RENEE MONTAGNE, host:
It's hard to find an exact date to mark the anniversary of the start of the financial crisis, but today is perhaps as good as any. It was three years ago, on August 27th, that the National Association of Realtors announced a major drop in existing home sales. That sent stock prices falling - and you know the rest. NPR's Planet Money partnered with the investigative reporters at ProPublica to look at why the crisis became so bad. NPR's Adam Davidson has this story.
ADAM DAVIDSON: I'm going to cut to the chase, and tell you our conclusion first. We believe we can show that some folks on Wall Street had evidence, a year or two before the crisis hit, that there were serious problems with subprime mortgage investments. Rather than wind down this business, they sped it up using financial trickery. These folks earned huge bonuses for their actions. They also made the crisis larger and more damaging.
All right, let's set the scene. The folks we're talking about work in the CDO department of big, Wall Street banks.
Mr. JAKE BERNSTEIN (ProPublica Reporter): The CDO department in a bank was the sexiest place to work on Wall Street.
DAVIDSON: That's Jake Bernstein, one of the two ProPublica reporters who helped uncover this story. CDOs - collateralized debt obligations, by their official and confusing name - were the primary way that big banks turned those subprime mortgages into what we now think of as toxic assets. But back in 2006, they were just the hot, new part of the finance industry.
Mr. BERNSTEIN: It attracted a young group of people, people who were enamored with computer models and believed that they had created a perpetual money machine, that the party would never end. They worked hard and when bonus time came, they made a lot of money.
DAVIDSON: They could make bonuses in the millions of dollars. It all depended on how many CDOs they sold. I think of a CDO as a bit like a sausage. You take meat nobody wants, toss it in a grinder. Out comes something delicious. With CDOs, you buy a bunch of unattractive, subprime mortgage-backed bonds, put them all together, then sell off pieces of this new structure. And like sausages in a diner on Sunday morning, CDOs were incredibly popular.
Mr. JESSE EISINGER (ProPublica Reporter): CDOs, they are the heart of the American boom. Everyone wants them - pension funds, insurance companies, small banks around the world; everybody wants it. They can't make them fast enough.
DAVIDSON: That's Jesse Eisinger, the other ProPublica reporter on this story. He says that for four or five years, CDOs grew dramatically.
Mr. EISINGER: Then, in the summer of 2006, it seems like the joyride might be coming to an end.
DAVIDSON: What happened was for the first time, lots of customers started saying no to the bankers selling CDOs - customers like Peter Nowell, with the Royal Bank of Scotland.
Mr. PETER NOWELL (Royal Bank of Scotland): There were a lot of things that were being relaxed, on a credit perspective, over that time, as people wanted to push out more and more deals. Too many California mortgages, too low credit scores.
DAVIDSON: Customers kept saying: We'll buy the good parts of the CDOs, but not the worst 10 or 15 percent. Jesse Eisinger.
Mr. EISENGER: This is a big problem for Wall Street, 'cause Wall Street has the assembly line going. And any hitch is going to be a big problem. It's going to stop the fees and those bonuses at the end of the year.
DAVIDSON: At first, Nowell says, CDO salespeople tried to convince him: Don't leave; buy some CDOs.
Mr. NOWELL: It was definitely the hard sell: frequent calls, wanting to take you out to dinner and, you know, encouraging you to invest early and invest often.
DAVIDSON: The hard sell wasn't working. Eisenger says that no matter what they did, the investment banks were stuck with the least attractive bits of their CDOs.
Mr. EISINGER: What's happening is, it's piling up and piling up and piling up. And so they have a big problem. They've got it all coming in through one end, and it's harder and harder to get it out the door. So they need to figure out how to sell this, how to move it out of there.
DAVIDSON: This is where the trickery comes in. To explain it, let's go back to the sausage analogy. I'm going to be a sausage maker. Here's my handy meat grinder; I'll turn that on.
(Soundbite of meat grinder)
DAVIDSON: My sausage is selling great. Until one day, my customers start to say, you know what? We like the nice bits in the middle, but we don't like those nasty, knotty parts at the end. Pretty soon, I've got all these end bits piling up on my counter. Nobody wants it, and I'm worried my customers are going to be turned off to the whole sausage business. I'm losing money. So what do I do? I shove those nasty end bits back in the grinder...
(Soundbite of meat Grinder)
DAVIDSON: ...and make new sausages. Brilliant. Of course, customers don't want the nasty end bits of those new sausages, either. So, I take those, throw them back in the grinder. You get the picture; this works for a while. But eventually, I'm making sausages that are made up almost entirely of nasty end bits.
Mr. BERSTEIN: So this is exactly what happened with subprime CDOs. The investment banks take the worst parts of the CDO, and they put it into new CDOs, recycling it again and again until pretty soon, the CDOs that you're left with are made up of the worst parts of the stuff.
DAVIDSON: With Wall Street, when they recycle a CDO, when they shove those nasty bits back in the grinder, they mark it as a sale, as if they found a real customer.
Mr. EISENGER: From the outside, it looks like, oh my God, the business is booming. In fact, a lot of the business is an illusion. The CDO guys are orchestrating the demand.
DAVIDSON: What we're describing here did not cause the crisis. By mid-2006, we already were well into a housing bubble that was surely going to burst and cause financial pain. But by delaying the onset of the crisis and allowing another year of bubble expansion, this financial trickery made the crisis bigger and more painful.
We asked the banks involved for comment. A spokesman for Merrill Lynch said the company has a new owner, Bank of America, and they're not going to comment on actions taken under the previous ownership. A Citigroup spokesperson told ProPublica that they cannot comment because the Securities and Exchange Commission is investigating.
Adam Davidson, NPR News.
MONTAGNE: To read ProPublica's account of exactly how Wall Street banks created fake demand, visit propublica.org. And you can find a link at npr.org/money. You'll also find Planet Money and ProPublica's collaboration with the Gregory Brothers - the guys known for their musical spoofs. They took real tape of bank executives and using audio trickery, created a song.
So joining the Gregory Brothers, there's Brian Moynihan, CEO of Bank of America, and Robert Rubin, former Treasury secretary and chairman of Citigroup. Here's an excerpt.
(Soundbite of music)
GREGORY BROTHERS (Music group): (Singing) ...see it coming, well did you see it coming? Did anybody see it coming? No one involved in the housing system foresaw a dramatic and rapid depreciation in home prices. No one? Lenders. No body? Rating agencies. Anybody? Investors. Somebody? Insurers, consumers, regulators and policy makers. So you didn't see it coming at all? And then when you look back, you always look back, and you look back look back. And you say, well, these were warning signs. And then we look back...