Being handed free money and then, by buying Treasury bonds, lending it back to the U.S. government at 3 percent, generated enormous profits. So, while the Fed waited for the gap to close between its intention, getting credit to the hardest hit parts of the economy, and the hard realities of the debt cycle, the banks. .h.i.t the arbitrager's mark, each day, notching "risk-free profits at zero cost."

For financial inst.i.tutions who'd spent decades trying, and so often succeeding, in engineering ways to make something from nothing, this particular arbitrage was helpful in restoring them to the form they'd enjoyed before the crash, only more so.

Lending that free money back to the government was just the largest of the advantages available from a negligible cost of funds. The spread between what banks paid depositors and what they received from all borrowers, and extensions of credit, grew admirably.

How much did this federal support of the banks cost taxpayers? By 2010, credible calculations had started to emerge. With debt of approximately $14 trillion issued by the Fed, Treasury, federal agencies, and munic.i.p.alities, which was scooped up by banks and other investors worldwide, the distinction between a near-zero rate at present (on short-term Treasury bonds) and the long-standing average of about 3 percent amounts to roughly $350 billion a year.

At the same time, that enormous taxpayer subsidy skewed the market for a key commodity, money, in ways that impelled investors to search for yields in higher-risk instruments than they normally would have sought.

That meant the great trading machine was running fast and clean.

Trading in derivatives booked its strongest year ever, with JPMorgan and Goldman leading the way.

As it was in the early 2000s, when interest rates were lowered by Greenspan to spur the consumer activity following the tech boom's crash, the world's aggregated wealth, in funds of all stripes, was again hungry for yield. The fact that 40 percent of the world's a.s.sets had vanished in the crash-that those funds had dropped from the 2007 peak of $70 trillion down to $40 trillion-seemed not to have changed behavior. Those a.s.sets moved forcefully into whatever exotic arbitrages (gap plays), derivatives (bets on the future), and swaps (noninsurance insurance) the financial engineers could gin up.

Just as banks had used their lowered cost of funds to increase profit margins, companies, especially large ones, used the downturn to cut costs even more than the sluggish demand merited. Their profit margins widened as well. And by early 2010 they had built up large cash reserves, estimated at more than $1 trillion. They weren't hiring, or expanding. This money, building like a lake above a dam, returned corporate treasurers to their lead roles, reuniting them with the large banks to help move huge sums to and fro in arbitrages of all kinds. The repo market got up and running again. Credit default swaps were bustling as well, with $35 trillion in outstanding swaps in early 2011.

People did make money from the rise in equities, but like the stock fluctuations of the late 1990s, it was largely recouping value that had always been on paper. Even with this surge bringing the stock market back to roughly the precrash level-albeit the same level as in 2000-Ranieri's prediction three decades back seemed to hold. Once the debt securities market takes off, it'll dwarf equities.

It wasn't until the spring of 2010-more than two years after the collapse of Bear Stearns-that the SEC finally made a first move. There had been no significant prosecution or disciplinary action, at that point, by any federal ent.i.ty. With its first salvo, though, the SEC shot high: in mid-April it accused Goldman Sachs of securities fraud in a civil lawsuit. The SEC charged that the bank created and sold a mortgage security secretly built to explode in the laps of unwitting investors, and then bet against it.

The mortgage-backed security in question, called Abacus 2007-AC1, was among two dozen CDOs that Goldman constructed so the bank and several of its most prized clients could bet against the housing market. The meat of the SEC charge was willful misrepresentation by Goldman, which said that the mortgage securities bundled into Abacus had been chosen by an independent firm, with no ongoing interest in the deal, to perform well under a variety of market circ.u.mstances. In fact, they had been selected by John Paulson, the hedge fund manager who built expertise in the mispricing of mortgage risk that resulted in one of the largest hauls in Wall Street history-$3.7 billion in 2007-his early and sizable short positions in the mortgage market. Paulson, in fact, had selected some of the most egregiously mischaracterized mortgage securities he could find: CDOs with triple-A ratings, which were all but certain to default. Two European banks and an array of investors lost more than $1 billion on the Abacus. Goldman and Paulson shorted the securities shortly after they were sold and made out handsomely.

"Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio," said Robert Khuzami, the head of the SEC's enforcement division, in a written statement on April 13. Goldman, as expected, denied any wrongdoing.

But a match had been struck. The company's stock plummeted. In the first half hour after the SEC's suit was announced, the company's share price dropped more than 10 percent, wiping out over $10 billion of Goldman's market value.

As his former employer was sucked into a prosecutorial vortex, Gary Gensler was thinking of gazelles. They were part of a favorite "way the world works" metaphor-one that Summers and Geithner and other old friends had often heard. "The way Washington works is you often start with what's optimal, a best solution to some complex problem, and, surprisingly, there's often quite a bit of bipartisan consensus on what will actually work, at least in private. That's your herd of gazelles. But you've got to get them across the savanna safely, to a distant watering hole. And the longer it takes, the more you lose. You may end up with very few. You may lose them all. Because there are predators out there, lions and tigers, packs of hyenas, and they're big and fast and relentless-considering how any significant solution to a big problem is bound to be opposed, do or die, by some industries or interests who'd figured out a way to profit from the ways things are, even if they're profoundly busted, and often because they're profoundly busted! So that's your challenge: see how many gazelles you can get to the watering hole."

The Goldman prosecution, he was thinking, might turn the tide. Something had to. He'd been losing gazelles for four months, since the House pa.s.sed a version of financial regulation that included significant loopholes for end users of derivatives.

Those loopholes themselves were victories for the financial lobby. In the Senate it was bound to get worse.

After his girls knocked off, Gensler trolled the financial filings of the large investment banks night after night. He, of course, could read a balance sheet; he'd overseen the drafting of enough of them. Goldman's balance sheet was generally considered a work of accounting arts-some would have said dark arts.

Back in mid-December of 2009 he'd found something that surprised him: Morgan Stanley's filing to the SEC for its third quarter, which ended September 30, had a notation about the company's over-the-counter derivatives portfolio. There it was, on page 139: only 40 percent of the bank's OTC derivatives were collateralized.

After the September crash, the estimations were that the major banks were demanding from one another sufficient posted collateral to back up their swap positions. Uncollateralized OTC derivatives, in the form of CDOs, were, after all, what got AIG in trouble. When the values on the CDOs plummeted, Goldman and JPMorgan made collateral calls on AIG. After making several payments, the insurer-which had not initially set aside sufficient capital-ran out of cash. A chain reaction ensued in which many financial inst.i.tutions had swap obligations with one another that had, as well, been uncollateralized-they owed collateral, and needed to come up with it, and were owed. Geithner's justification for paying 100 cents on the dollar for AIG's swaps was to stem that panic, rather than, as some later suggested, to try to unwind the insurance-like swaps that linked banks in a disastrous daisy chain. In the backroom dealings on derivatives reform, the banks were stressing that they'd learned their lesson, that they didn't need the great dark pools of OTC derivatives to be forced onto clearinghouses-which demanded sufficient collateral and were themselves backstop trades. Morgan seemed to accidentally undercut such a.s.surances with this tiny notation. The result: nearly 60 percent of Morgan's $80 billionplus derivatives book was uncollateralized-an exposure of roughly $55 billion.

Gensler did a bit more research, feeling like he was back being a young executive for Goldman, digging through financial filings. Come January, he had a "deliverable" for his ex officio role of deciphering complex trading issues for Summers and, less frequently, Geithner. He had discussed with both men Volcker's suggested ban on proprietary trading by banks; both remained quietly opposed. And in the months since Obama's meeting with Volcker and Wolf, both had succeeded in bringing up logistical issues about how such a rule might be implemented-it was, indeed, complex-and so had successfully "slow-walked" it almost to a dead stop. Obama, otherwise occupied, again didn't follow up on the matter, which was turning into a smaller version of the previous spring's Citibank breakup scandal-a presidential decision slowed to oblivion-and no one the wiser.

What resurrected, of course, was external necessity, Volcker's proprietary trading in the wake of Scott Brown. As the president groped for a narrative, as he'd told staffers darkly, he reached back, not surprisingly, to the campaign and summoned Paul Volcker to stand behind him at a press conference on January 21-Summers and Geithner standing sheepishly nearby-to announce the he had heeded that "tall guy" and would push for a ban on proprietary trading. With Volcker behind him-as done to such winning effect during the campaign-Obama dubbed the provision "the Volcker Rule." Then, like the rest of financial reform, "he staffed it out," according to one senior financial regulator.

Geithner's and Summers's positions didn't change. For Summers, as he'd revealed to Wolf the previous fall when the president said he wanted to do this, it was personal, a lone victory for his vanquished opponent Volcker. Geithner felt it was an imperfect, backdoor way to establish the kinds of Gla.s.s-Steagall barriers that didn't fit with banks' needed lat.i.tude to respond to whatever the marketplace demanded. Neither one stood in the way when Dodd's committee quietly punched a hole in the hull, saying that any provisions for how to define and enforce a ban on banks' making large trading bets using taxpayer funds to trade could be "modified" by regulators at their discretion.

Obama wasn't much involved with derivatives, either. But the Morgan Stanley data, Gensler thought, might catch his attention. He showed Summers the Morgan exposure and explained its particulars. Summers was startled. "The president is not going to like this," he said emphatically.

But nothing happened-the White House was leaving financial regulation to Geithner's deputies at Treasury and to Congress.

Gensler, who had become something of a one-man show on derivatives, was now being noticed, profiled in the press, and mentioned in the same breath with Volcker and Elizabeth Warren. It was an odd position for a regulator from a sleepy no-name agency, but it fit into a larger concept: that the nature of regulation itself had to change, that the job of regulators such as Warren, if she ultimately ran her consumer agency, and Gensler, at CFTC, was not to be a friend of the industries they oversaw, emerging from them to take the big regulatory jobs and then, returning to some corporate suite once their term was up.

But come spring, as Wall Streeters were busy calling Gensler "the most dangerous man in Washington," he was starting to feel like an imposter. Say what they will, financial lobbyists had the upper hand and were making steady advances.

By mid-April, though, Gensler saw it: a plan to save some gazelles. Senator Blanche Lincoln, a conservative Democrat from Arkansas, had become chairwoman of the Senate Agriculture Committee six months before, when an enfeebled Ted Kennedy ceded his chairmanship of the Senate's Heath, Education, Labor and Pensions Committee to Iowa's liberal lion and longtime agriculture chairman, Tom Harkin. All manner of financial lobbyists considered this a stroke of fortune, especially considering that derivatives issues, and oversight of Gensler's Commodity Futures Trading Commission, were handled by Agriculture-a holdover from the decades when derivatives were called "futures" and dealt solely in commodities such as corn and wheat.

Over the past month, Lincoln had been meeting with the committee's ranking Republican, Georgia's Saxby Chambliss, to work out a derivatives deal that was shaping up to be more favorable to industry than the House legislation. That package, even the proud Barney Frank privately admitted, had to ingest too many exemptions to a.s.sure pa.s.sage, especially for "end users"-such as airlines working derivatives to manage fuel costs-that could be exploited by the four largest banks, controllers of 97 percent of the derivatives market.

But Gensler had a ringer, a plant. When Lincoln became chairwoman, she needed a top staffer with expertise in derivatives. She found one . . . on Gensler's staff. Robert Holifield, an effusive and preternaturally polished thirty-one-year-old, had stayed in close touch with his old boss. His new boss, Lincoln, was meanwhile facing an ever-more-serious primary challenge from Arkansas' progressive attorney general, Bill Halter, who was gaining ground in early April charging that she was soft on Wall Street. Gensler huddled with Treasury and crafted a subtle threat: if Lincoln went with the package she was crafting with Chambliss, the White House would, in essence, take Halter's side by publicly saying her deal was inadequate. This "warning" was delivered to Lincoln on Friday, April 9. She had the weekend to think over her next move.

On April 13, a few hours after early-morning news broke about the SEC's charges against Goldman, Arkansas' senator stepped to the lectern to announce a startling about-face: she wanted all derivatives operations to be removed from banks. They needed to be spun off, so that taxpayers-with their obligations, still, to bail out "too big to fail" banks-wouldn't be on the hook to bail out derivatives activities. Plainly said, banks would have to spin off their most profitable business. There was more: she was also stipulating that the derivatives dealers had to act as "fiduciaries," always putting their clients' interests ahead of their own.

Reaction was swift. Startled Republicans, who'd been counting on Lincoln's acquiescence, were outraged, as were all-but-speechless financial industry lobbyists. But this time they had unlikely kindred. Some reform-minded Democrats and even Sheila Bair thought this idea might be ill-considered. You wouldn't want something as unwieldy and dangerous as derivatives trading to be spun off into an array of subsidiary companies. At least housed within banks, the burgeoning derivatives industry would be inside inst.i.tutions that submitted to regular-albeit, of late, rather ineffectual-regulatory oversight.

It didn't matter. A week later Gensler, with a staff of seven, arrived early at the Agriculture Committee hearing room. He was carrying a stack of what was fast becoming one of the most consequential doc.u.ments in the U.S. government. After finding the Morgan data, Gensler had gone back to the files. He needed a way to detail the dangerous ongoing credit exposures in the derivatives market, and the web of interrelationships, in a way that a busy senator could look at and quickly understand. He and his staff worked through several models-graphs, charts, printed PowerPoints.

Finally, he had it: a single page with three pie charts, one for each of the major categories of the $400 trillion over-the-counter derivatives industry: foreign exchange derivatives, single-currency interest rate derivatives, and equity-linked, or commodity, derivatives. Using data his staff had dug up from the Bank for International Settlements, or BASEL, he'd produced color-coded charts showing the division of each pie among the three major players in the market: nonfinancial customers, such as Boeing and its fuel; reporting dealers, such as Goldman and JPMorgan; and other financial inst.i.tutions, such as insurance companies.

The one-pager was a corollary to the Morgan findings from the winter; it showed that more than half of the derivatives market was operating in shadows and was without collateral, just like Morgan was. If there was another systemic risk moment, companies across the world would have to come up with collateral, in almost unfathomable amounts, that they had not already set aside. These so-called dark pools, where no one could be sure of the size and scope of another inst.i.tution's liabilities, create precisely the fear and uncertainty that helped shut down the flow of money through the global economy. Systemic risk from derivatives, in other words, was still with us, and worse than ever.

In the minutes before the vote, senators from both parties were looking at the pie charts, each and every one, like kids who had just been handed back a failing test paper. The charts showed the financial system still loaded with dangerous interconnections; one meltdown, like a Lehman, could bring it all down.

Lincoln's bill pa.s.sed the committee 13 to 8, with a surprise vote from Iowa Republican Charles Gra.s.sley.

Crowded into the chamber, side by side with representatives from public interest groups, journalists, and a.s.sorted onlookers, were Wall Street lobbyists who could scarcely believe what they were seeing.

"This is the way we make our money-they're trying to take away our lifeblood," said one of them, who, like most lobbyists, wouldn't give his name. "Maybe we did this to ourselves, sure, but we're just responding to the way things are. We've gone 'long' on developing markets around the world, and gone 'short' on America, where the whole game is using debt to give people what they haven't been able to earn, and may never earn, and derivatives is a key way we make that possible."

Six days later, on April 27, Michigan's canny seventy-five-year-old Democratic senator, Carl Levin, chairman of the Senate's Permanent Subcommittee on Investigations, was looking to prove in public hearings exactly why Goldman Sachs was under investigation.

A few months before, in January, the independent, blue-ribbon, bipartisan Financial Crisis Inquiry Commission, headed by a former California state treasurer named Phil Angelides, had begun to hold hearings. Slow and steady, they were going at the financial crisis, and the actors involved, piece by piece.

Not Levin. He went with a frontal a.s.sault: pull in the most recognizable actors on Wall Street and let them explain how they make their money.

At the hearing table before his committee on April 27 was a procession of Goldman Sachs executives, culminating in a late-afternoon appearance by CEO Lloyd Blankfein.

Throughout the day, Levin offered examples of how giant firms such as Goldman had their many arms moving in a kind of subtle coordination to ensure that, no matter how the market broke, they won.

In questioning Goldman executives, Levin pressed this point without much success. The questions were too technical, and the executives could simply claim they knew only what their department was doing, not other departments.

Levin needed a CEO. Blankfein, atop the much reviled and feared Goldman, was his sterling opportunity.

His committee's investigators had pulled up internal e-mails on the Abacus deal and read them aloud, showing that Goldman traders knew that the securities, freshly painted and buffed for sale, were actually ticking time bombs.

Blankfein stammered and, under hot lights, tried to explain how Goldman could represent the interests of clients who could have conceivably made money on Abacus at the same time that the firm was a "market maker," drawing investors into a liquid market by taking the "other side" of the bet on the securities these traders were interested in, and hoping to crush them.

Finally, Levin had his opening.

LEVIN: We've heard in earlier panels today in example after example where Goldman was selling securities to people and then not telling them that they were taking and intended to maintain a short position against those same securities. I'm deeply troubled by that, and it's made worse when your own employees believe that those securities are "junk" or "a piece of c.r.a.p" or a "s.h.i.tty deal," words that emails show your employees believe about a number of those deals . . . Now there's such a fundamental conflict it seems to me when Goldman is selling securities, which particularly when its own people believes they are bad items . . . Given that kind of a history . . . how do you expect to deserve the trust of your clients? And is there not an inherent conflict here?

BLANKFEIN: Our clients' trust is not only important to us, it's essential to us, it is why we are as successful a firm as we are and have been for 140 years. We are one of the largest client franchises in market making in the kinds of activities we're talking about now, and our client base is a pretty critical client base for us, and they know our activities, and they understand what market making is.

LEVIN: Do you think they know that you think something is a piece of c.r.a.p when you sell it to them and then bet against it, do you think they know that?

BLANKFEIN: I want to make one thing clear . . . the act of selling something is what gives the opposite position of what the client has. If the client asks us for a bid, and we buy it from them, the next minute we own it and they don't . . . we can cover that risk, but the nature of the princ.i.p.al business in market making is that we are the other side of what our clients want to do.

LEVIN: When you sell something to a client, they have a right to believe that you want that security to work for them. In example after example . . . we're talking about betting against the very thing you're selling, without disclosing that to that client. Do you think people would buy securities from you if you said, "you know, we want you to know this, we're going to sell you this, but we're going out and buying insurance against this security succeeding. We're taking a short position" . . . That's a totally different thing from selling a security and no longer having an interest in it . . . Is it not a conflict when you sell something to someone, and then are determined to bet against that same security, and you don't disclose that to the person you're selling to?

BLANKFEIN: In the context of market making, that is not a conflict. What clients are buying . . . is they are buying an exposure. The thing that we are selling to them is supposed to give them the risk they want. They are not coming to us to represent what our views are. They probably, the inst.i.tutional clients we have, wouldn't care what our views are, they shouldn't care. We do other things at the firm . . . where we are fiduciaries.

LEVIN: And that's the part that's very confusing to folks . . .

BLANKFEIN: I know.

LEVIN: . . . because they think you're fiduciaries.

BLANKFEIN: Not in the market making context.

LEVIN: Yeah, but they are not told that not only are you not a fiduciary, you are betting against the same security that you are selling to them. You don't disclose that. That's worse than not being a fiduciary. That's being in a conflict-of-interest position.

In the 1970s the financial marketplace held many separate ent.i.ties with distinct functions. Investment banks were partnerships, ever wary of the downside of investments because the partnership's money, in the event of losses suffered by a client or the firm, was on the line. They advised clients, often being granted "privileged" information, and helped them decide what financial instruments to buy or how to manage their balance sheets or which were the good places to invest their capital. They could partner with a client in a deal, at which point the client's interest and that of the investment bank were identical. Brokerage houses, meanwhile, represented clients, generally individuals, in managing their investments and executing trades. Market makers were involved in the issuance of stocks, standing, when needed, on the other side of trades to "make a market" for a buyer, or seller, in search of a trade. It was more of a technical function. And of course the cornerstone of the system was commercial banks, which took in deposits, paid interest, and, for the most part, made loans to businesses and individuals. When a bank wanted to get some extra yield on deposits that weren't tied up in loans, it could do so only in the safest, sleepiest investments, mostly bonds, as designated by the rating agencies' then-precious triple-A stamp.

Now virtually all these functions are held, in sum or in large part, within a half dozen huge inst.i.tutions that, together, hold a.s.sets that amount to nearly two-thirds of the U.S. GDP. They enjoy enormous leverage over the crafting of law, regulation, and wider acts of governance. They stand at the center of America's vaunted professional cla.s.s-a human yield, in many ways, of the enormous resources and effort the country commits to education-and have formative relationships with the large industrial and manufacturing corporations that are pistons and flywheels of America's economic engine.

What's fascinating about the public exchange between Levin and Blankfein, among the most illuminating of this period, is how it so clearly elucidated the conflicts of self-dealing irreducibly knitted into the country's largest inst.i.tutions, and the very latest definition of "arbitrage."

The term had circled back, finally, to its etymological origins, to the French word, dating back to 1704, to denote a decision by an arbitrator or tribunal. An arbiter. A decider.

The large firms are designed to gain "informational advantage" as a fiduciary and, day to day, simply to decide how to use it to crush compet.i.tors on the trading floor. After Levin grilled Blankfein about how Goldman traded for clients, against clients, and often for itself using the precious information gleaned from clients, computer models, or relationships with the government, Blankfein demurred that "we do other things in the firm . . . we are a fiduciary," and then had to agree with Levin's statement that "that is what confuses people." Sitting behind Blankfein in the hearing room, Goldman's battalion of lawyers gasped-this was the last place they wanted him to be.

A fiduciary, by a variety of legal definitions dating back to Roman law, must not put his personal interests before that of the princ.i.p.al, the person to whom he owes a "duty of care," which, in this case, would be the Goldman client. And "he must not profit from his position as a fiduciary," say numerous court opinions, "unless the princ.i.p.al consents."

That last issue of consent, though, is ugly in its complications.

What exists at this point, based on the stunning consolidations and concentrations of power among a few "too big to fail" inst.i.tutions, is an unwritten code: clients are drawn to Goldman or JPMorgan or any number of large hedge funds not in spite of the threat that those firms will act beyond the edge of propriety, but because of it. They're counting on it.

Despite what Levin said, there was no confusion about it at all. Let them do whatever they want, just as long as I, as a valued customer, get a piece of it. And if I can help in any way, I will.

This is, of course, the way criminal syndicates rise up. It's an issue of might. If the government, with its power of law and prosecution, can't challenge them, they spread, and their influence deepens. The large banks and their companions, unregulated hedge funds, had increasingly taken ownership of the trading enterprise, opened new casinos dealing with the more complex, often shadowy realm of debt, and figured out ways to rig it on their behalf. For the clients and smaller compet.i.tors, this hard reality first brought frustration, then, year by year, acquiescence, and finally a kind of furtive partic.i.p.ation. If it's not going to change, then why not be part of it? If they didn't sign on, their compet.i.tor would. The aim for clients is to be large enough, or strategically important enough, that Goldman sees them as valued partners and protects them or, even better, gives them a cut.

Goldman and JPMorgan act as the arbiter, deciding, in ways both subtle and overt, which client prospers and which is crushed, with the goal being, ever and always, the bank's profit. That's called "protecting a balance sheet." To be sure, the bank's balance sheet.

17.

Business as Usual.

Greg Fleming wasn't planning to return to the Street. He had it all mapped out-the option he'd won, a precious gift: freedom. At only forty-seven, with enough money to do whatever he wanted, the options were all his.

When cla.s.ses commenced at Yale in the fall of 2009, he was already accustomed to not racing from his home in the New York suburbs to the city each morning and staying late most nights. He and his wife, Mellissa, went on a few vacations during the summer. He was spending time with his son and daughter; he was reconnecting with old friends from college. Up ahead was his ethics inst.i.tute. He had another procession of Wall Streeters on their way to Yale for the fall semester as speakers.

But someone, an old Merrill buddy, had said something that he couldn't get out of his head: "Is this it, your last time out on the field?"

He had been a member of a community, almost all men, who played, and played hard, in a storied game. It was social and professional. Their wives were friends. Finance was all any of the guys talked about. "I just couldn't bear to think of the disaster at Merrill, even considering how proud I was to sell the firm-that that would be my last time at bat."

Which is why, come spring, he was far from Yale's Elysian campus and back to a perch overlooking the skyline of New York. No spring semester in New Haven for Fleming. In February he took a top job at Morgan Stanley after an old buddy from Merrill, Morgan CEO James Gorman, pressed him to get back in the game. Almost immediately, Fleming was being seen as Gorman's number two, there to whip various parts of the firm into shape.

Now, looking out a wide window in Morgan's executive suite, forty-one stories up, Fleming was considering whether he'd done the right thing. "There are moments when I wonder," he said, waxing about his year thinking "beautifully disinterested thoughts" at Yale. "I'm entirely focused on substance these days, the gnashing of the business sector, and the banks, and it just keeps going on . . . in an environment that is very ugly."

But as reentry shock wore off, he'd begun to feel the native self-interest of New York and its needs. The banking industry's recovery, now nine months along, now faced the threat of renewed ardor for financial reform.

Fleming, like much of Wall Street, had recently become a fan of Tennessee's former Democratic congressman Harold Ford, Jr., now at Bank of America/Merrill, who'd been taking on his former colleagues, especially the ones from New York who'd started attacking the Street. "In Texas, no one picks on the oil companies. No one in Michigan picks on the car companies," Fleming said, paraphrasing a recent riff of Ford's. "Why does everyone in the New York congressional delegation think Wall Street is now fair game? We're the people paying taxes, providing the jobs. What industry is in New York-and I mean a real industry, that creates real employment-besides financial services?"

But before a few minutes had pa.s.sed, Fleming edged into a deeper conflict: a recognition that what was currently good for Wall Street, quarter to quarter, might not be good for the long-term interests of the wider country or its economy.

He talked about the Street's restored trading bonanza, namely in fixed-income debt and especially at firms such as JPMorgan and Goldman, now replenished with free Fed funds to trade enormous volume, and profit accordingly.

Morgan, meanwhile, was trying to call for a "return to fundamentals" strategy, by focusing on traditional lines of business such as its brokerage operations and a.s.set management, along with the mutual funds it pushed through a vast retail operation that included Smith Barney. Fleming was brought back to revamp and refresh those areas, "to create a solid, sustainable revenue stream that acts as a steady counterweight to fixed-income trading," he said. Not that Morgan's earnings were depressed, just less than the trading-fueled earnings of its two major compet.i.tors.

"Morgan is now getting whacked for not being aggressive enough in certain areas of exotic trading," he demurred. The firm's stock price was sagging, in the high $20s, making it flat or down for the year, "and there's pressure on James [Gorman] to change course."

Fleming said he was trying to be the voice of caution, of "stay on course." The previous fall, up at Yale, he'd talked about being "like Colin Powell inside of Merrill, calling the alert on the fixed-income trading in mortgages" in the summer of 2006, when CEO Stanley O'Neal wanted to fire the firm's head, an old-style risk manager and friend of Fleming's named Jeff Kronthal. "I voiced my disapproval, but I didn't resign. And I should have. If I had taken a stand, Merrill might have not loaded up on CDOs-more than $50 billion of them in the next year-and it might still be there today. But I didn't."

He didn't want to make the same mistake again. "I mean, did we learn anything or not?" he said, and ran through a bearish a.n.a.lysis: at times like these, when the underlying economy is sluggish after a crash, and huge fixed-income players are looking for yield, that "we've always started to build the scaffolding for the next bubble, the next boom and inevitable bust." He didn't know where the bubble would begin to inflate-"we never do in the first year or two"-but he added that he was regularly checking for volatility in the fixed-income trading records of Morgan and other firms. "That's where you see the first signs."

Just a short time into his job at Morgan, he was testing whether the marketplace-still structured, as it had long been, in terms of quarter-to-quarter yardsticks and short-term incentives-would respect a long-term, steady growth strategy.

The answer: not at all. Unless Morgan quickly expanded and juiced up its fixed-income trading, with the now-familiar brew of complex credit hedges backed by a systemically risky web of credit swaps, he and Gorman might find their days numbered. "The question is will any of us be given enough time to show that we're farsighted."

Thus, Fleming, sitting quietly atop the city, marked the distance between Yale ethics and prudence seminars and the compensation-a.s.sisted amnesia of Wall Street.

He thought back over the past four years, over what he'd learned since what he calls his "Colin Powell moment" in 2006, and he came around to Obama, how he had his chance in early 2009, when Wall Street was scared and vulnerable. At that point, Fleming said, Obama "could have inst.i.tuted compensation reforms because people thought their compensation would never be coming back. But that's over now."

And that means New York, with its mighty industry largely restored by Washington, "will defy any change, even if it's for their own long-term good." Wall Street made its money furiously trading funds "it borrowed from the government at zero interest rates, and for them to take the level of compensation that they now are, and not see that people will say that the government did that for them, is unbelievably tone-deaf."

He recounted a recent conversation he had with an old friend from Goldman. "He said our compensation this year dropped to 42 percent" of earnings, down from the usual split of 50 percent. "I said, 'Yeah, but on the elevated profits, that means 20 million bucks, and what value did you really create for that?' "

As long as that compensation model exists, Fleming concluded, before returning to tend to Morgan's traditional, old-line investment operations, "there will be no replacement businesses built" in America's capital of money and risk.

Fleming's compet.i.tor now, as he revamped Morgan's a.s.set-management business, turned out to be one of his oldest friends, Larry Fink. It was a long way since, sixteen years back, Fleming, as a Merrill investment banker, helped Fink break his a.n.a.lytical operation away from Blackstone, the private equity firm, to form BlackRock. A few blocks east of Morgan Stanley, Fink's firm, BlackRock, now stood like a behemoth. In December it closed its deal to purchase Barclays, making BlackRock the largest a.s.set manager on the planet-larger than Fidelity or Pimco. By early 2010 it was managing $3.9 trillion in a.s.sets, including holdings, across its many funds, of a 5 percent or more share of 1,800 companies.

But the ever-more-distinctive feature of BlackRock, and its claim to still being in the lineage of traditional investing, was that it was not a princ.i.p.al. It didn't trade its own account, the way Goldman or JPMorgan or, for that matter, Morgan Stanley did. No proprietary trading desk, betting the firm's money against its customers' accounts, or deciding, if there was a choice between clients, who might end up on the losing end of an arbitrage. There's no doubt that BlackRock leveraged all manner of "informational advantage," but it did it strictly for clients. BlackRock invested other people's money hoping to get a return.

"I don't have a balance sheet to protect," said the loquacious Fink. "Jamie Dimon, everything he does is protecting his balance sheet.