382: The Watchmen

Ira Glass

Previously on This American Life.

Ira Glass

This is where we have to talk about Alan Greenspan, right?

Ira Glass

Over the last year, we've brought you many stories explaining exactly how the economy collapsed. We've heard about mortgage-backed securities and derivatives and bank balance sheets. And today, looking for a little ray of hope about our country's economic plight, we turn to the past.

Ira Glass

This is Michael Perino, a law professor who's writing a book about Ferdinand Pecora. Pecora was the lead attorney in the hearings of the Senate Banking Committee back in the 1930s. And when Pecora got that job, he turned the hearings from an unimportant and not terribly useful exercise into a real investigation of Wall Street and the causes of the 1929 stock market collapse and The Great Depression.

Pecora was a former district attorney, and he did this very, very well.

Ira Glass

Did they go into the hearings looking for bad guys, or did they go into the hearings looking to come up with an analysis of here's what went wrong and here's what we've got to fix and to have a kind of a teaching moment for the country?

Ira Glass

One of the famous morality tales from the hearings, Pecora put Charles Mitchell into the witness chair. Mitchell was the head of National City Bank, which is an institution that we know today just as Citibank. And Pecora asked him about some bonds that his bank sold, bonds that had been issued by Latin American countries. The bank's own internal documents showed that the bank thought that maybe these bonds were no good.

Ira Glass

And there's also a show trial aspect to this, right? Like, it wasn't all substantive seriousness. Can you talk about that other part?

Ira Glass

This is one of the few times that flash photography or filming was allowed in the hearing room, and it led to the most famous photograph of the hearing, which came after a senator complained that all the media that had turned out to see J.P. Morgan had turned the proceedings into a circus.

Ira Glass

Reading these hearings, do you think we should do this now?

Ira Glass

And do you feel like that's what we've gotten so far?

Ira Glass

So, basically, they call these executives, they yell at them about executive compensation.

Ira Glass

We talked about this for a while. I told Michael Perino that I was surprised that President Obama, for all of his communication skills, hasn't really presented the public with a real analysis of what went wrong on Wall Street. The most the president usually says is that the problem is that the stuff that people did on Wall Street that got us into this mess was all perfectly legal.

Well, sitting in on this interview with me was NPR's Economics Correspondent Adam Davidson, who appears on our program all the time reporting on these issues, who has actually been looking into what kind of hearings Congress might hold on the banking crisis.

Ira Glass

A circus.

Ira Glass

Yeah.

Ira Glass

Well, until our government's hearings get going, if they ever get going, we today would like to make our own modest contribution, our own mini-hearing, because we do not want to wait. Our hearing will not last 17 months.

We don't have subpoena power to force the most powerful people on Wall Street to come before us and testify, but we do have a question for our hearing, and it's this. There were regulators and there were watchdogs who were supposed to be overseeing the banks and the finance industry to make sure that things wouldn't blow up like they have. Clearly something went wrong. And we ask today, where were the watchmen?

And so, I call this program to order. From WBEZ Chicago, it is This American Life, distributed by Public Radio International. I'm Ira Glass. Our hearing today, in two parts, we have one investigator who looked at government watchmen, and one who looked at the watchmen in the private industry who were supposed to verify the safety of these financial instruments that collapsed. Stay with us.

Ira Glass

OK, settle down. Order. Our first investigator we sent out with this assignment. We asked her to take one financial institution that really screwed up and tell us what was the deal with their regulators. Where were the government officials who were supposed to be overseeing that institution?

Well, AIG seemed like a good institution to pick. The government has now committed $170 billion-- that's billion with a b-- into that company, which dwarfs the bailouts of GM, Citibank, and Bank of America. Our intrepid investigator, reporter Chana Joffe-Walt, first set out to answer what seems like a very simple question, which government regulator was supposed to be regulating AIG?

Chana Joffe-Walt

You and I, we read about the collapse of AIG on a Tuesday morning in the newspaper, but Eric Dinallo got a personal phone call Friday night. Dinallo's the insurance regulator for New York State, and it was AIG's chief financial officer on his cellphone. Eric, we need to discuss a liquidity problem.

Chana Joffe-Walt

Saturday morning, Dinallo heads into AIG. At the door, put the BlackBerry away, Sir, please. He does, and enters this conference room. There's no space at the table. AIG executives, Wall Street CEOs, bankers, advisers, treasury people, they're all there sitting next to a bunch of snacks no one has touched. AIG needs cash, and no one in the room is offering it up. Dinallo looks at his deputy, Hampton Finer. Finer looks around the room.

Chana Joffe-Walt

AIG's collapse was shocking to you and me, sure. It was shocking to people who held AIG insurance policies. OK. But these guys, Eric Dinallo and Hampton Finer, they are regulators, regulators, New York State insurance regulators, guys who talk about AIG in their morning meetings, guys who go out to AIG companies and do examinations, hold conferences about AIG quarterly reports. These are exactly the guys you hope will not be surprised when the enormous insurance giant based in New York calls its regulator and says we have no money.

I asked Superintendent Dinallo about that. You're the New York insurance regulator, doesn't that make you the guy in charge?

Chana Joffe-Walt

A couple minutes of Google and some secretaries and the next day I'm asking Commissioner Thomas Sullivan the same question.

Chana Joffe-Walt

OK, anyway, Dromer just proceeded to tell me in, I have to say, the most snooty way possible, obviously the subsidiary was regulated by the French regulator, but the subsidiary didn't mess up the global economy, Financial Products did, and Financial Products is a US company. France, not responsible for American mess-ups.

AIG has approximately 400 regulators in 150 countries and all 50 states. I think I called 35 of them. Do you know how hard it is to get a regulator to even talk to you, to even say the words, not my fault? Which, by the way, is what every single one of them told me. It sounds crazy, right? And unsatisfying and frustrating and confusing.

But also, unfortunately, mostly legit. AIG was this enormous company, gigantic international operations, $1 trillion in assets. Those 400 regulators, they were each handed a small chunk of the monster.

I asked Eric Dinallo, the New York insurance regulator, about that.

This took 18 minutes, four men in suits, one computer, two cell phones, and I'm not sure how many calculators, to figure out what portion of AIG this one office is in charge of. Here's just a little piece of all that.

Chana Joffe-Walt

He did bang his head on the wall. And then--

Chana Joffe-Walt

In other words, Eric Dinallo is great at property and life and car and death insurance in New York State. He is not-- no offense, Dinallo-- a star at airplane leasing, insurance in Bangladesh, real estate in Tokyo. So Dinallo focuses in on his one thing. He's given 7% to 10% of AIG, and he says, I regulated my 7% to 10% very well, thank you.

The problem was that all these regulators with their 5% here and 3% over here, it didn't all add up to 100% of the company. There were a few percentage points missing, parts of the company that nobody had specific jurisdiction over. And that right there became the story of what went wrong with AIG. Federal Reserve Chairman Ben Bernanke told Congress:

Chana Joffe-Walt

The Financial Products Division was the part of the company that bought and sold derivatives, which, as you may have heard, were the complicated financial instruments that nearly sunk AIG. And Bernanke was saying no one was regulating that part of the company. And for months, that story stuck.

And then one day, Donald Kohn, also with the Fed, he's telling that story. He's in a Congressional hearing, and he's going on about how, unfortunately, no one was watching that part of the company and no one was watching over the whole thing, the whole of AIG. Senators dutifully asking follow-ups, and then they get interrupted. A hunched man peeking over his glasses says, um, we were, we were in charge, we screwed up.

Chana Joffe-Walt

There it was, Scott Polakoff, interim director of the Office of Thrift Supervision, OTS, saying, blame us. Thrifts are the same as savings and loans. They're a type of bank. And the OTS regulates thrifts and holding companies that own thrifts. And what Scott Polakoff was saying here is, we were the thrift regulator and we were the regulator for the whole company, what's called the lead regulator, for all of AIG. We were supposed to fill in all those gaps.

At this moment, you can tell, watching the hearing, that congressmen, they're kind of taken aback. They actually seem sort of incredulous. Senator Mel Martinez leans in.

Chana Joffe-Walt

Polakoff says, yes, I'm the one, sir. And Senator Jeb Hensarling from Texas, in a hearing two weeks later, he asks Polakoff, wait, did you say that?

Chana Joffe-Walt

Senator Hensarling then says, so it wasn't that you didn't have the authority, it wasn't a lack of resources, it wasn't a lack of experience, you just flat made a mistake? Polakoff says, once again, yes, sir.

So, here's this guy standing up and saying, yes, me, I'm the one you've been looking for. And everyone kind of goes, you? Who are you?

I'm guessing you've never heard of the Office of Thrift Supervision. The OTS is the smallest federal bank regulator, and it's the youngest, 20 years old. I did call the OTS several times. No one talked to me about AIG. The press guy told me, we've testified before Congress twice, we're not going to go beyond that.

So then I started calling the regulation expert people, like Patricia McCoy. She's a law professor at the University of Connecticut, someone who in her free time sits down with a pen and paper and does bank autopsies. She'll research failed institutions, look at what went wrong. You know, for fun. So one night, McCoy's making this graph of major bank failures from '07 and '08.

Chana Joffe-Walt

You might recognize some of those names. For instance, IndyMac, the most expensive bank failure of this crisis, regulated by the OTS. Second most expensive, Bank United, regulated by the OTS. The largest bank ever to fail, Washington Mutual, OTS. Other OTS claims to fame, Countrywide and AIG.

Chana Joffe-Walt

This is William Black. He's professor at the University of Missouri-Kansas City. And he used to work as a lawyer for the Office of Thrift Supervision back in the early '90s. Black says the idea that the OTS could ever go up against AIG, the world's largest insurance company, well--

Chana Joffe-Walt

You think about how institutions get their regulators, and you just think, they must get assigned one, right? It's like, you get assigned a boss, someone tells you who your regulator is.

No, if you're a national bank, you have four choices. And maybe you knew this already, but this seemed insane to me. Financial institutions, they choose their regulators. They go regulator shopping. And when AIG was regulator shopping, the OTS looked pretty good.

The OTS was actually created because another regulator really messed up, the Federal Home Loan Bank Board. It used to regulate savings and loans until the savings and loan crisis in the late '80s, at which point Congress abolished it and created the OTS.

And I talked to several people who worked for that predecessor agency, The Bank Board, and they described that, on that day, the day the OTS was created, they left the office, these agency employees, and they walked across the street to a hotel. They turned on the TV, and they sat and watched the first President Bush stand up at a podium and declare, never again will America allow any insured institution to operate without enough money. And then the agency employees watched as the president trashed their agency.

The press conference ended, they turned off the TV, left the hotel, crossed the street, and went back to work. Pretty soon, someone came by and changed the sign, the Office of Thrift Supervision.

So there was this newborn savings and loan regulator, and for a while it did try to change its ways. A new administration brought in new management, but the OTS was in a tough spot. Savings and loans were dropping like flies, and this was a problem for the OTS, a serious problem, because-- and this brings us to an even more insane fact about the way our system of regulation works-- federal bank regulators, they're paid by the banks, the people they're supposed to be regulating. They don't get a government budget. The more banks they regulate, the more money they have.

So, if you're the thrift regulator, and hundreds of thrifts just drop dead, that's a problem for you.

Chana Joffe-Walt

Now, the OTS couldn't hold a press conference and say, hello, we're having a going-out-of-business sale. We'll be the laxest regulator in town. Come on down, sign up. No, instead they went to industry meetings. They talked about the services they offered, how you could do more things. And they did make sure to show up at other kinds of press conferences, make their presence known.

Like, this one time a bunch of federal regulators were getting together to announce a campaign to ease regulation, cut through red tape, and James Gilleran, the head of the Office of Thrift Supervision, he shows up for the photo op. Gilleran, just by the way, did not return calls, so Patricia McCoy and William Black, they paint the picture.

Chana Joffe-Walt

Companies got the message. In 2000, General Motors bought a thrift. Next year, so did GE. A few years after that, H&R Block had a thrift. And in 2000, a large insurance conglomerate called AIG opened a small savings and loan in Delaware. It was 1/1000 of AIG's total balance sheet, but that meant AIG could get OTS as its lead regulator, overseeing its entire business. All of it. The holding company regulator, the international regulator.

Calling up the world's regulators and asking, which one of you screwed up with AIG? Extremely frustrating. But talking to people about the OTS, I've got to say it's pretty satisfying hearing, man, they screwed up. Finally, it's clear-cut, simple answer, easy villain, great. Should have stopped there.

Chana Joffe-Walt

This is Mike Roster. He's a veteran regulation lawyer, and he says, sure, you can dump on the OTS if you want, but spread out your anger a little. First of all, save some for Congress.

Back in December of 2000, Congress passed legislation that made it incredibly hard to regulate the exact part of AIG that caused all the problems. It was this law called the Commodity Futures Modernization Act. And it said, certain kinds of derivatives-- those complicated financial instruments at the heart of AIG's problems-- cannot be regulated by the federal agencies that typically watch over that kind of thing.

Let me just repeat that. In 2000, Congress decided federal regulators could not regulate the thing that got AIG into trouble. President Clinton signed that act into law. In retrospect, it seems crazy, but at the time derivatives were still a pretty small market. Politicians just didn't see the risk, which means, in the end, that even if the OTS had really, really wanted to regulate the hell out of AIG, in theory, as the lead overarching regulator, they could do it, but they would have had to step in and do things that were really the specialized job of this other federal agency, a job Congress had just barred that agency from doing.

And Roster says, don't use up all your anger on Congress either. How about all those other firms that did deals with AIG? All firms with regulators, by the way, who thought everything looked great. And they thought everything looked great at AIG, not because the OTS was doing such a bang-up job regulating. No one, Roster says, was paying any attention to the OTS.

Chana Joffe-Walt

So, if you want to know which regulator to blame AIG on, it's not the state insurance regulators, or London, definitely not France, the Office of Thrift Supervision officially takes the blame, but then we can also point the finger at Congress and the rating agencies. The rating agencies, now, they were supposed to be looking at each and every bond, each and every derivative, to make sure it was safe.

The rating agencies are a whole other can of worms, and one we will open in just a minute.

Ira Glass

Well, I couldn't have said that better myself. Thank you, Chana Jaffe-Walt. We have can openers at the ready and worms ready for the close-up. And by worms I don't mean to disparage anybody in our nation's financial industry. That's in a minute from Chicago Public Radio and Public Radio International when our program continues.

Ira Glass

This American Life. I'm Ira Glass. Come to order. Come to order, please. Well, we in our program are hungry for the kind of hearings that they had back in the 1930s after the stock market crash, where investigator Ferdinand Pecora made complicated Wall Street shenanigans understandable to everybody. And so, because we don't have those yet, we are holding our own hearings today, right now.

And we turn our attention now in these hearings to the credit ratings agencies. When all those financial instruments that brought down our economy, the mortgage-backed securities, the derivatives, all that stuff, were originally issued, three rating agencies, Standard & Poor's, Moody's, and Fitch, gave many of those things their top rating of Triple A, meaning very low risk, as safe as can be.

Because of the great ratings, trillions of dollars went into those financial instruments and into the housing market, creating a big bubble, of course. And of course, the ratings did not turn out to be correct. Standard & Poor's, for example, has downgraded roughly half, half, of its triple As, some way down to almost its lowest level, the Triple C.

The rating agencies just had one job to do, assess how risky these things were. That seems pretty clear. On that job, they failed. So should they take a lot of blame for the global financial crisis?

Well, our hearing continues. Here's Alex Blumberg and David Kestenbaum.

David Kestenbaum

Pretty much anyone who issues a bond gets a rating from the rating agencies. Companies, cities, even entire countries get rated. Standard & Poor's gives IBM an A+. The Saint Louis County School District R-9 gets a double A-. Argentina, B-.

Alex Blumberg

There's this old book, Moody's Analysis of Investments, Steam Railroads, 1917. Adirondack Railroad? Triple A rating. Aberdeen & Rockfish Railroad? Stay away from that one. They got a B. So for something like 100 years, this is what the rating agencies have done, tried to answer one simple and critical question, if I lend someone money, buy one of their bonds, am I going to get my money back?

David Kestenbaum

But in the early 1980s, a different kind of bond came along. Today they go by many names, mortgage-backed securities, collateralized debt obligations. They all fall under the broad heading of structured finance, which is basically that thing you've heard a lot about. Thousands of loans or mortgages pooled together in bundles and then sold as bonds.

And their numbers grew. Over the last decade, Wall Street created trillions of dollars of these bonds. And the rating agencies rated them. Frank Raiter worked for one of these agencies, Standard & Poor's, in the Structured Finance Division.

David Kestenbaum

These days, Frank Raiter lives far away from Wall Street. In fact, he's out of cellphone reach entirely. He's clearing himself a little farm in rural Virginia. He does have an office, but it's got a turtle in it.

And the reason I wanted to talk to him is that Frank Raiter was at Standard & Poor's at the very beginning, when the structured finance products were really taking off. And he was on the team people that had to figure out the best way to give them letter grades.

Alex Blumberg

So let's say you had a mortgage-backed security. It's made up of, like, 5,000 or so mortgages. Basically, you have to estimate how safe each of those 5,000 people is, how likely they are to default.

David Kestenbaum

Raiter says when he first started working at Standard & Poor's, they had databases on all kinds of borrowers, ones with good credit, bad credit. And to figure out how likely the borrower is to default, they hired a company, a math company. And the math company made them a computer model based on an actual equation.

David Kestenbaum

So, for the first five years or so that Frank was with Standard & Poor's, things went pretty well, he says. They were taking their historical data about borrower behavior, feeding it into the model, and using the results to issue their ratings. But then, in the early 2000s, as we've heard, banks started issuing mortgages to people who wouldn't have gotten them before, people with bad credit scores, putting no money down and not saying what kind of job they had.

There wasn't much history on how this kind of borrower would behave. The equation couldn't really handle them, and that worried Frank. He says they had to basically guess at the default probabilities, put magic numbers into the model. Raiter says the only way that seemed OK to him was if they started collecting data on these new borrowers to see how they performed over time, so they'd have some real historical data to put into the equation.

But when he went to his bosses saying, we need a new model, we need to collect more data, this is the answer he got.

Alex Blumberg

This brings us to witness number 2, Jim Finkel. He works at a company called Dynamic Credit, and some of you might remember him from an earlier This American Life episode, The Giant Pool of Money. He was the guy putting together some of these structured finance deals that the rating agencies were rating. He was with Wall Street.

And he says what a lot of people say: one reason the rating agencies didn't just say no, put the brakes on everything, it would have cost them money. The rating agencies get paid by the Wall Street investment banks who are creating and selling the bonds. If a rating agency said to one of them, I'm not going to rate this newfangled bond of yours, I don't have enough information, Wall Street had an answer, a very persuasive one.

Alex Blumberg

Felicia Grumet, like Jim Finkel, worked on Wall Street, at Bear Stearns. We'll call her witness 2A. She also created these bonds, and she explained how she would try and get the rating she wanted from the rating agencies.

For instance, sometimes she'd have a new type of deal she needed to get rated. The rating agencies didn't have a set methodology for rating something new like this, and so her team would propose a structure to try to get as much of the deal Triple A as possible.

Alex Blumberg

Felicia and I had talked for a long time, and so said that eking the most out of every deal, scouring the rules for every loophole, that was just what you did. That was everyone's job on Wall Street.

Alex Blumberg

Again, Structured Finance Manager Jim Finkel.

Alex Blumberg

OK, Dave, we just have one final witness for the prosecution. She comes from the one corner of this whole thing that we haven't heard from: the investor.

David Kestenbaum

Mabel Yu, yeah. She worked at Vanguard, which manages $400 billion in bond investments. And every time a new structured finance deal came out, these deals, with their Triple A bonds, would land on her desk and on the desks of hundreds of people like her. And those deals looked great to a lot of investors, but they did not look great to Mabel Yu.

Alex Blumberg

And here, at long last, is the defendant, or at least an employee of the defendant, Tom Warrack.

David Kestenbaum

He actually used to work for Frank Raiter, the guy on the farm.

Alex Blumberg

With the turtle. Warrack has been at Standard and Poor's for over 15 years. He's helped rate hundreds of mortgage-backed securities. And we asked him about Frank Raiter's concerns, that mortgages were being given out to a new type of borrower with low credit scores and little documentation.

David Kestenbaum

Let's examine that last sentence. We are able to develop assumptions around what the future will be like for these particular borrowers. I think that's one frustration many people have. Those are not the words people are looking for.

The words people are looking for are these, I'm sorry, we were wrong. Moody's declined our request for interviews, but the president of Standard & Poor's, Deven Sharma, did agree to speak with us. Here's the closest he came to admitting that his company screwed up.

David Kestenbaum

Some of you may detect the delicate verbal parsing of a man who, before our 20-minute interview, had probably undergone many hours of legal counseling. The credit rating agencies are of course being sued, and they don't want to say anything that can be used against them in court. And, apparently, listen, we really screwed up, we're very sorry, can be used against you in court. As a result, we'd ask a question, and we'd get a talking point in response.

Alex Blumberg

And so, we find ourselves in a strange position. We've had so many conversations over beer, over coffee, over the phone, with former and current rating agency employees who didn't wish to go on tape. We've read articles, we've sat through panel discussions, and we think we can explain their point of view more clearly than any of their official spokespeople.

David Kestenbaum

Well, we're going to try. So, Alex, you want to be the rating agency, I'll be the pitbull reporter?

Alex Blumberg

All right, bring it on, man.

David Kestenbaum

All right. Where to start? How about this? Look, when you rate something Triple A, it's supposed to be safe, it's supposed to be really safe, it's supposed to be so safe that the rating really shouldn't change, and yet nearly half, 1/2 of the securities you rated Triple A during the bubble, they've been downgraded. Explain that.

Alex Blumberg

OK, those letter grades, the Triple A's and Triple B's, those are just our best estimate. They're not a buy or sell recommendation. Investors just weren't using our ratings properly. They should have been more like Mabel Yu, asking more questions. They should have come up with their own conclusions.

And besides, it's smart to change the ratings. The economy has fallen off a cliff. You want me to make sure my ratings never go down? Fine, I'll rate everything Triple C. Oh, and by the way, we publish all our models on the internet. You can see how we came up with a rating all along if you wanted to.

David Kestenbaum

Yeah, but what about the fact that you were paid by the people whose securities you were rating?

Alex Blumberg

Sir, the notion that someone could buy a rating from us? You offend me. Look, someone has to pay us. It's either the issuers or the buyers. There are conflicts of interest either way. We know that and we deal with it.

The vast majority of our ratings held up. We rate trillions of dollars of all kinds of bonds. Most of them have behaved exactly as we expected them to. Mortgage-related bonds are a small part of what we do.

And anyway, it's totally unfair to put all of this on us. Wall Street and mortgage lenders lied to us. Investors got lazy and bought the stuff without doing their own due diligence. You want to know what I think? I think we are a convenient scapegoat, and we're being used by you and everybody else to avoid examining their own mistakes.

David Kestenbaum

Are you done?

Alex Blumberg

Yeah, it actually felt good to get that off my chest. I'm back now.

David Kestenbaum

OK, because there's something else we need to talk about, which is the back story.

Alex Blumberg

Right, the back story. How did these companies go from publishing their little railroad guides in 1917 to being at the center of a global financial meltdown?

David Kestenbaum

To find the answer, we went to talk to a professor at NYU named Larry White. And when we say professor, we mean the whole package: gray, slightly unkempt hair, a novelty tie featuring NASDAQ ticker symbols. And in one of the many books in his office, Larry White is sure is the name of the one man who planted the seeds of our current crisis.

David Kestenbaum

Our man, J.F.T. O'Connor, was Franklin Delano Roosevelt's comptroller of the currency at the height of The Great Depression. During The Depression, it was O'Connor's job to fix the banking system. And he did what seemed like a totally reasonable and prudent thing, to try to keep the banks from taking too many risks.

Alex Blumberg

This, says Professor White, was a pivotal moment, because now the rating agencies' little letter grades took on a very special meaning. Whereas before the tool was just a tool for investors to use, now the rating became a requirement.

And things didn't just end there. In 1975, the SEC, The Securities and Exchange Commission, passed a rule saying, financial institutions couldn't rely on the ratings of just any rating agency, but only on specially designated ones. For many years, that meant just three: Moody's, Standard & Poor's, and Fitch.

States jumped on the bandwagon and started requiring ratings for pension fund investments and for insurance companies. Even the financial industry got involved and wrote ratings requirements into its own deals.

David Kestenbaum

And so, these three companies and their letter grades became the foundation for trillions of dollars of investments. It was as if, without fully realizing it, the world had wired the global economy with explosives, and the ratings were the fuse. And then, on July 10, 2007, the first fuses got lit. Moody's saw the light and downgraded hundreds of subprime bonds. Standard & Poor's said it would too.

Alex Blumberg

As it was happening on TV, it didn't seem like that big a deal. This, after all, was the summer of '07. The Dow was near its all-time high. The recession had not yet begun. This announcement by Moody's got a mention in the business section of the New York Times, but the front page featured the headline, "Can't Sell Your Home? Maybe it's Priced Too Low."

Jerry Fons was inside Moody's at the time.

David Kestenbaum

Jim Finkel, as you can hear, saw the downgrades a little differently. Finkel, remember, is the Wall Street structured finance guy. He'd spent the last few years creating and managing and investing his own money in CDOs, which were made up of lots of bonds, many of which were now being downgraded.

He could see things were going to spread. And watching those ratings downgrades, Jim said the room was silent, the phones weren't ringing, everyone was watching the same thing.

Alex Blumberg

Over the next year and a half, that death wind grew louder. Those first downgrades were followed by more downgrades of higher and higher rated bonds. And remember, a lot of financial institutions were required by law to hold bonds that were above a certain rating.

Now they had to sell, and because they were all selling at the same time, prices dropped. These dropping prices destabilized the banks which held these bonds: Citibank, Merrill Lynch, Lehman Brothers. Eventually it made its way to AIG.

David Kestenbaum

Jerry Fons, the former manager at Moody's.

Alex Blumberg

The rating agencies on their own certainly didn't cause all our economic problems. There's plenty of blame to go around for that. But on the way up, they helped inflate the housing bubble. And on the way down, they were sometimes the ones holding the pin to pop it.

David Kestenbaum

There are all kinds of proposals on the table for how, in Jerry Fons' word, to rethink the whole business. One idea is that bonds should get a kind of skeptical second opinion from a rating agency paid by investors. Another would set up a system to reward agencies that get their ratings right. Another idea, get ratings out of regulations completely.

Alex Blumberg

The two biggest rating agencies, by the way, Moody's and Standard & Poor's, would be fine with that, would be willing to give up their special legal status. The world may see them as watchmen, the people who could have stopped this global crisis, but they don't see themselves that way, or at least they don't want to anymore. It's nice to get all the business. It's not so nice to get all the blame.

Ira Glass

Alex Blumberg is one of the producers of our show. David Kestenbaum is a correspondent for NPR News. And if you like what you heard today, David and Alex and Chana actually, in fact, do a blog and a thrice-weekly podcast that is a co-production between our program and NPR News called Planet Money. www.npr.org/money.

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This American Life is distributed by Public Radio International.

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And WBEZ management oversight for our program by our boss, Mr. Torey Malatia, who just got back from his vacation in Greece. He had trouble getting around. He says the signage was really weird.

Torey Malatia

It looked like a lot of Greek letters.

Ira Glass

I'm Ira Glass. Back next week with more stories of This American Life.

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