the time he became Treasury secretary [in 2006], the toothpaste was out of the tube. In fact, he had been doing a lot of squeezing as the CEO of Goldman Sachs, and in many respects the toothpaste was out of the tube.

So, you know, TARP I think was just emblematic of the slow-footed response, the lack of grasping of the depth of the rot within the financial system. Again, I don't impugn people's motives here, but Hank Paulson is the same person who, throughout the spring of 2007, is assuring everyone. And he is Treasury secretary. He has been in the financial marketplace. He is assuring everyone that the subprime crisis will not spill over and there is little risk of that, as is Bernanke.

So look, TARP, like the AIG bailout, is just a manifestation of the mad scramble that has to take place to try to contain the damage from years of neglect in Washington and recklessness on Wall Street. I mean, the bill finally came due.

And when this TARP goes up before Congress, there's an enormous amount of anger, and it doesn't even pass the first time. I mean, what does that say?

Well, you know, I think the anger is partly born out of the fact that here we are in this crisis, and now policy-makers are asking for a large blank check, having previously underscaled, undersized and really underrepresented the scale of the challenge that our financial system faced. I think that was the real problem with TARP. But I think it is interesting. TARP gets a lot of attention because it was the one piece of this that actually went through the deliberative legislative process.

But it was just the tip of the iceberg. TARP was $700 billion. And it was just a piece of what ended up being trillions of dollars of assistance to the financial sector, much of which was not known [to] or seen [by] the public at large.

So trillions of dollars, in secret, flowed out of the coffers of the taxpayers' money, out of the coffers of the Fed to these banks in secret. Why, number one? And what is the lesson to be learned from that?

Well, what should be clear is, TARP was the tip of the iceberg and that the Fed did announce a whole series of lending programs along with others like the FDIC [Federal Deposit Insurance Corp.] to stabilize the financial markets. What I don't think people have fully understood until recently -- you can read our report; you can see other aspects -- is the breadth of what happened here. And, you know, no matter what they say about money coming back, this was risk money. This was money of the taxpayers of the United States put out with the risk of loss.

And we did pay a price for it, because, to the extent the political capital has been used to stabilize the financial system, I think there's no question that that's inhibited the ability to seek the kind of assistance to rebuild our economy, to help homeowners. There's no question -- you know, the popular argument is, "Well, TARP made us money," but it also precluded us from moving forward and asking the people of this country to make the kind of investments to stabilize the housing market, to help homeowners, to create jobs that [were] necessary in the wake of this crisis. So we paid a dear price for TARP and for all the associated lending that happened out of the Fed.

And Geithner's attitude always was, "No, our role here was to save the banks." He in fact at one point says, "Coddling the banks is actually -- that's what our philosophy is." So what was the philosophy, and what was going on?

Well, I can't look into their heads. Here is what I can say. The reason we ended up, as a country, having to deploy massive amounts of money to stabilize the financial system is because there has been a philosophy of laissez-faire, a philosophy of condoning recklessness, a philosophy of turning a blind eye that allowed the magnitude of risk and therefore disaster to build up.

So much of the focus has become on the immense amount of resources deployed for the bailout, and I think that's a rightful focus. But I think it misses the larger point, which was how did it come to be that we allowed our system to take on so much risk? How did we allow these systemically important financial institutions to undertake the kind of reckless acts they did without the proper regulatory oversight that required, at the end, this level of assistance?

I mean, it just speaks to the magnitude of the disaster and the failure of financial policy in the years leading up to the crisis. That's the real lesson to be learned here. You know, at the point that the fire's burning, you call out all the trucks to put it out. The real question is, who lit the match? Why was the fire unattended? Why were the alarm bells to put the fire out early, why weren't they heeded? That's I think the real question that we have to ask ourselves.

And I think that goes back to the fact that the financial sector was so dominant politically, and the ideology, which they pushed at every turn, of deregulation, laissez-faire, light hand of public oversight, that that had been very successful for them. And that's the price that we paid, was having to deploy these massive resources.

You write in the report that we didn't build jobs; we didn't build wealth; we built a sand castle economy. Explain what you meant by a "sand castle economy" that we built and how this came to be.

Well, I think looking back on it, we're going to see that one of the great tragedies of the years leading up to the crisis, particularly from the late '90s on, is we had cheap capital available, which could have been deployed to build enterprises, to create wealth, to put people to work in this country. But what did we do instead? We created $13 trillion of mortgage securities, many of them defective, many based on loans that never should have been made, many based on loans that were fraudulent.

And in the end of the day, what did we have to show for it? No real wealth creation, but merely the use of capital for speculation and speculation only. In the end, this was not anything about an economy that was creating real value. It was about an economy of money making money all the way along the chain. And you just have to look at the whole mortgage securities industry itself. People were making money at each step in the link, taking money out of the system. And at the end of the day, when the tide came in, it washed [it] all out, and there was nothing left.

The anger that grew on how the banks were dealt with, along with the amount of money being spent and everything else, came back to haunt the Obama administration. The midterms came about, and, I mean, what was the reality that they found themselves in?

Well, I think by 2010, of course, what people had seen was massive assistance to the financial sector. Yet at the same time, homeowners, people without jobs were left in many respects to fend for themselves. So, you know, there was anger that had built up, and that always accrues to the detriment of those that are in power. But I do think there was a golden opportunity lost in the wake of this crisis to bring in fresh ideas, a fresh team essentially, to examine what we had done over the last two decades and to talk about how we could reverse the damage and remake the economy so that we had a financial system that could support real growth in this country.

And, you know, it really is striking. Take a look, for just a minute, about what we did for banks and what we did for homeowners. Trillions of dollars going to the banks -- 24 separate programs of financial assistance, TARP obviously being the crown jewel or the centerpiece of that program, $700 billion.

For homeowners, we had a series of anemic efforts to try to help people stay in their homes. Less than a million people have been helped by HAMP [Home Affordable Modification Program], which is the main program to help people modify their mortgages. So we are now in a place today where 11 million households owe more on their mortgages than their homes. The first wave of foreclosures in this country were in the people that got all those loans that probably never should have been made. The second wave happened when millions of people lost their job. And now the third wave that is happening are millions of people who are underwater so badly that they just know that there is no hope that they will ever have equity in their homes, and they are beginning to walk away. Those homeowners, those underwater homeowners, are underwater by about $700 billion, and not enough has been done to help them.

It's striking that we did so much for the banks. Yet what we haven't done is lowered the principal amount for homeowners so they could stay in their homes so we could restart the housing market. And it really is kind of a striking dichotomy between what the most powerful banks got and what tens of millions of homeowners got.

Citibank analyst Mike Mayo testified before you, and he lists the reasons why the financial industry are out of control, operating on steroids and such. Why was he called? What were his main points? Why was he called? Your thoughts on that?

Well, we called him on the same day that we called some of the major bank CEOs there, because we wanted a check on reality. And I think he gave some very strong testimony about the extent to which banks were unbridled in the risks they took, the extent to which their boards sat on the sidelines when these great risks were being taken, the extent to which their internal control mechanisms were either nonexistent or broken down.

And I think he pointed out that the whole deregulatory philosophy was built on the notion that we didn't need public oversight because these institutions themselves had built very rigid, new measures to control risk. But in fact, they were highly leveraged institutions. They were geared towards maximizingmum profit, therefore maximizing compensation for their executives; that the whole system was geared to making sure you could book as much profit as possible in any given year to reward the biggest possible compensation no matter what the long-term consequences were for shareholders andin the larger economy.

And look, all you need to do is look at the payouts to some of the executives at the firm that ran aground. Take a look at Citigroup, where Robert Rubin made over $100 million duringat his tenure there, an institution at the end that was saved only by $45 billion of TARP money and a $300 billion guaranty by the government of the United States. Take a look at Merrill Lynch, which essentially collapsed and was acquired by Bank of America with the helping hand of the U.S. government. Stanley O'Neal, the CEO, makes $91 million in 2006 and leaves with a severance package of $161 million. Take a look at AIG, where Martin Sullivan, in his brief tenure, makes $107 million.

The way each of these companies operated was to book as much profit as you could immediately based on the fees and the -- as it turns out -- phony value of the assets you have. Take the money out, and be damned for the consequences long-term.

Do you feel, in the end, that we need these big banks? I mean, what social good is there in banks that engage in proprietary trading, for instance?

Look, in my view, banks can do the trading they want, but those kind of institutions shouldn't be backed up by the taxpayers of the United States. And they shouldn't be of a scale where they're too big to fail and systemically important that we have to ride to their rescue.

So it's fine if a financial institution wants to be a trading house. Let them take their risks. And if they win, they win. If they lose, they lose. But when you allow that to happen in the mega-financial institutions, and you couple that with a backing by the taxpayers of the United States, that's a formula for disaster. And unless we break that bond, we're going to have repeated crises.

You know, it's interesting. People on the right who have resisted many of the financial reforms point to Fannie Mae and Freddie Mac as deeply flawed business models. And they were. The profits were privatized; the losses were socialized. But the model of Freddie Mac and Fannie Mae that were so disastrous really ended up being the model for Wall Street, of the big institutions: profits privatized, losses socialized.

So, you know, some would argue that you need mega-financial institutions for us to compete in the global economy. I'm not so sure that's the case. Most big loans are syndicated. And, you know, we competed just fine in the global economy when we had more banks, more regional banks, more diversitye in their financial sector for years and years.

After all the hearings and all the attention spent on it all, the lessons we should draw from MF Global [derivatives broker]?

Well, it's really quite striking. Here we are again, three years after the crisis. And here is a major financial house that's leveraged 40-to-1, meaning for every dollar of capital, they're borrowing $40, the same kind of leverage ratios that brought down Bear and Lehman and would have brought down Goldman or Merrill or the others had they not been rescued by the United States government.

Now, if MF Global ends up being a small enough institution, where they rise and fall, fine. Of course, what's also striking is the extent to which it looks like, again, the regulatory system and their own internal checks missed what may be, you know, enormous sums of money not yet found.

Is there some truth to the fact that Washington is soft on Wall Street?

Oh, is Washington soft on Wall Street? I think yes. I do think that in 2009, the Dodd-Frank bill did make some important changes that Wall Street resisted. And the administration stood up, and the Democratic leadership in Congress stood up. But, you know, it's going to take some real work to change a culture that developed over 30 years. I mean, first of all, for 30 years, many regulators approached banks on the basis that they were not so much regulated entities as partners together, when, in fact, the job of public oversight is to exercise public oversight.

In fact, if you listen to some of the testimony given to us during the commission, regulators told us time and time again that they were urged not to be confrontational with banks. But in fact, in the end of the day, what we want are regulators who are. So that culture changes slowly.

Secondly, there is a real mismatch here. I mean, we have regulatory agencies that are understaffed, where pay is not what it needs to be to attract and keep people. What I saw -- and I really wasn't aware of this before I took this position -- but I was struck by the number of people who would work for a regulatory agency for three or four years, and then it was three or four years up and out to Wall Street.

And look, unless we have the political will to back our regulators and then give them the pay and the resources to do their job, it's going to be a mismatch. Look, Wall Street is like a greased pig. It moves fast. It's always looking for the new opening. Hard to catch. And unless you recognize that mismatch, you're going to continue to have Wall Street with victories at the expense of the American people.

The fact is that in the wake of this crisis, there has been very little rethinking of the practices on Wall Street. Why is that? Generally we learn, we grow from the consequences of our mistakes. But Wall Street was spared the consequences of their mistakes. They didn't really pay a price for those kind of practices in any real terms.

And the irony of the bailout is it may have saved the financial system, but it may have done great damage in terms of our ability to have Wall Street rethink what was right, what was wrong, what was sustainable, what was not.

How is this possible when Obama was considered such a reform kind of guy, a guy who was a president for the people? The expectations for him were much different. Why do you think this administration got caught in basically coddling with banks and bailing out the banks, and not bailing out Main Street?

Well, they inherited the bank bailout, and it was already in place. The real question is, in the wake of the bank bailout, why hasn't there been the kind of hard pivot to remaking the financial industry? And I think that's still a very troubling question. There needs to be. And we're seeing the president articulate more and more concerns about income inequality, about the damage done by recklessness to the economy. And my hope is that it takes hold, that beyond rhetoric it becomes real policy.

Again, I don't believe reform is too late, because the fact is, the country is still hurting deeply. I mean, we've got the lowest ratio of wages to GDP since the Great Depression, 24 million people out of work; the foreclosure disaster continues each and every day. So therefore, in many respects, the political ballast for real reform still exists today, even though a lot of revisionists would want to wish away the truth of what happened in the crisis, and although Wall Street has more power than it had clearly in the wake of the meltdown of September of 2008.

Will it take another disaster, another crisis, to actually create real reform?

I hope not.

But that seems to be the reality. I mean, that's why [chair of the President's Economic Recovery Advisory Board Paul] Volcker walked out at some point from a speech of Obama's in New York. And one of the things he said to the people around him was: "You know, it's kind of a shame the crisis didn't last longer. We would have gotten more reforms."

Well, we need it. I mean, to me, I would use the technical term it's mind-blowing that, in the wake of this disaster, we wouldn't have had the reshaping of the financial sector that was required. And again, I think that's because the irony of the bailout, which may have been necessary to preclude a depression, saved Wall Street from the true consequences of its reckless behavior.

And, you know, the fact is we look today, and the practices continue. But many of the same people who were in power in the run-up to the crisis are still there. I mean, [former Fed Chair] Alan Greenspan is gone. In many ways, he was the architect of the deregulatory philosophy that brought us down. But Ben Bernanke came out of that school and was -- he did close the lid, finally, on the worst of mortgage lending, but really after the horse was out of the barn. Tim Geithner headed the Federal Reserve Bank of New York at a time when, in fact, many of the reckless practices manifested themselves and crippled the financial system. It's really I think quite remarkable that so many of the practices and people that existed pre-crisis are still running the show today.

… You guys grilled Goldman pretty well on the issue use of derivatives. Why? What was your attitude about that?

Well, first of all, what we did as a commission is, given the limited budget we had -- you know, we had about a $10 million budget, which I suspect is less than each of the major banks spent on attorneys trying to fight our efforts or make our life more difficult. But what we did is a series of case studies to really try to expose, you know, so the commission could understand and the public could understand how the derivatives market worked. And we chose to look at the relationship between Goldman and AIG and to try to unfurl that for the public, and so we could also get a good look.

So we did a set of case studies. And we chose Goldman and AIG because it was a fascinating relationship. Here was AIG, you know, writing these derivatives contracts, essentially backstopping what turned out to be woefully defective subprime securities. And here was Goldman on the other side of those deals. And when the subprime securities started to go down, here is Goldman pursuing AIG.

What was really striking about that is here was AIG writing essentially $80 billion of insurance. Now, it's not really like insurance, because if it had been insurance, it would have been regulated. If it had been insurance, there would have been reserves posted.

But here is AIG writing $80 billion of protection on subprime securities, of which Goldman was the largest holder. And not the CEO, not the chief financial officer, not the chief risk officer, none of the people heading AIG understood that if the value of subprime securities declined, they would have to post collateral payments to their counterparties like Goldman.

And of course what happens in the summer of 2007 is the subprime market begins to crater. Goldman knocks on AIG's door, and they say, "You owe us a couple of billion dollars." And they said, "For what?" "Well, for the protection you wrote." And that came as a complete surprise to the leaders of AIG. They had no sense that they had that obligation in their contracts. And of course ultimately that was what led to their downfall. …

One last thing for me is, why were you appointed? Why was it necessary to create this group to look into it the way you did?

Well, what the law required and what was the intent was to have an official account of what led to this crisis, to put on the record for posterity, and for policy-makers and for the public to understand what had occurred. And I think what we saw as our most important role was to tell the story as it happened, and to do the best we could in the year we were given to tell that story, because you already see that there are dramatic efforts to rewrite history, to shift the blame away from Wall Street, to blame government housing policy, even though the facts don't support that. So we were appointed to lay out the causes so that policy-makers and the public could better understand what led us into the abyss.

And in that regard, I think our most important contribution was to write a history that could stand. Our job was, in a sense, to record what had happened, not to rewrite it, but also not to allow it to be rewritten. And I think that was the most important contribution. And over time, I hope more people look at the report so they can see what occurred in our country, what brought our financial system to its knees, and so we [can] pursue the fundamental reforms that still elude us today. …

So how surprised were you by the role and influence of Wall Street in Washington?

So let me just tell you two things that really I think stunned me more than anything. This was a journey of revelation for me and my fellow commissioners. And there are two things that really stick out. And first, let me say, you know, I've been treasurer of the state of California; I had been in business for two decades, so I had been, in a sense, a user of the financial system. I thought I knew something about finance in this country.

I was struck by two phenomena, first of all, the extent to which our financial system had become a casino, not what it should be or what I thought it was, which was a place that deployed capital for an economy and the nation. I felt sometimes like I had walked into my local community bank, and I had opened the wrong door, and what I saw was a casino floor as big as New York, New York. And I was shocked. And, unlike Claude Rains in Casablanca, I was truly shocked at what I saw, the extent to which the big financial institutions of this country had thrived by taking enormous risk and trading, not by lending capital to grow the economy.

The second revelation for me was, again, not as someone who's politically naive -- I had run for governor of the state of California -- but I was taken aback at the raw exercise of power by the financial industry, the resources they could throw at any "problem," like our commission, the hired guns they hired, the toughness with which they approached what we were doing, which I saw as an important service for the country. And I was really taken aback at what I saw as a tremendous power being wielded without reservation. …

What is the worst possible consequence? What’s the worst case scenario?

I just want to say, in many respects, the financial crisis never ended. It never ended. People seem to think about this financial crisis as one in which there was a run up to September, 2008, a bailout, and then the crisis passed. But, in fact, those clouds are still hanging over the global economy. And they're still filled with risk.

This crisis really never ended. There was a period of reckless lending, securities activity that extended over a number of years. And the overhang of that is still there. And it still hasn’t washed out of the system completely. Now, up until now, who has been asked to bear the brunt of that, have really been not the financial sector, but it’s been homeowners and workers. And, by the way, in the U.S. and in Europe. So you look at Europe, every effort [is] being made to protect the lenders, potentially driving countries like Greece and Spain into a depression. Here in the U.S. every effort [is] being made to protect lenders, at the same time that homeowners are drowning under a mountain of debt in this country. …

There are a lot of Republicans that will say this was all caused by Freddie and Fannie. Just give me the overview of what you found about Freddie Mac and Fannie Mae.

We looked extensively at Fannie Mae and Freddie Mac and their role in the crisis. And I think one of the most interesting notes is that when it was all done, and we looked at the data, we looked at their role versus Wall Street, and nine of the 10 commissioners -- five Democrats, three Republicans, and one independent -- did not concur with the view that Fannie Mae, Freddie Mac, and government housing policy were the driving forces of this crisis. So this was an area where the facts were on the table. And at the commission, there was bipartisan agreement.

Great, thank you.