That’s why a new documentary “American Casino,” by famous filmmakers Andrew and Leslie Cockburn, is already getting attention. In it, a former banker from Bear Stearns, is filmed, with his identity concealed, elaborating on Wall Street’s role in packaging and selling subprime loans, and admitting that the financial world knew the whole thing was a big scam all along.

But think about that for a moment. The former banker insisted on being filmed in shadow, to feel free enough to talk about Wall Street’s role in the crisis. How telling is that? On Wall Street, apparently, you have to hide in anonymity to tell the truth about the mortgage market meltdown.

Here’s David Denby in The New Yorker, describing the former banker’s turn on the screen:

We might be watching a retired criminal or spy, a man both proud of his dexterity and ashamed of the disaster that it led to. Out of the shadows, he explains how such bizarre instruments as collateralized debt obligations (C.D.O.s) quieted the normal skepticism of investors. Here’s the drill: when the bank assembled a group of mortgage-backed bonds as an investment product, it submitted them to a ratings agency. But the agency, rather than run its own computer models on the trustworthiness of such bonds, he says, merely handed the job back to the bank, which ran its models. Having received a fee of perhaps a hundred thousand dollars for not doing anything, the agency then signed off on the phony ratings. You can read about a scam like that in a newspaper and be surprised, but when the perpetrator actually explains it to you your reaction falls somewhere between nausea and hilarity. It’s as if the Russian Mafia had paid a Colombian drug cartel to certify its integrity.

At the Wall Street Journal’s Speakeasy blog, the Cockburns were asked whether they thought any of the financial executives they talked to for the film were contrite.

I think that when some of them came to the film, they were very thoughtful about the link between what they were doing and what was actually happening.  It’s a very enclosed world on Wall Street. As one of the execs says, if we’d all gotten in a car and seen for ourselves what was going on Florida, or California, or wherever, we might have viewed things differently.

That’s an especially interesting comment, given that the aftermath of the foreclosure crisis in some cities is shaping up to be as bad, or worse, than the foreclosures themselves, with trashed and vandalized bank-owned foreclosures piling up. Now would be a good time for Wall Street to take a road trip into the rest of the country. And policymakers in Washington should probably go along.

Sens. Carl Levin (D-Mich.) and Susan Collins (R-Maine) introduced legislation today authorizing federal regulators to oversee the credit default swaps market — which has ballooned into a $57 trillion industry.

You remember credit default swaps. These babies — in essence, private insurance contracts in which one institution pays another when a third party defaults — are used to spread financial risk. They’re just one branch of the enormous swaps market. Yet the over-leveraging they allowed are thought by many experts to be among the primary factors leading to the global economic meltdown.

You might think that, considering the sheer size of the market, federal regulators would have been examining these swaps beneath a microscope. Think again. Current federal law actually prohibits the federal government from overseeing swaps at all.

Levin, who chairs the Senate Homeland Security and Governmental Affairs investigative subcommittee, and Collins, who also sits on the panel, are hoping to change that. Their proposal would remove the regulatory prohibitions on swaps while authorizing — though not requiring — the federal government to regulate the various swaps markets.

From Collin’s statement:

While local credit unions and small community banks are subject to safety-and-soundness regulation, enormous Wall Street financial institutions that have a far greater impact on our economy have not been subject to such regulation. This legislation would clear the way for federal financial regulators to oversee the swaps market. It is a critical component of the overall reform needed to restore confidence in our financial regulatory system.

The statement also lends a sense of just how huge the swaps markets have become:

Swaps are typically an agreement between two parties placing a bet on future cash flows. Some swaps bet on whether a stock price, interest rate, commodity price, or currency value will rise or fall; others bet on whether a company will default on payment of a bond. Stock price bets are referred to as equity swaps; bets on whether companies will pay their debts are referred to as credit default swaps.

According to the latest data compiled by the Bank of International Settlements, as of June 2008, worldwide swaps markets included credit default swaps with a total notional value of $57 trillion; commodity swaps with a notional value of $13 trillion; equity swaps with a notional value of $10 trillion; foreign currency swaps with a notional value of $62 trillion; and interest rate swaps with a notional value of $458 trillion.

The real question is, with so much at stake, why regulators have been banned from monitoring these transactions to begin with.

That’s not great news for the embattled Dodd, who is fighting for his political life in the face of a 33 percent approval rating and a 2010 reelection challenge from former Rep. Rob Simmons (R-Conn.). But even if the five-term senator doesn’t have too many fans in Connecticut, they love him at Intercontinental Exchange, one of the nation’s leading exchanges trading credit default swaps and other risky financial instruments.

Executives at Intercontinental (known as ICE) donated $18,400 to Dodd’s reelection campaign during the first quarter of this year, according to the senator’s report to the Federal Election Commission this week.

That’s more than four times the amount that Connecticut residents contributed to Dodd.

And ICE has good reason to cultivate a friendship with the Banking Committee chief. The company was recently approved by government regulators to begin “clearing” trades of derivatives, the risky financial instruments that helped take down AIG and were estimated last year to exceed the real value of the whole world’s financial holdings. ICE now has an interest in ensuring that derivatives trading remains supervised by a small group of firms, thus maximizing its ability to profit from the market.

But ICE isn’t the only company outdoing Connecticut natives in generosity to Dodd. Six employees of the lobbying firm Patton Boggs gave the senator’s campaign $5,500 on a single day during the first quarter, and employees of the financial services company Chesterfield pitched in $6,900.

So Dodd has an impressive number of supporters … just not that many who can vote for him next year.

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But then you find out that even in a year when people saw their retirement and college savings accounts decimated, top hedge fund managers raked in the big bucks, according to The New York Times.

As major markets and economies careened downward last year, 25 top managers reaped a total of $11.6 billion in pay by trading above the pain in the markets, according to an annual ranking of top hedge fund earners by Institutional Investor’s Alpha magazine, which comes out Wednesday.

James H. Simons, a former math professor who has made billions year after year for the hedge fund Renaissance Technologies, earned $2.5 billion running computer-driven trading strategies. John A. Paulson, who rode to riches by betting against the housing market, came in second with reported gains of $2 billion. And George Soros, also a perennial name on the rich list of secretive moneymakers, pulled in $1.1 billion.

The thing is, we need these same hedge funds to buy up those toxic assets from banks. So it might not be a great idea to start picking on them, even though Treasury Secretary Timothy Geithner wants to regulate them and tax their profits. From The Times:

Even as the spotlight intensifies, these hedge fund managers and others who made it through last year with cash on hand are the sort of investors the federal government hopes will step in and buy troubled assets from banks. The richest managers are also in the best position to take advantage of the distressed environment to build their wealth.

“The guys who own the future are the guys like John Paulson and the others on the Alpha list,” said Keith R. McCullough, the chief executive of Research Edge, a firm in New Haven that provides trading analysis for hedge funds. “Ironically enough, we’re going to go beg for capital from the very people we’ve been trying to vilify.”

More evidence of why populist rage exists. And how, in this increasingly complicated crisis, it can be difficult to decide where to direct it.

I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage.

After 12 months of hard work dismantling the company — during which A.I.G. reassured us many times we would be rewarded in March 2009 — we in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials. In response to this, I will now leave the company and donate my entire post-tax retention payment to those suffering from the global economic downturn. My intent is to keep none of the money myself.

I take this action after 11 years of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down.

DeSantis also aims at Liddy directly:

I have the utmost respect for the civic duty that you are now performing at A.I.G. You are as blameless for these credit default swap losses as I am. You answered your country’s call and you are taking a tremendous beating for it.

But you also are aware that most of the employees of your financial products unit had nothing to do with the large losses. And I am disappointed and frustrated over your lack of support for us. I and many others in the unit feel betrayed that you failed to stand up for us in the face of untrue and unfair accusations from certain members of Congress last Wednesday and from the press over our retention payments, and that you didn’t defend us against the baseless and reckless comments made by the attorneys general of New York and Connecticut.

This tidbit on Liddy’s timing is particularly interesting:

At no time during the past six months that you have been leading A.I.G. did you ask us to revise, renegotiate or break these contracts — until several hours before your appearance last week before Congress.

Read it for yourself, and decided whether DeSantis deserves your sympathy. But whether or not you agree with his side of the story, it’s worth hearing. In the outrage and anger of last week, not everyone’s voice was heard.

We should all have jobs like that.

My favorite non-explanation comes from AIG’s leader Edward Libby, who said in a letter to Treasury Secretary Timothy Geithner that AIG had to pay those big bonuses to keep all of its super-talented staff, The Washington Post explained. Those highly prized folks might leave the firm, Libby said, “if employees believe that their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury.”

Those employees might actually have a point. When a company takes $170 billion in taxpayer money to keep itself afloat, there’s always the possibility the government might have a few things to say about how those funds get spent.

And this is one of those times.

Clearly, the Obama administration is ticked off about this whole thing, or they wouldn’t have leaked the bonuses payments all over the media. But that’s not enough. This whole mess raises a raft of concerns that aren’t assuaged simply by knowing that Geithner is really, really mad.

Let’s start:

1. Compensation contracts are renegotiated all the time in corporate America. Surely, some court or judge would be open to the reality that circumstances changed greatly after those bonuses were initially promised, before the financial crisis began.  AIG could tell the employees to go ahead and sue. The company might either win, or its legal costs and possibly lower bonus payments still would be less than the $450 million. And AIG would set a precedent – this isn’t the way the world works now. We could be on the precipice of a depression. You don’t get a bonus just for showing up for work anymore.

2. Geithner could say this to Libby: Fine. You pay the bonuses, we take our money back. This would be my preference. It also would severely lessen the chances another bailed out firm would try to pull this stuff.

3. Geithner could say to Libby: Fine. Let those employees walk.

I’ve raised this point before: where are the companies out there dying to hire these people? The most recent experience on their resumes is at a company that failed spectacularly. They worked in the financial products unit — which totally blew it. What firms, exactly, find themselves in dire need of someone highly skilled at devising credit default swaps? Where are the feature stories in Fortune about the race among corporations to get their hands on prized former AIG employees?

Call their bluff. If they all go, there are enough other unemployed or underemployed people out their with financial services experience that I don’t see the difficulty in filling the jobs. And next time around, maybe AIG should look a little closer at character issues and ethics awareness. Just a suggestion.

AIG may have thought it won this round, but I suspect it badly miscalculated. This story is not going away anytime soon, and angry lawmakers and the public will be pushing for even more punitive measures. Government officials are said to be “exasperated” with AIG over the bonuses. That’s nothing. Wait until it sinks in with the rest of us.

Economist Dean Baker tore into this argument Monday on Marketplace.

The government has no legal obligation to honor AIG’s credit default swaps, but ostensibly it is choosing to do so because these swaps are held by financial institutions that could fail if the credit default swaps were not honored.

The problem is that the public has no idea if this claim is true because we don’t know who holds the swaps and how much they are owed. We don’t know if the Fed is only honoring AIG’s credit default swaps to ensure the solvency of banks and pension funds, or whether it may be paying off credit default swaps even in cases where hedge funds or other speculators were just making a bet that a bond would go bad.

The Fed and the Treasury are asking us to trust them with our money. But these are the people who completely missed the buildup of this financial bubble and minimized the problem at every turn. Their track record does not warrant much trust at this point.

Thanks, Dean. I couldn’t have said it better myself.

New York Stock Exchange (Flickr: ralphunden)

As Congress mulls how to buoy a sinking economy, lawmakers seem increasingly determined to rein in the unregulated derivatives industry, which many suspect has caused much of the mess.

During two congressional panels convened this week, key lawmakers have vowed to push new regulations for the derivatives market, with a particular focus on complex instruments called credit default swaps, or CDS.

Those swaps — effectively private insurance contracts in which one party pays another when a third party defaults — are used by banks and other financial institutions to spread risk. Unlike insurance contracts, however, no one in Washington is charged with overseeing them. The practice has left trillions of dollars in exposed debts — including mortgage-backed securities — in the hands of the same firms that are flailing under the current economic crisis.

Illustration by: Matt Mahurin

The lack of oversight, combined with the sheer complexity of the layered transactions, has left lawmakers convinced that new protections are needed, but unsure what form they should take. The agriculture committees in both the House and Senate took up the issue this week, because past deregulations of CDS had fallen under their jurisdiction.

“There is an estimated $55 trillion in credit default swaps somewhere out there,” Rep. Collin Peterson (D-Minn.), chairman of the House Agriculture Committee, said Wednesday, “but no one knows for sure if any of these swaps offset each other, exactly who is on the hook for these swaps, who is trading with who and on what terms. And worst of all, no one has any idea who is solvent and who is upside down.”

These comments emerge in the middle of an economic downturn that’s already caused Washington to intervene in the finance industry in ways not seen since the Great Depression. On Tuesday, the Bush administration officially announced a partial nationalization of the banking industry, pledging to invest as much as $250 billion directly in the nation’s largest financial institutions before the end of the year. Word of the plan sent stocks soaring on Monday. Yet on Wednesday, news of slow consumer spending sent the Dow Jones Industrial Average plunging more than 700 points.

In the face of the downturn, both Congress and the White House are scrambling to search for possible remedies. Regulating the CDS market has been increasingly floated as one such reform.

On Wednesday, some administration officials joined Peterson and other House lawmakers in calling for a system allowing “clearinghouses” to scoop up the CDS, thereby mitigating risk among the participants in CDS contracts. All are hoping this might help thaw out the frozen credit market. There is growing debate about how many clearing entities would be created, and whether they would fall under the jurisdiction of the Commodity Futures Trading Commission or the Federal Reserve.

“Clearinghouses ensure that every buyer has a guaranteed seller and every seller has a guaranteed buyer,” said Walter Lukken, acting chairman of the Commodity Futures Trading Commission. “No U.S. futures clearinghouse has ever defaulted on its guarantee.”

The rise of CDS as tools of the finance industry has been meteroric. Lukken said the global notional (or face) value of CDS has doubled each year this decade. In 2007, according to the Bank for International Settlements, that value was roughly $58 trillion — close to the gross domestic product of the entire world.

There’s good reason for that skyrocketing popularity. First, CDS can be traded, or swapped, by large financial firms more easily than insurance policies can. And second, the buyer doesn’t have to prove it can cover the risk if the deal goes south.

The swaps were used by financial institutions to back their obligations — including mortgage-backed securities — in order to make even risky investments appear healthy.

Experts agree that, used properly, CDS are vital tools for managing market risk. But there are perils. Testifying before the House committee Wednesday, Henry T.C. Hu, a finance expert at the University of Texas School of Law, attributed the downfall of American International Group largely to its estimated $440 billion exposure to CDS. “It’s hard to disentangle [AIG's CDS ventures] from the failure of the entity itself,” Hu said.

The enormous leverage assumed by CDS inspired Warren Buffet, in 2003, to warn, “The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen).”

Complicating the picture, CDS are private over-the-counter deals, not traded openly on any exchange. Not only do Washington regulators not monitor these swaps, they are legally prohibited from doing so.

Testifying before the committee, Erik Sirri, director of the SEC’s trading and markets division, pointed out that his agency, charged with regulating broker dealers, is authorized to intervene in the CDS market only in cases of fraud. In recent years, he said, many firms tended to hold their swaps outside the realm of broker dealers, in unregulated corners of the finance industry.

Sen. Tom Harkin (WDCpix)

Both Lukken and Sirri urged lawmakers to consider a model in which separate, global entities act as competitive clearinghouses. But that idea also raised concerns among some Democrats. Rep. Jim Marshall (D-Ga.) wondered how the competitive clearinghouse model would differ from the competitive swap model that many contend just failed. “It would potentially be another layer of lip-gloss,” Marshall said.

On Tuesday, Sen. Tom Harkin (D-Iowa), chairman of the Senate Agriculture Committee, held a similar hearing on CDS, concluding that legislation will be needed to rein in the industry.

“The credit-default swaps and derivatives have been put together by mathematics and physics geniuses, but carried out without an understanding of human behavior and market behavior,” Harkin said. “We must have regulations that will protect the rest of the economy from the excesses of the financial markets.”

If, indeed, the absence of a regulated derivatives market is partly to blame for the current economic crisis, both parties share the responsibility for bringing that environment about. In late 2000, Congress passed an enormous end-of-the-year spending bill packed to the gills with goodies. One law tucked into that package was the Commodity Futures Modernization Act (CFMA), which explicitly prohibits Washington regulators from overseeing CDS. Congress passed the bill easily, and President Bill Clinton signed the legislation into law later in the month.

A description of the CFMA says it would “promote legal certainty, enhance competition, and reduce systemic risk in markets for futures and over-the-counter derivatives.” Now some lawmakers are looking back on the passage of that bill will rueful eyes.

“Instead of alleviating risk,” Rep. Earl Pomeroy (D-N.D.) said Wednesday, “we compounded it.”

In the face of the scrutiny, voices for the derivatives industry insist that it’s been wrongly blamed. Appearing before the House panel Wednesday, Robert Pickel, CEO of the International Swaps and Derivatives Assn., defended the industry, placing the blame for the mess squarely on “ill-advised mortgage lending.”

“Both the role and effects of CDS in the current market turmoil have been greatly exaggerated,” Pickel said. “To say that CDS were the cause, or even a large contributor, to that turmoil is inaccurate and reflects an understandable confusion of the various financial products that have been developed in recent years.”

Such responses didn’t go over so well with the primarily Democratic House panel. Rep. Tim Walz (D-Minn.) said Pickel’s argument represents a delusional optimism about the industry’s role in the crisis — “like the band playing on the Titanic.”

Peterson also had a terse message for the industry. “Your folks need to get real,” he told Pickel, “if they think they’re not going to get regulated.”

Sec. Henry Paulson (WDCpix)

After the extraordinary federal takeover of Fannie Mae and Freddie Mac on Sept. 6, Treasury Sec. Henry Paulson Jr., Washington’s capo di tutti i capi on the credit crisis, drew a line in the sand with Lehman Bros. and Merrill Lynch. That makes the sudden federal takeover of the giant insurer, AIG, all the more surprising -– especially since AIG isn’t even a bank.

After Fannie and Freddie, the total commitment of taxpayers’ money to various bailouts and rescue schemes was more than $2 trillion, without any visible slowing of Wall Street’s skid off the cliff.

When Lehman Bros. showed up with their begging bowl last weekend, therefore, Paulson summarily sent them off to bankruptcy court. Merrill Lynch would never have rushed into the shotgun merger with Bank of America if they believed there was still a rich uncle in Washington.

Illustration by: Matt Mahurin

So when AIG cheekily asked for a modest $40 billion (!) “bridge loan” on Monday, they were laughed out of the room. Undaunted, AIG was back in the afternoon to report that, er…, sorry, they really needed $75 billion. Once again, they were sent off with business cards of bankruptcy lawyers.

Surprisingly, then, at 9pm that same evening, the Federal Reserve Bank announced that AIG would be nationalized, and receive an $85-billion line of credit from the government. The stated reasons were the size of AIG, its 100,000 plus employees, the 30 countries it operated in, blah, blah, blah.

It was all smokescreen. AIG’s insurance subsidiaries, which comprise the lion’s share of its business, are separately capitalized and regulated. They’re almost all profitable, and would have been only incidentally affected by the bankruptcy of the parent. With a bankruptcy trustee in place, they would have been quickly sold off to other insurers, in the same way that Lehman’s profitable brokerage operations and its Neuberger-Berman asset management group have stayed open, and are in the process of being sold.

AIG’s problems all stem from one group, “Financial Products,” which invested heavily in the same toxic mortgages and takeover loans that have wreaked havoc throughout the financial sector. But Paulson’s change of heart was triggered by just one product, a “regulatory relief” swap, with a notional value of $300 billion — an amount that hardly raises an eyebrow in today’s high-rolling world.

But here’s why the regulatory relief swaps loomed so important. In 2005 and 2006, various European banks created CDOs, or tiered bonds, supported by residential mortgages and corporate takeover loans. The banks sold off the riskiest tiers of the CDO bonds, which stand first in line to absorb any losses from the bonds. The “super senior” CDO bonds that the banks retained on their books therefore seemed pretty safe.

For extra protection, the banks executed a swap transaction with AIG. The mechanics of the swap were that AIG sold a “put” on the CDOs to banks. The put gave the banks the right to sell their CDO holdings to AIG at a price near par. To make it easy for AIG, if the puts were exercised, the banks promised to lend AIG the cash for the purchases.

The deal was a near-sham transaction, a “regulatory arbitrage.” Regulators were skeptical of CDOs, and were increasing the amounts of capital banks had to assign to support them.

But if the banks had a guaranteed takeout from a high-rated insurer like AIG, regulators could treat the CDOs as if they were riskless instruments, minimizing the capital the banks needed to support them. The only purpose of the deal was to reduce the capital requirements of the European banks.

But no one expected that AIG might fail. And if they did, the puts would fail — since there would be no counterparty on the other side. Then the banks would have to mark their CDOs at their true value, at best probably 50 cents on the dollar. On $300 billion of CDOs, that’s a mark-down, or capital loss, of $150 billion.

The mark-downs would be booked as losses and subtracted from bank equity. At a stroke, the European banks would be in a mad scramble to raise more cash, and would be clamoring for emergency infusions from their own governments. The phone lines from Europe to Washington must have been buzzing — “Hank! You can’t let this happen!”

To Paulson’s credit, he made the bailout as unpleasant as possible. The debt will carry a junk interest rate of more than 11 percent; the federal government has first claim on all company assets, 80 percent ownership of AIG stock and effective management control.

Current shareholders will be wiped out, as the company will broken up and sold off as soon as possible. The puts will eventually fail — but at least the the Europeans will have more time to prepare.

The positive result of the debacle is that future claimants for Fed-Treasury relief will have to walk under the sign, “Abandon all hope, Ye who enter here.” The government will help you fend off the sharks, in other words — but only by turning you into fish food.

The negative is that the whole mess in the credit default swap market has been left unresolved. Credit default swaps, or “CDS” are guarantees of debt payment that are privately traded among big financial players. These are the derivatives that Warren Buffet called “financial weapons of mass destruction.”

Losing payoffs can be large: AIG’s loss on the European CDO put could have been $150 billion. Deal terms are often murky, an alarmingly high number of settlements end up in litigation, and “counterparty risk,” or the possibility that the party on the hook for a large payment doesn’t have the money, is quite high. Highly leveraged hedge funds, for example, are big players in the market since it requires little cash to take big positions.

Allowing AIG to go down would have forced a violent restructuring of the entire CDS mess. Officials have been pleading with the big players to clean up their acts for years. While there has been plenty of lip service, there has been little action. Meanwhile, outstanding volumes have grown from a notional value of $1 trillion in 2000 to $62 trillion at YE 2007, and could well be $90 or $100 trillion by the end of 2008.

Wall Street has little vested interest in a cleanup. For one thing, since most CDS trades are murky and individually tailored, the Street pulls in at least $10 billion in annual fees for matching buyers and sellers.

For another, it’s been an enormously effective tool for cowing the Feds. The only reason Bear Stearns wasn’t left to shrivel up in bankruptcy was that they were the counterparty in $2.5 trillion of CDS deals. The mantra, just as with AIG, was “Save us, or our CDS will trigger a global catastrophe” — not unlike a two-year falling on the floor and turning purple to get his way.

Paulson has turned into the star of the Bush administration. It’s hard to imagine how any other Treasury secretary, particularly one working for an uninvolved and lame duck president, could have performed any better.

Lancing the CDS tumor before he leaves office would ensure his legacy.

Charles R. Morris, a lawyer and former banker, is the author of “The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash.” His other books include “The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy” and “Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”