What Could Trigger the Next Crash? Lessons from 2008 | Lloyd Blankfein

The future is very hard to identify. But I noticed the people who are very good traders are the people who react the quickest to changes because they're not so set and they're not selectively perceiving everything in the world as reinforcing of their current view. They change their minds more easily and more frequently. There are people I know who are in very senior and powerful positions who are the kind of person that was voted most likely to succeed every year of their lives starting in kindergarten. I was blessed by not being that person. So I worked my way up. I knew that a lot of the magnetism I had was the magnetic pull of Goldman Sachs and the big very successful firm and the influence and frankly the power that you have at being at the top of that heap and the power of the firm was kind of transmitted by me and that made me attractive, but I knew what the source of it was. I think optimism is generally justified. Things tend to work out over time. And so earlier you asked me, am I always in risk in equities? Yes, I mostly am in risky assets because most of the time you get fairly or overly compensated for taking risk. And so if you can't bear something not working out, then don't go near risk. But most of the time people are in a position to benefit from taking more risk and having generally optimistic about the way the world would play out.

Well, thank you very much. It's a pleasure to be here.

Yes. Well, you know, Wilf, we know each other for a while. I mean, let's be honest. We know each other for a long time. And actually, I find, look, I grew up with some advantages, including the advantage of low expectations because I grew up in what here would be called council housing and they got scholarships to good schools. And I was totally unburdened as my own kids are burdened with high expectations. And that is to some extent an advantage. Look, in any situation, there are advantages and disadvantages. But I bet we've never talked about this, but to have a prominent father and the high expectations that get associated with it is to walk into a room and wonder whether the person thinks you really earned it. And I didn't suffer from any of that. Anything that came my way was all a positive. And sometimes I see the stress on my own kids who have to make their own way and convince everybody that they deserve it.

Would you like to lie down on my couch while I analyze?

Well, again, you're being very generous here. It's a clever attempt to soften me up before we get into the...

Oh, I think we're all kind of stamped when we're young and you can lean against those tendencies that were formed early on, but I don't ever think you ever leave them behind. Totally. Sure. I always, you know, walked into a room and, you know, when I went to college, you know, my parents went out and bought me what they thought. My parents didn't go to college and you know my siblings didn't go to college and their children didn't go to college because they were older than me and so the kids weren't that much younger than me. And you know they went out and bought me clothes at a store where for $100 you got two suits, three pairs of slack. I mean this is in the early 70s during the Vietnam era and everybody was kind of wearing jeans and everything and I went to college based upon some movie they had seen about what college life was like in the 1950s. So yeah, I always felt a little bit like an odd duck out and I could see it in other people looking back and eventually, you know, you can form and you know how to do things, you know how to dress and do it, but I always felt a little bit out. You know, I have a pretty heavy Brooklyn accent, outer borough accent, and you know, that kind of stamps me. And you know, guess what? It is what it is. I go with it.

I don't think it's harder. I think it's easier, but it doesn't mean that the people who are grinding through it feel that way because anybody who has come to the point of sitting across from you has already done it. It's already in the bank and booked on the shelf, whatever you want to say. And so I accomplished it and other people are striving today. But I think today there's more financial aid for people who aspire to reach out. Look, in my era, women had to be teachers because a job on Wall Street wasn't available to them and many many careers weren't. They didn't become engineers. They didn't go to graduate school in the sciences. And today they do. That's one category of people. Certainly for minority groups, we've had generations of reachouts and making other things available. The scholarship programs at the elite institutions in the US are much greater. I can't tell you how it feels to people, but as an observer from the outside, I think there's more opportunity today, but not infinite opportunity. So, you'll always hear the story of the people the hard scrabble people with bad luck or hard scrabble lives who don't make it. And that still persists. But I think if you looked at it statistically, you had more opportunity today than you did back then.

I would say that Goldman, well, I wouldn't say it went all the way over to a pejorative, but Goldman was a very very established firm. It hired most of its people from the Ivy Leagues and Harvard Business School and the like. And J. Aron was a commodity trading firm. So just the background, I practiced law for, I went to college and law school. And so you have student loans, you go right into, you get caught up in the vortex of going into a job at a big law firm. I left after about four or five years when a number of people would say, 'Do I really want to do this for the rest of my life?' Look for other things. I lived in New York, which is a finance town. I applied to financial firms. And I interviewed at several and got a job at none of them, including Goldman Sachs. Turned me down, which is why, you know, part of my abiding respect for the firm because they turned me down early stage. But as I was interviewing there, they acquired this commodity trading. Commodity trading at that point was considered, was day class A, was kind of the lowest point among all the assets you could trade. Equities and bonds and commodity trading was something really down the totem pole. And I had gotten a job at J. Aron and J. Aron was acquired by Goldman Sachs and that's how I got into Goldman and it was a different culture at Goldman. They had training programs and a hierarchy and real mentorship that went on. And J. Aron, the way people got promoted at J. Aron is they were the driver for a more senior partner at J. Aron and many of them went to college but many of them didn't go to university let alone Ivy League universities and so it was a little bit more streety. And again that background was good DNA for the firm to absorb and if you push the clock forward a lot of the trading investing businesses were later dominated by people who came through the J. Aron part of the firm.

I think that look, there are people who will always remember that they had gotten this right and never remember they had gotten that wrong. But my observation as somebody who sat at the top of this enterprise is that in my view, and this no one, people won't like this analogy but I think sometimes good traders are a lot like good poker players. Over your life as if you're playing poker, over your life statistically you're going to get the same amount of good hands and bad hands that anybody else will get because of the randomness of all the law of large numbers takes over and everybody gets the same set of opportunity but somehow the good poker player always wins and the poor poker player always loses. Why is that? If they're all getting over time the same kind of hands is that one will play the cards better than others will fold quicker. In other words, get out of a bad position because they'll identify it sooner and let his opportunity run in a good position. Now, poker and the distribution of cards will seem more chance and of course in trading you're actually doing analysis and getting it right. But so the analogy doesn't hold completely but I would say in my observation talking about the markets with people and then seeing what happens the good trader could be just as wrong predicting the future. By the way, people have trouble even as we sit here today with so much going on people could barely predict the present let alone the future. People could barely describe what's going on today. The future is very hard to identify but I noticed the people who are very good traders are the people who react the quickest to changes because they're not so set and they're not selectively perceiving everything in the world as reinforcing of their current view. They change their minds more easily and more frequently.

You know something I think they might because I think one of the things in banking, the more traditional investment banking kind of positions as advisers to CEOs, you're kind of honed and really identified and the natural selection process hinges a lot on presentation skills and being articulate, putting together good pitches. By the way, identifying too, I'm not suggesting in any way not also brilliant, not the smartest people in the rooms that they go into and everything, but you can very much underestimate people who are quite brilliant. Just think of the physicist that, you know, who the Nobel laureate in quantum mechanics who can't make a presentation, can't articulate even basic principles to somebody else because his head is in the mathematics. And this would be an example of people who's just their skill set is not honed for that. By the way, I was one of those people maybe, you know, to some extent still am. You know, one of the problems, I don't want to jump too far forward. I know we're going to get there. But one of the problems we had during later in the financial crisis when I was already being the CEO is at Goldman really the skill set of even a Goldman Sachs was not to be good on television and not to put yourself out front but to be supportive of your clients. And so we were never, our particular purpose was to keep our name out of the paper. We were a wholesale firm. We didn't have branch offices where people had checking accounts or anything. So our particular skill and if you wanted to run Goldman Sachs, it wasn't because you were a good presenter even at the overall level of the firm or you were telegenic. You were there because your skill set was involved being effective in the background as a good adviser or as a good risk manager and suddenly the world had changed and we became too big too influential maybe too powerful to be invisible to the world and guess what had to step up and do things that you weren't necessarily trained for or really selected for.

Well, really a year away. One house year.

Yes. But to really the question you're asking, let me just answer with an emphatic yes. That's how I'm identified and that's how my reputation inside the firm and outside the firm was set. In other words, the value of performance during that era. Of course, nobody thinks they get valued for when you make no money, but coming out essentially flat during that period was an achievement. One of the things that really struck me was I guess how, you know, I would think of Goldman through that period as not really ever being at risk. Certainly never needing to go cap in hand to the government, not likely to be taken over from a bigger bank. But I guess you acknowledge in the book how much you feared at the worst moments that more because of issues outside of your control that you could have gone bust.

Oh, absolutely. Everyone could have. Just let me just say in the financial crisis which was also a banking crisis simultaneously. We could talk about the difference between a recession that has a banking crisis and one that doesn't. But it was a moment in time where the assets on people's balance sheets, in other words the value of things that you own, mortgages, if you're a big company, but anyone even industrial companies got would be affected by this. GE was one of the most put out companies for example. The value, everybody's solvency was being questioned what were the values of assets and as a result of that in this world everyone has to make payments all day long to everybody else. I owe you money but because I did a transaction I know that money is going to be there because someone else owes me money and when I and you need me to pay you because you sold it to someone else and that person gets paid. Certainly the banking system revolves around that and at the end of the day everything gets sorted out because there's this stream of payments that get made to each other and it all settles. But at a point in which you have a kind of crisis where nobody knows the value of the other person's assets, what they have and what they're worth or whether they're solvent, all of a sudden I'm not paying you until I get paid. And that money is not, anyway the money that I owe you is not coming in because they don't know whether I'm solvent, whether I'll meet my obligations. So the system freezes and all of a sudden no one is making payment and everybody could be in default. That could have happened. That started to happen. And then at that point the only balance sheet big enough to reassure the market and say I have looked at you all. You all can afford to make these payments. I will make sure it all works out. The only one capable of doing that is the government at that point. And so I would say could the system have survived it? Probably yes. Would we have survived it? Probably yes. But there was a big enough risk that when I think of I insure risks that have less than a 1% chance of occurring should we have taken a chance what was far greater than a 1%. The way I said it there...

I said 15 to 20%. And I say you know what else is 15 to 20%? A turn at Russian roulette, right? In a six shot revolver. That's a turn of Russian roulette. Would we have wanted to face that? No. So if somebody said would you have likely gone? No. Very unlikely. Was it possible? Far greater possibility than we would have wanted to go to sleep. But it wasn't. We were one of the most solvent with one of the best balance sheets. But everyone would have been at risk at that time because there could have been a daisy chain of defaults and no one would have been solvent.

I think I wasn't in his shoes. And this is the benefit of hindsight certainly. There was, it seemed that he would have had to have done something that would have valued the firm a lot lower than he thought the value was and he didn't do it. You can recover from anything other than being dead and so there were other institutions that, the shares traded very very low, the shares of Morgan Stanley traded very very low, single digits, something that was much more highly valued before down a lot and they recover and it's a very very strong firm today and they recover and it reasserted itself and the pendulum swung back the other way but the pendulum doesn't swing back if the pendulum falls off. And so yes that was something he and he's had to endure a lot of criticism over it.

Yeah, sure. I mean, the point is, and again, I'm not doing it to mock those people who performed very well in the crisis and sorting things out and they don't get as much credit as they deserve for doing it because we never had the blowup and because, you know, it's like when James Bond diffuses the bomb before it goes off. No, the world doesn't thank him for it because the bomb never went off and so no one will ever know about it. So I think those guys deserve a lot of credit for what they did. But you could find the predicate for a lot more problems than they turn out to be. You just don't know. So the answer is yes. I would say that if one is in the game of taking risk, one has to be a good risk manager, which means you're always fearful. You're always anxious. You're always looking around corners for what could happen next. And I'll always tell you what the things I'm most nervous about. That's a good thing to be nervous about today. Private credit. In fact, that has now come into everybody's state of mind. Everybody's looking at private credit today. So, that has echoes of it. Doesn't mean it's big enough. But the mortgage crisis, as you point out by saying that thing and by quoting those things, and I quoted it for that very purpose, to say you just don't know. These are the brightest minds, certainly focused on the business. They're not naive people who are trying to minimize problems, but they didn't see it. Could this, the problem with finding something that no one else is seeing is it may or may not be a problem. The old joke goes, yes, here I am, I've identified 10 of the three problems that ever happened. You don't know. But I could tell you there are things that I would be, if I were still managing the risk of a big institution today, I'd be very very, I'd be pointing to and very very concerned about something that could trigger. Now, when you're dealing with a crisis, I think an apt metaphor would be a forest that may or may not have a lot of kindling on the floor of the forest. Branches fall down, trees go down, the wood dries up, and it's kindling and dead branches, a form of stored energy. And at some point, a spark will happen that will set it ablaze. And that spark, if the kindling weren't on the floor of the forest, the spark would come down and nothing would happen. Lightning would strike and nothing would burn. But if there's a lot of kindling picked up, a spark that otherwise would have accomplished nothing would set it ablaze and eventually something will set it ablaze. The mere passage of time creates the accumulation of, and I could tell you what kindling is in the context of banks and other financial institutions. But the mere passage of time causes the accumulation. And I think this is a good time to look for the spark. Could the spark be private equity? Could be private credit, could be the price of oil suddenly doubling because of what we're sitting here now and observing what's going on in the Gulf. It could be any of those things and the world might absorb that at any other time except we haven't had a problem in 15 years or more. And so, we're accumulating assets on balance sheets that are probably not worth what people think they're worth. So I can give you like an example.

We're living in a world where private equity firms are incented to sell off the assets, the divisions of companies and the companies they've bought over the last several years. And quite famously that hasn't happened. They've accumulated and some of them are finding great difficulty in raising new money because they haven't returned money, because they haven't sold things. Where we're just coming off a period of record high equity prices and a very very friendly market for raising financing. In fact, a brilliant period, almost unprecedented, and yet as incented as they are to return capital, they haven't been sold. Why? Could it be that these companies were overpaid for or marked higher on balance sheets than they're worth? Very possibly. And so that would be an example of assets for which there's been no forced reckoning. At some point there'll be a forced reckoning. People will have to sell. People will have to raise equity and capital. And so that will have to happen. Usually that reckoning occurs because I said we have the crisis of the century every four or five years but we haven't had one for a long time. And because of...

The buildup of assets that may be overvalued on balance sheets or kindling on the floor of the forest has been built up. And so eventually it'll happen. I guess the other kicker to your point about the 15 years without a crisis is the balance sheets of governments have gotten a lot worse because the response has tended to be, you know, kick the can. And no fault of the government, you'd say. The government still hasn't recovered from the swelling of the balance sheet that happened because they stepped in at the financial crisis. So a lot of the risk has gone from the private sector onto the government's balance sheet with big outstanding debt and obligations. So yes, that's another part of it for which, you know, hopefully there won't be a reckoning because if the government balance sheet is in trouble, who's bigger? Who can assuage the market that the government is okay?

You know, anything could be, you know, think of the spark as being the straw that breaks the camel's back. That straw didn't do it. It was the accumulation of a lot of straws that did it and that was the last one. Yes. Almost anything could do it. But you bring up an interesting point. That's one thing, how does a government default? The US government borrows for the most part in its own currency. How could it default? They could print as many dollars as they want. If the government owes you dollars, I assure you they can pay you back dollars. They just run the printing press. But the point is the US government defaults on its debt by allowing the dollar to inflate. So you lend the US government money for 10 years and we pay you back the dollars that you lent us, those dollars don't purchase what they used to purchase and that's how the US government defaults. And so everybody is watching inflation because the way the government also defaults to its creditors is by allowing its currency to inflate.

You know, it does. And it's kind of weird because everybody, you know, the US now is providing great theater to the rest of the world because as you know...

Well, entertaining theater. I say great in the sense of entertaining, not necessarily great outcomes in the immediate. Well, don't forget tragedy could be great theater also.

So, in that spirit, it's great theater like great tragedy is great theater. But the strength of the US is in some ways that it deals with its problems very aggressively. You know, the social contract is a little bit different. The stresses and strains, the fighting, you know, the US has been ground zero for a lot of crises and yet the US recovers quicker than almost anybody else. Has its trials, everyone, believe me, I know this firsthand. You get called in front of Congress. You get beaten up. You get vented and attacked. Legislation, very aggressive legislation gets drafted very quickly. And then over time, as tempers calm down and everything, it comes back down again. But it deals with its problems very quickly, very aggressively and sometimes with immediate damage in the short term, but it gets to the long term quicker than anybody else.