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SYNOPSIS:

ANDY SERWER, MANAGING EDITOR, "FORTUNE": This is Wall Street, where billions of dollars of mortgages were bought and sold. To so many Americans, this was a risky business. Like playing poker on the floor of the New York Stock Exchange, or in our case, just around the corner. This is Delmonico's. For nearly 200 years a Wall Street institution, where titans like JPMorgan and Andrew Carnegie used to come and wine and dine and wheel and deal. We're here to wheel and deal with a few modern day movers and shakers. Ladies and Gentlemen, let the game begin. Tonight, we're going to be talking about the nation's housing crisis and all the problems since then affecting the economy. We have a great group of guess tonight to play this game. And let me turn over the first card. Subprime. Janet, why don't you start us off by giving us a definition of what subprime is?

JANET TAVAKOLI, PRESIDENT, TAVAKOLI STRUCTURED FINANCE: Well, subprime is sort of the catchall word that we're using for loans that were made to people with low credit scores, so they had bad credit, and these were risky mortgage products. So no job, no income, no documentation, no down payment, no problem. You can get a loan and maybe get in over your head.

JON SHIBLEY, CEO, LENOX FINANCIAL: To make a correction real quick, just if I might.

SERWER: You want to jump in?

TAVAKOLI: Yes, please.

SHIBLEY: Just in the sense of educating people properly. The subprime was kind of the bottom here. They were the -- that's the group of people that were really desperate and didn't mind taking a risky loan program because they had to compensate for their inability to qualify under normal guidelines.

SERWER: Paul, were these people -- should these people not have been given mortgages?

PAUL KRUGMAN, ECONOMIC PROFESSOR, PRINCETON UNIVERSITY: Many of them shouldn't. Many of them shouldn't have been given mortgages that large. And what's happening now is that so many people borrowed up to the hilt to buy houses based on the assumption that prices would only keep going up.

GERRI WILLIS, CNN PERSONAL FINANCE EDITOR: Well, between lousy people, these weren't lousy loans. You know, at the end of the day, what do we call them? Liar's loans? We call them strangulation loans. There were lots of problems with the loans and the way they were made. And people who -- maybe they shouldn't have had a house. Maybe they should have. They ended up getting terms they simply could not afford. You know, they had high rates of interest. They had high penalties, high fees. And of course a lot of people didn't even understand that those problems were there until it was too late.

(BEGIN VIDEOTAPE)

WILLIS (voice-over): Atlanta, Georgia. The first Tuesday of any month sounds like this.

UNIDENTIFIED MALE: Electronic registration system.

UNIDENTIFIED MALE: Hear ye, hear ye.

WILLIS: Today, 4,000-plus homes are about to foreclose on the courthouse steps.

UNIDENTIFIED FEMALE: Are there any further bids?

WILLIS: Georgia is one of only nine states that sells off distressed properties outside the court.

UNIDENTIFIED MALE: The opening bid for this property is $105,068.44.

WILLIS: Homes are sold to the highest bidder. And if no one bids...

UNIDENTIFIED FEMALE: Sold to Medici Financial.

WILLIS: It's the property of the lender.

UNIDENTIFIED MALE: Let me know when you buy something.

WILLIS: Victor Warren and his wife, Robin, have spent Tuesdays on the steps for the last 26 years.

UNIDENTIFIED MALE: So where I was willing to pay three...

WILLIS: He buys foreclosed homes and tries to sell them for a handsome profit.

(on-camera): How much are you prepared to bid today?

UNIDENTIFIED MALE: There's over two commas here.

WILLIS: So over a million dollars?

UNIDENTIFIED MALE: That's correct.

WILLIS (voice-over): Victor has an ear on every cryer.

UNIDENTIFIED MALE: Seven hundred and sixty-five Coleman Street.

WILLIS: The lawyers representing the lender. What happens to you that you find your house being foreclosed on in this public fashion?

UNIDENTIFIED MALE: Well, first of all, you would have had to have missed typically one or more payments, sometimes up to six payments.

WILLIS (voice-over): That's right. Here in Georgia miss a few monthly payments and 30 days later your home could end up here. Homeowners have always ended up here after the loss of a job, a divorce, or an unexpected illness. But in the last two years, foreclosures in Metro Atlanta have more than doubled. Why? Because of subprime loans. Loans designed for borrowers who Andy Shuping (ph) describes as...

ANDY SHUPING, BORROWER: People with credit scores that demonstrated an inability to pay their debt were buying houses.

WILLIS: And here we are today.

SHUPING: Right, but the pressure I think in society was to get people in houses. This is a segment of society. But there are a lot of people, they are just one notch above who are struggling and actually making those payments.

UNIDENTIFIED MALE: Any bidders here on 7365 Old Chapel College Park? Bernita Jones property.

WILLIS: Bernita Jones, I met with her a week earlier at her home southwest of Atlanta.

BERNITA JONES, HOME WAS BID ON: We had about 30 of them on this one block foreclose.

WILLIS: Thirty?

JONES: Thirty.

WILLIS: A minority community suffering under the weight of subprime loans. And now foreclosures. What did this home mean to you?

JONES: It's security. It's security.

WILLIS: Do you feel secure right now? JONES: No, I don't. So I was still cold even though I had the fire guard. Bernita has no heat, no electricity, and now she stands to lose her home. In fact, we had to bring in a generator just to power our lights. Now, you know, we're sitting in your living room here, and it's cold, and we're on your mattress. Why is your mattress in here?

JONES: Because I had to move everything out, and then the heat and the water out. So I had to keep the fireplace to keep me warm. So I was burning wood, paper. I start burning up all my mortgage receipts.

WILLIS: What?

JONES: To stay warm.

WILLIS: A truck driver, Bernita saved up $14,000 to close on a six-bedroom house. Purchase price -- $180 grand. She thought she got a deal on her first loan, a two-year adjustable rate mortgage at 8.375 percent. Her monthly payments -- $1,200. Did you know you were getting an adjustable rate mortgage when you did that the first time?

JONES: I don't know anything about adjustable rates. And the way they made it sound, like OK, just stay in it for two years.

WILLIS: But right before the two years were up, Bernita was injured and couldn't work. She declared bankruptcy and still managed to hold on to the house. She went back to work in pain as her loan reset. Her monthly payments almost doubled to $2,300 a month at an interest rate of 14 percent.

JONES: I was told it would go down, but it never went down. It just kept climbing up, up, up, until it maxed out.

WILLIS: She refinanced with America's top lender, Countrywide. Securing a subprime loan fixed at nine percent. She paid her mortgage faithfully until another injury made the pain unbearable.

UNIDENTIFIED MALE: Can I get you to lay down for me?

WILLIS: Bernita has been out of work ever since. Diagnosed with sciatica, a shooting pain running from spine to toe.

JONES: Oh, Lord.

WILLIS: A lot of people say that people like you just aren't working hard enough.

JONES: Oh, I work hard. God knows I do. I work 18 hours, sometimes 23 hours just to make it. WILLIS: Four months behind on her mortgage payments and desperate to save her home, Bernita writes bible verses.

JONES: Yes, I am poor and needy. Come quickly to me. Oh, God, you are my help and my deliverance.

WILLIS: So your feeling is that you've got to get back to work?

JONES: Yes. And I've got a feeling I might end up going back to work sick, not well. And I'm just praying that it don't paralyze, because it can.

WILLIS: But Bernita was too late. Her home ended up here, on the courthouse steps.

UNIDENTIFIED MALE: Going once, going twice, sold to Mortgage Electronic Registration Systems, nominee for Countrywide Home Loans Incorporated. Thank you very much.

(END VIDEOTAPE)

SERWER: When we come back, did your mortgage company have a subprime addiction?

SERWER: All right. Is the group ready for the next card? Let's turn it over. Reverse redlining.

(BEGIN VIDEOTAPE)

SERWER (voice-over): It was the dirty little secrets in the 1960s. Home loan lenders literally drew lines around entire minority neighborhoods and refused loans to these residents. It was called redlining. The dirty little secret of the last few years is reverse redlining. Seeking out minorities and setting them up with mortgages. It started in 2002, after President Bush issued a challenge.

GEORGE W. BUSH, PRESIDENT OF THE UNITED STATES: By the year 2010, we must increase minority homeowners by at least $5.5 million.

SERWER: Lenders found a way to boost their own bottom lines and increase minority homeownership. They offered subprime mortgages. High interest loans for people with low income or shaky credit. People like Bernita Jones. Remember her? Now she's packing up after losing her home.

JONES: Come here I need your help.

SERWER: Bernita had refinanced her loan through Countrywide Financial. On its Web site, Countrywide calls itself the number one lender to minorities. But what good is that claim when loans like Bernita's land on the courthouse steps.

UNIDENTIFIED MALE: Property is held by Bernita Jones.

SERWER: Countrywide set the selling price for Bernita's home.

UNIDENTIFIED MALE: $157,960.

SERWER: Almost $158,000. Bernita owed around $200,000, which means she was in the hole almost $42,000 more than the home's selling price.

UNIDENTIFIED MALE: $157,960. Any bids? Going once, going twice.

SERWER: Bernita lost her home. And Countrywide took a loss on the loan. The company did not reply to our call for comment on Bernita's case and turned down our requests for an interview with Countrywide's founder and CEO, Angelo Mozilo.

ANGELO MOZILO, CEO, COUNTRYWIDE: Since 1982 through early 2007 Countrywide's stock appreciated over 23,000 percent.

SERWER: Mozilo founded Countrywide 40 years ago. In 2006, Countrywide was number 91 on the Fortune 500. Half of the company's new mortgages that year were adjustable, meaning rising interest rates would replace a lower teaser rate, yielding big profits for Countrywide down the road. At least that was the plan. But in 2007, when a lot of those adjustable rates reset, the economy cooled down and many customers just couldn't make their payments. In 11 months Countrywide's stock nose-dived 80 percent.

MOZILO: In my 55 years in the industry, this by far is the worst housing crisis I have ever seen.

SERWER: Bank of America bought what was left of Countrywide and offered Mozilo a golden parachute worth $37 million. But shareholders howled. Ultimately, Mozilo turned it down but wound up in front of a congressional hearing on excessive executive pay.

MOZILO: My greatest concern is that the reaction to current events will take us back to the early 1990s, when minorities and lower-income families did not have the opportunity to own a home.

SERWER: That opportunity is over for Bernita Jones. Now she's moving in with her daughter. Her story isn't unique. The largely minority neighborhood she leaves behind is dotted with broken dreams.

(END VIDEOTAPE)

SERWER: John, I want to start you off on this one. Reverse redlining is held up as a way of bringing everyone into the American dream. But are you guys really doing that, or are you just looking for profits for your company?

SHIBLEY: Well, the American people somehow or another throughout, you know, the last 25 years just decided to start screwing each other over in the mortgage world. OK? People took advantage. They made millions and millions of dollars, billions and trillions of dollars by basically sucking the blood out of the homeowner. Convincing people, oh, it's good to have a mortgage. Take the tax write-off. You know what's good? Make no mistake about it. Saving is the same as earning. You understand that?

SERWER: Yes.

SHIBLEY: How about paying your mortgage off?

PETER DUNAY, WALL STREET INVESTOR: There are two sides to the responsibility, though, isn't there? There is the borrower as well as the lender. And the borrower says I want to live in this home. And home ownership is a very good idea. You're saving for the future as long as you're buying something you can afford, as long as you're borrowing at rates that are reasonable, and as long as you understand, which requires the lender to turn around and say I need to make sure I'm lending...

(CROSSTALK)

SHIBLEY: And he's hit the nail so much on the head. Because what happened was not everybody is qualified.

SERWER: So Paul, what about this buzz phrase reverse redlining?

KRUGMAN: This is a way of getting people who couldn't buy homes before. It's a way of making homeownership available to the people, who, because of status, class, income, color, were not really part of this thing. And this was sold as the great justification for the whole thing. And the fundamental fact that you need to know is home ownership is back down to more or less its levels of 2002 now. Nothing was achieved. This whole thing was just a lot of bad lending.

WILLIS: One of the changes I think that happened that regular consumers didn't understand is that these loans were being packaged and sold as investments. But nobody really told consumers that the people who were giving them the loans were selling them on the back end. So they thought, they thought, they were getting great advice from their mortgage brokers, their bankers, and in fact they weren't.

TAVAKOLI: I think that there were a lot of naive people who were taken advantage of. These loans were presented as gifts. But they were Trojan horses that you could ride to your financial ruin.

SERWER: Up next, how this little mortgage went to market.

(NEWSBREAK)

SERWER: All right. Is the group ready for the next card? Let's turn it. Wall Street.

Peter, that's your card, isn't it?

DUNAY: Yes, it is.

SERWER: What did Wall Street have to do with the housing crisis? How is it culpable and responsible for what happened?

DUNAY: The market and financial institutions were really looking for ways to make money. So they encouraged lending. They start to say these loans will be great and we'll turn around, package them, sell them to someone else, make our money now.

(BEGIN VIDEOTAPE)

UNIDENTIFIED MALE: The Feds slashed interest rates today to an all-time low.

UNIDENTIFIED MALE: No income? No job? No problem.

SERWER: It was the medicine for the disease. Low interest rates to prop up an economy reeling from the dotcom bust and 9/11. It seemed like a good time to grab a piece of the American dream.

UNIDENTIFIED MALE: How about an interest-only loan, no money down, or an arm, low payments for the first two years?

UNIDENTIFIED MALE: OK.

SERWER: It was that simple. Everybody grabbed their piece of the pie and passed it on. Along with the risk. It's that risk that Wall Street was after. The riskier the debt, the bigger the payoff. So investment banks packaged up these home loans into what are called mortgage-backed securities. These bundles of debt were then resold to investors across the globe. Everybody wins, right? Wrong. It shouldn't have been that easy. It turns out a lot of homeowners couldn't make the monthly payments they signed up for. And those risky bets turned out to be big losers. Now nobody can say for sure just how bad it's going to get.

(END VIDEOTAPE)

TAVAKOLI: This is the largest Ponzi scheme in the history of the (INAUDIBLE).

SERWER: A Ponzi scheme? That's a pretty strong phrase, isn't it?

TAVAKOLI: Yes, it's an accurate phrase. Without the money train leaving Wall Street, this couldn't have happened. What was originally a good financial product that was sort of nutritious for investors ended up becoming a financial Meth lab

SERWER: Gerri, did the financial Meth lab of Wall Street really do this much damage to American consumers?

WILLIS: Oh, you bet. Oh, you bet. We're seeing values of homes -- look, you don't have to be somebody who has a subprime loan to be suffering right now. Right? If your next-door neighbor is in foreclosure, the value of your home is now going down. You're going to see this play out for years for folks.

SERWER: So Paul, you could say it caused a ripple effect in the stock market, which of course then hurts everyone's 401(k), too. So there's broad implications.

KRUGMAN: And a lot of people -- a lot of institutions, actually, have got money invested in these securities. You've got the Florida school system suddenly having a cash crisis. You've got small towns in Norway suddenly having taking a lot -- so there's a lot of spill over. And then, almost everybody is suffering from this. Stick around, I smell blood.

SERWER: Players, we ready to go here? We've got some more cards to turn over. Let's see what lurks beneath. Predatory lending. Gerri, you know a thing or two about this. What does that mean? What were these people up to?

WILLIS: Well, I've been in the living rooms and the kitchens of people who have been victims of predatory lending. People who are offered loans that they had no chance of paying back. And the deck, the cards, were exactly stacked against them. I have to tell you, there are a lot of people out there who didn't know until it was too late that they had a loan that they couldn't afford or that was problem.

SHIBLEY: Let me tell you the problem. As I came out of the gate, thinking that you're supposed to have a fiduciary relationship with your customer, look out for their best interest, run the numbers, see what works for them. That's not the case. OK? Somehow in the mortgage industry it got flipped around to where it didn't matter if you were a millionaire or a mailman. The object was squeezed as much out of you, if they can get you to go for. And it wasn't regulated to prevent it.

(BEGIN VIDEOTAPE)

ANNOUNCER: The Ameriquest Mortgage Super Bowl XIIII halftime show.

PAUL MCCARTNEY, SINGER: Live and let die.

WILLIS (voice-over): In 2005, Ameriquest was the rock star of the mortgage world. The company spent $15 million and got Paul McCartney to perform in a Super Bowl halftime spectacle. The subprime lender with primetime ads --

UNIDENTIFIED MALE: That's a lot of money for a deck.

WILLIS: Ameriquest reported a $1.3 billion profit in 2005.

UNIDENTIFIED MALE: Did you hear me? You're getting robbed.

WILLIS: The ads were unwittingly ironic. By 2006, it was Ameriquest that was taking a beating. It faced fraud charges. It was accused of bogus appraisals.

ANNOUNCER: Ameriquest. An open-minded, equal opportunity lender.

WILLIS: Forty-nine states in the District of Columbia threw the book at the self-described equal opportunity lender. Mark Bomchill knows why.

MARK BOMCHILL, WORKED FOR AMERIQUEST: Greed and money took the best of everybody at Ameriquest.

WILLIS: He peddled loans for Ameriquest in Minneapolis.

BOMCHILL: I saw people alter W-2s and alter pay stubs to make it appear as if people made more money to qualify for loans.

WILLIS: Bomchill says Ameriquest was hiring people with no financial experience whatsoever.

BOMCHILL: Most of the people that worked there didn't have the maturity level to know the real effect that it would have on people.

WILLIS: The case against Ameriquest started in Des Moines, Iowa. State Attorney General Tom Miller led the charge.

TOM MILLER, STATE ATTORNEY GENERAL: A number of things come together here that made fraud so tempting. One is it's so complex. The lender would say here's all you have to do, sign this paper.

WILLIS: If you've ever bought a house, you know the dizzying process to seal the deal. Dozens and dozens of signatures, countless scribbling of initials. It all goes by very fast. How many of us actually read what we signed?

MILLER: So you combine complexity, a vulnerable population, a lot of money to be made, and you have the formula for disaster.

ROLAND ARNALL, FOUNDER OF AMERIQUEST: Some employees did not do the right thing.

WILLIS: The late Roland Arnall founded Ameriquest in 1979. As his fortune grew, he funded museums, community centers and political campaigns. ARNALL: I am honored to appear before you today as President Bush's nominee to be United States ambassador to the kingdom of the Netherlands.

WILLIS: That appointment was held up until Ameriquest settled its issues with Miller and the other plaintiffs.

ARNALL: I have not been involved in day-to-day activities for the last 10 years.

WILLIS: But Mark Bomchill was involved with Ameriquest's day-to- day activities.

BOMCHILL: One of the things we had to do is constantly role-play our cold calling skills.

WILLIS (on-camera): Let's do a couple of those, then. I'll give you the objection, and you tell me what they told you to say.

BOMCHILL: OK.

WILLIS: All right. So, I just refinanced. Why would I refinance again?

BOMCHILL: Well, Ms. Willis, oftentimes people refinance, they're not able to get all their needs met. Were you able to get all your debts consolidated that you need consolidated?

WILLIS: I'm not interested.

BOMCHILL: If I was able to show you how I can save you $60,000, $70,000, would you be interested then?

WILLIS: That's a compelling argument. Is it true?

BOMCHILL: Of course not, it's not true. Those people that fell for it are probably -- a lot of them are probably in foreclosure right now.

WILLIS: Do you ever feel guilty about having been there and having worked there? Did you put some of these people in these loans?

BOMCHILL: I don't think anybody that can seriously look back at their employment at Ameriquest, no matter what level, could honestly say or feel good about what they did to the customers.

WILLIS (voice-over): On behalf of those customers, the states reached a $325 million settlement with Ameriquest, hardly enough to make its victims whole again. Ameriquest never admitted to any wrongdoing. Citigroup bought out Ameriquest's mortgage operations in 2007. As for Roland Arnall? He served two years in Amsterdam as U.S. ambassador.

(END VIDEOTAPE)

SERWER: This whole thing about predatory lending, you know, there's always predatory lenders.

KRUGMAN: Right.

SERWER: Were there more of them over the past couple years?

KRUGMAN: Sure, there's always predatory lending but there was an epidemic of it breaking out and the regulatory framework fell apart. As this new kind of stuff like subprime started to come out, a number of states said, you know, maybe there's a problem here. We should do some regulating. And Washington stepped in and said no, you can't do that.

DUNAY: But a lot of people have to learn self-responsibility here.

SHIBLEY: Exactly.

DUNAY: They have to learn to make investments that they are going to own up to.

SHIBLEY: Exactly.

DUNAY: The belief was real estate will always go up, but we learned it doesn't always go up. There are values that it doesn't have.

SERWER: Janet, let me ask you, who do you think is more at fault, the predatory lenders or greedy homeowners?

TAVAKOLI: Well, there is some blame to go around. Certainly, there were homeowners who knew that they were getting in over their heads and were hoping, speculating that housing prices would just keep rising and bail them out of a bad situation. But there are a lot of people who are simply taking advantage of, who are more financially naive, who didn't understand the terms that were being given to them, and who were actually actively misled. Let me give you an example. No cost, no fee mortgages. Jon, I'm sure you're well aware that in the state of Arizona, as an example, even Lenox Financial, I think, agreed to an assurance of discontinuance because under Arizona law it seems that the advertisements for no closing costs, that didn't seem to disclose that there were some restrictions in terms of the creditworthiness of the borrowers...

SHIBLEY: Let me tell you what happened --

TAVAKOLI: ... potentially in violation of Arizona's consumer lending laws.

SHIBLEY: Well, that's a pretty strong accusation. I'd like to take a second --

(CROSSTALK) TAVAKOLI: Well, they allege that. They alleged that and that the statement is $95,000 fine.

SHIBLEY: Well, I'll tell you exactly. Remember earlier, I said everybody doesn't qualify, everybody shouldn't get a mortgage?

SERWER: Yes.

SHIBLEY: This came about because a guy that had three judgments and a 580 credit score couldn't get a no-closing cost mortgage. Everybody doesn't get a driver's license.

WILLIS: Mortgage brokers have to have higher standards. They have to have some standards, any standards. The standards right now are low for education and for what they're required to do. They should have a stake in my loan and making my loan work. Whether I have low income, a subprime loan, or I'm fabulously wealthy, it doesn't matter.

SERWER: When we come back, who's writing the rules to this game, anyway?

(BEGIN VIDEO CLIP)

ALAN GREENSPAN, FORMER CHAIRMAN, U.S FEDERAL RESERVE: This was an accident waiting to happen.

(END VIDEO CLIP)

WESTHOVEN: Good evening. I'm Jennifer Westhoven. "Busted! Mortgage Meltdown" continues in just a moment. Here's what's happening now in the news. Officials in the U.S. and Iraq confirmed that the latest Iraqi offensive against Shiite militias is not going as well as the U.S. had hoped. CNN has learned that U.S. military intelligence analysts believed the Iraqis now control only about a quarter of the southern city of Basra. President Bush is calling the current offensive a defining moment for the Iraqi government. And a short time ago in Nevada, Senator John McCain called the offensive a "tough fight" for the Iraqis, but McCain says it's a sign of the Iraq government's strength. New dirt on New York's former governor, Eliot Spitzer. A criminal prosecutor said despite the former governor's public denials, Spitzer personally ordered the release of records in an attempt to embarrass one of his political rivals, State Senate Republican leader Joe Bruno. And Secretary of State Condoleezza Rice is weighing in on the presidential race. She tells the "Washington Times" that Senator Barack Obama's speech on race is "important" for a whole host of reasons. Have a good Friday night. I'm Jennifer Westhoven. "Special Investigations Unit: Busted! Mortgage Meltdown" continues in just a minute. Stay here.

SERWER: All right. I'm counting up my chips here. How are you all doing? Pretty well? Good. We've got one more card to turn over here, gang. Ready?

WILLIS: Yes.

SERWER: The Fed. King Greenspan. Alan Greenspan, who, of course, was the Fed chairman as housing prices rose. Paul, I think you might be the resident expert here.

KRUGMAN: Yes.

SERWER: How much responsibility does Alan Greenspan have at this?

KRUGMAN: A lot.

(BEGIN VIDEOTAPE)

SERWER (voice-over): For nearly two decades, the throne at the Federal Reserve was occupied by one man, Chairman Alan Greenspan. The so-called maestro fattened America's piggy bank during the dotcom '90s, overseeing the biggest economic boom in modern times.

LARRY SUMMERS, FORMER U.S TREASURY SECRETARY: I wouldn't underestimate luck.

SERWER: Two Clinton administration treasury secretaries shared the cover of "Time" magazine with Greenspan. It was titled "Committee to Save the World." Larry Summers remembers the Clinton White House was itching to take credit for the good times.

SUMMERS: People in the White House were always suggesting that the president and the secretary of the treasury, or other senior officials go to the White House and celebrate how high the stock market prices were. I advised the president and advised others that live by the sword die by the sword, it was a mistake to do photo ops that were based on the level of markets.

SERWER: They took his advice. Neither President Clinton nor Alan Greenspan ever rang the opening bell. But when Greenspan left office in 2006, no one sounded any alarm bells, either. The overheated economy was about to boil over. Suddenly, Greenspan found himself on the defensive.

ALAN GREENSPAN, FORMER CHAIRMAN, U.S. FEDERAL RESERVE: This was an accident waiting to happen. If it weren't subprime, it would have been something else.

SERWER: In Greenspan's bubbles, author and investor Bill Fleckenstein takes a critical look at Greenspan's tenure.

BILL FLECKENSTEIN, AUTHOR AND INVESTOR: In an attempt to fight off the ill effects of the stock bubble, we wound up with a real estate bubble. One of the consequences of Greenspan's reign at the Fed is, we in America have sort of bastardized capitalism and that we don't ever seem to want to have the downside of it anymore. We want the upside and then more upside, and that's not how it works.

SERWER: To be fair, Greenspan did warn us of the dotcom bubble back in 1996, in his trademark Fed speak.

GREENSPAN: But how do we know when irrational exuberance has unduly escalated asset values?

SERWER: Irrational exuberance. Greenspan's subtle warning conceived in a bathtub, now part of Wall Street lexicon. I sat down with Greenspan just as the housing bubble was bursting.

GREENSPAN: We have been through this type of event innumerable times over the centuries. We get to a state of extraordinary exuberance which, when confronted with reality, turns to unrelenting fear.

SERWER: But how could he have not seen this housing bubble coming? After all, his public service spanned six presidencies, four of which he served as Fed chairman.

GREENSPAN: Thank you very much.

SERWER: Greenspan first took the title of Mr. Chairman in 1987. Ten weeks into the job, stocks plunged 508 points, the biggest one-day loss ever. "The New York Times" headline read, "Does 1987 equal 1929?" But within 15 months, the market would recover all of its losses and was roaring again. That's why this real estate bust, according to Greenspan, is just another giant market correction.

GREENSPAN: Bubbles will not run out until they essentially come to an end. You can't stop them prematurely. The fever has got to break by itself.

SERWER: Greenspan's critics say he failed to step in. Or, as a former Fed chairman once said, it's the Fed's role to take away the punch bowl when the party's warming up.

FLECKENSTEIN: The hangover's going to have some correlation to the size of the party. So the sooner you get on it the better. The Fed could have done many things. They could have used their bully pulpit to jawbone about speculation.

SERWER: Instead, in 2004, Greenspan used the bully pulpit to extol the virtues of mortgage innovation.

GREENSPAN: American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed rate mortgage. SERWER (on-camera): Now, of course, people are pointing fingers at you, Chairman Greenspan, in terms of the so-called housing bubble bursting and saying that you're responsible or partly responsible. Look what he said in 2004. Adjustable rate mortgages are prudent. How do you respond to those critics?

GREENSPAN: I think revisionist history is coming on with a rush. I thought that people who had special individual cases ought to be looking at adjustable rate mortgages.

SERWER (voice-over): But adjustable rate mortgages became the loan of choice for subprime America, or those with poor credit histories.

GREENSPAN: I don't know where you draw the line because a lot of the subprime lending has been frankly truly egregious and I think in many cases criminal fraud.

SERWER: In retrospect, some feel a little regulation could have gone a long way.

FLECKENSTEIN: Deregulation up to a point is a good thing. The problem is when those changes went wild, no one ever said hey, wait a minute, this is too much.

SERWER: But can a Fed chairman really save us from ourselves?

GREENSPAN: The crucial issue of regulation is not to determine what people do but create a system, which no matter what they do, it doesn't do significant harm to the economy.

SERWER: And by the way, guess who didn't get an adjustable rate mortgage.

GREENSPAN: I like 30-year mortgages.

(END VIDEOTAPE)

KRUGMAN: If Alan Greenspan had listened to the warnings that he was getting from a lot of people, we might -- me included, right? Then we could have avoided a lot of this pain. His belief that the market is always right, that there's never a need to regulate, never a need for oversight is a big factor.

SHIBLEY: He had bad advisement. Make no mistake about it. Adjustable mortgages, they're OK as long as property values are escalating.

KRUGMAN: Yes. Let's not forget that he actually said people should get into arms just at the point when the arms were about to go way up in price. He was giving really bad advice.

SERWER: We thought he was the maestro for all those years, didn't we?

WILLIS: Well, you know, you think about asset bubbles, you go back to what happened at the stock market. He was trying to fix that.

DUNAY: When Greenspan came in '87, the U.S. was in this very strange situation where people were still saving. They remembered the recession periods of the '70s. And debt levels have risen so dramatically since 1987 that it's terrifying.

TAVAKOLI: The Fed has a lot of moral suasion as well, where they can say we have to get back to sound banking practices.

KRUGMAN: There are two attacks on Greenspan. I only agree with one of them. One attack says he took interest rates too low for too long. And I actually think he had no alternative. People were really scared about the aftermath of the tech bubble.

SERWER: Right.

KRUGMAN: And I would have done exactly what he did there. That may have given rise to this bubble, but it was unavoidable. But he didn't do anything precautionary. He was being warned about predatory lending. He was being warned about subprime. He was being warned about the housing bubble, and he brushed it aside.

SERWER: Coming up next -- a dirty word. A dirty, dirty word.

SERWER: I'm going to now talk about a dirty word. Are you ready to play the wild card?

TAVAKOLI: Sure.

SERWER: Recession. Possibly depression. Janet, what do you think?

TAVAKOLI: I think these losses should be pushed back to the sophisticated investment bankers and sophisticated investors who invested in these products and knew or should have known that they were taking a lot of risk.

SERWER: Sounds like you want Peter to pay the piper over here.

DUNAY: Well, one of the things that I do believe you're right is it is going to fall back to the financial institutions. We've already seen over $150 billion in writedowns. So they are paying a great deal. And the question is how much more of the writedowns exist. That's what the market is very concerned about. The second side, it's spread into other areas. And that's where the recession feeling is coming from.

SERWER: Gerri, what's the mood of consumers that you talk to?

WILLIS: They feel like it's a recession for sure. I think people are really worried. And you're seeing it. They're not paying their credit cards on time. Debt is accumulating. People are worried about their biggest asset, their house.

(BEGIN VIDEOTAPE)

SERWER (voice-over): Recession. The scary monster under the bed. But what is it?

UNIDENTIFIED MALE: Huh?

ANNOUNCER: A recession is two quarters of negative GDP growth.

UNIDENTIFIED MALE: Indicative of a cyclical period of decline --

SERWER: Here's the easy explanation. It's six months of dropping values for all the goods and services we produce in the U.S. It starts with fear. When consumers are afraid to spend, businesses suffer. When businesses suffer, they lay people off. When people don't have jobs, they don't spend money. It's one big ugly cycle. Scary, right? Not as scary as recession's nasty big brother, depression. Depression is like recession, but it lasts longer, and it's catastrophic. The last one we had in the 1930s was called the Great Depression. Twenty-five percent unemployment. Falling wages. A run on the banks. So big they wrote books and made movies about it.

UNIDENTIFIED MALE: Sure do look not too prosperous.

SERWER: But unlike recessions, which come once a decade or so, depressions are rare, showing up perhaps once a century.

(END VIDEOTAPE)

SERWER: Jon, is your business in a recession or depression right now?

SHIBLEY: Well, we're still busy ripping people off that mysteriously we were up 36 percent last year.

SERWER: I guess that sarcasm means no? Is the housing market in a depression?

SHIBLEY: Absolutely.

SERWER: It's in a depression?

SHIBLEY: Oh, absolutely.

SERWER: OK. Paul, you were seeing this. The housing market is in a depression, consumers are depressed. Now, we're maybe seeing inflation.

KRUGMAN: Yes. SERWER: How bad is this? You're the economist.

KRUGMAN: Yes, I would say there's a non-negligible chance. I'm talking a little bit like Greenspan --

SERWER: Non-negligible --

(LAUGHTER)

KRUGMAN: No. This could be really, really bad. I mean, there's a paper that's making the rounds. How's the U.S. by the numbers compared to countries that have had really bad crises in the last 25 years? And the answer is unfortunately we look like among the worst. We're going to look like Sweden in 1991, where the unemployment rate shot up by seven percentage points of the crisis. We're going to look like Japan which wasn't so bad at the beginning, but it lasted a decade. That doesn't have to happen, but it's pretty bad.

TAVAKOLI: But Paul, let me ask you about the early '70s. Because I seem to remember that our highs were higher and our lows were lower, and that the housing market was actually worse off then. Is it possible that we can weather this, or is this just so much more?

KRUGMAN: This is the worst housing slump since the Great Depression. Look at the likely fall in prices that has to happen. I'm one of those people who's done the numbers, and I think we'd need another 20 percent down average nationally at least. And that means 15, 20 million people underwater on their mortgages. So this is big.

TAVAKOLI: Could I tell you about the long term for our kids? The bigger issue here, and this is a symptom of what's been going on is that we Americans turn the corner and it was a bad corner. Currently, in this country, we now consume more than we make.

SERWER: So does this mean Americans should save more? Does it also mean they can't move?

WILLIS: You've got to look at the long term. A lot of people will be stuck in their houses for longer than they wanted to be. Remember, people only live in their homes for about nine years now. This is a medium-term investment for Americans, not a long-term one. But you may have to bite the bullet here and stay longer than you wanted to.

SHIBLEY: A lot of people would rather just look good and lose. Quit borrowing so much money. It's a great time to rent right now. Go rent a house. That doesn't help my business to say that. But go rent a house for a while, sit back and watch.

SERWER: So there's a couple definitions of a recession, of course. Are we in one? There's the two quarters of negative growth. There's the institute in Cambridge, Massachusetts, that officially declares, decrees that we have a recession. So are we in a recession already, Gerri? WILLIS: Well, you know the old definition of recession and depression. You have a recession if you lose your house if you're my neighbor, but it's a depression when I lose my house.

SERWER: Right.

WILLIS: And I think consumers out there are saying, you know, this is awful tough and I'm really worried.

SHIBLEY: Right now, we have seven out of 10 people that call our office that are upside down on their mortgages. Let me tell you what. That's a catastrophic pace. If you've got 70 percent of people that are starting to show up upside down, you tell me if we're in a recession.

SERWER: And upside down means what?

SHIBLEY: They owe more than what their houses are worth.

DUNAY: We are in the slow-down period of the economy. We are seeing it slow down dramatically. We're seeing it spread into other areas. So it certainly looks as if we are in a recession.

SERWER: How bad will it get, though, Peter?

DUNAY: What concerns me is it may not be a deep recession, but it may last for a long time. That it will be one of these things where you're actually getting zero growth so they'll go, it wasn't actually a recession but it turns out to last throughout 2008.

KRUGMAN: I think 2008 is wildly optimistic. In fact, we should be expecting to see trouble, you know, well into 2010.

SERWER: So where do we go from here? Will the housing market and the economy recover from this debacle? Of course, they will. But in the meantime, we should all do a little soul searching. There's plenty of blame going around. Predatory lenders, greedy bankers, lax regulators, slick Wall Street operators, and, yes, even plain old homeowners who got in over their heads. The bottom line is this, if all of us treat our houses more like the homes that they are, rather than personal piggy banks, we will all be that much better off in the future.

Originally broadcast, 8.30.08