🎙️ Inside the Next Financial Crisis with Lloyd Blankfein #podcast #theforum

Well, you know, I'm a markets guy, so I'm more of a responder to what happens. I take certain things, you know, I think things fall the way they are for a reason. What would I like? I'd like the sun to shine every day and the birds to chirp every day. If I were in charge, I'd make sure that that happened, but I do think that Wall Street does a very good job of responding in the uncertainties that exist at every moment about what is going to happen next and being good contingency planners and very resilient and great responders. And of course gets killed by the reviewers and the pundits who after acquired information look back and say, 'Aha, I thought, Oh God, that's not what I would have done.' Just like nobody voted for Nixon except he won in a landslide. Everybody always remembers being right because the pundits don't have P&Ls. People with P&Ls can't walk away from what they had thought in the past. And so, I think we have a system that allows for animal spirits and with that comes the inevitability. She asked me what I wish, I wish it would never go off the rails. But if you're going to have animal spirits and that's going to produce a kind of cycle where you have a bad outcome and then everybody is nervous about risk, husbanding capital, afraid to take risk and then over time the memory of the trauma of the crisis ebbs and people get a little bit more sportier, which is what happened today. And again, dimmer memories, people retired, new people came in who only read about the financial crisis or the tech bubble in books, so it doesn't quite register and get sportier and sportier and then sows the seed for the next crisis and the next reckoning, in which case everybody tightens up, bad assets get off of balance sheets, it gets shipshape again and it takes another couple of years for that to go. And guess what? That's why we have a business cycle and that's why we have historical cycles. Can you imagine if we all lived forever and we kept our memories intact forever? We'd be afraid to do anything.

No, no, no. I'm an observer of it. I'm not critical. By the way, Goldman Sachs was a participant in private markets. Not everything we did was in the regulated part of the firm. We had funds that were unregulated, private credit funds. Not everything was done off balance sheet. So, I'm an observer of it and I was commenting on what the risks of that are that people are underestimating.

Look, let me be clear. Going back to what I just said about cycles, in this kind of cycle, when you start feeling good and sprightlier and get less disciplined about it. And as we separate ourselves from the trauma and we haven't had really one for more than 15 years since the big great financial crisis, things get a little more lax. It's just again, it's the nature of things. And the real issue for me in the market today is that we haven't had a reckoning in a long time. So, we haven't cleared those assets that are on balance sheets that probably are marked too high. That really people who thought they were worth X and they may not be worth X. Why do I say that? Because a lot of these private assets, they're acquired on the balance sheets of private equity firms, insurance companies buy them. And you know what? The companies that do this activity are in business to recycle them and sell them as soon as they can. We've just had the highest equity markets ever and the best financing markets ever. And assets are getting kind of aged on balance sheet. So, that must mean for people who are highly motivated to sell them are not selling them because the price isn't being met because they're probably marked as a little high. So, I'd say the metaphor that I would use is we've been accumulating a lot of dry tinder on the floor of the forest. You know, if you think of California and when it gets dry and everything and they put out the fire alerts because it's dry outside. The real problem is the fuel on the floor of the forest, the tinder, the dried wood that fell down. And at some point, inevitably, someone will toss a cigarette butt, someone will be careless with a campfire, there'll be a lightning strike. Do you blame the lightning? Do you blame the cigarette? It's inevitable. It's really the fact it's the accumulation of the debris, the fuel that makes this inevitable at some point. I think because we have not had a reckoning, we've not had these preventive brush fires that they try to do in a controlled way to burn that stuff off. We are having one now a little bit in private credit, which is a good thing because you want these little things, markets pay attention to little things, get them out of the way before they engulf and get out of control. That's a little bit like a kind of burn-off. But because we haven't had that in a big sense in a long time, I'm nervous it'll be something. It could be a fat finger. It could be somebody says, 'Oh my god, the price of oil is going to be sustained this high.' It could be a lightning strike. It could be a meteor hitting the planet. Something will happen that at a different time would not have set anything off because there wouldn't have been a lot to set off. But because that kindling is there, something will happen like that. It could be a bad credit, it could be the credit event like a highly leveraged fund can't make a payment or something like that. It could be an insurance regulator that looks at the balance and don't forget, insurance is regulated by 50 state regulators, not necessarily all the same caliber. They may look at the balance sheet of an insurance company and say, 'Gee, we don't know if these assets are going to be sustained to make the... we're going to make you sell some.' And then they might find themselves selling into a market that doesn't want it and won't pay the price and that might make everybody crazy at the same time going for a door that trying to sell stuff that no one wants. So, I've lived through a lot of these. It could be almost anything and it could be something that at a different time wouldn't have registered. The problem is the accumulation of assets on balance sheets that may not be worth what they're worth.

A betting man.

Well, Goldman Sachs, prior to 2008 was not regulated as a bank holding company. There's always regulatory arbitrage just like there's any other arbitrage. The market will find places where capital is cheapest. Capital is going to be cheap where there are less regulatory requirements that you hold capital against leverage. And so, there'll always be stuff like this. As I said, even Goldman Sachs in its regulated form has funds that are private credit funds because it's other people's money in an account not subject to regulation, not on the balance sheet of the firm. In fact, ours were very big very early. So, I think that's a part of the market. It creates a problem in the system. Again, it might not be the spark, but it's part of the tension. In the financial crisis, the Fed could get probably 90% of all the outstanding loans around its conference room at the Federal Reserve building if they just had 16 banks represented. And by the way, if they had five represented, they could have had 75% of all the loans that were outstanding get together and say, 'Okay, show of hands. Who has this? Who has that? What are we going to do about it?' Today, because of the distribution and the wider net that they'd have to have, they'd have to take out Citi Field and have a meeting there and stand on second base and say, 'Show of hands. Who has this?' And they don't have the visibility on it and they don't have the influence on it. And so, I think the conditions are such that I think it would be hard to work out those problems. That said, I think under normal times, I don't think private credit is by itself necessarily such a systemic overwhelming thing. It could be the last straw on a market that's already waiting for something to set it off. And so, it could have that effect. But I don't think private credit by itself is that substantial or that bad. So, I wouldn't be worried about that. Again, I'm more worried about the kindling than I am about the cigarette, the loose cigarette butt at this point. That's what I would work on if I were a regulator today. I'd be worried about getting rid of all the mismarked assets here. I'd be pressing... Look what's happening now in the market. You have some of the sponsors aren't selling their investments. The limited partners are selling their interests in their limited partnership interests at a discount because they need to raise the money. Endowments are going to the market. That's why the rise of all these secondary funds that are buying limited partnership interests is because they're not getting distributions. They have to sell their limited partnership interests. I don't want to be picking on that. There are other things also. And again, I don't think that's hypercritical in and of itself. I think the general background is critical. Ironically, in part because we haven't had a crisis in a long time. You know, every guy quotes from The Godfather, so forgive me. Remember that scene in The Godfather where they're talking about there's about to be another mob war and one of the old capos puts his arm on like said he said, 'Don't worry about it. We have to have these wars every 10 years to get rid of all the grudges and bad feelings that build up over 10 years.' I think we have to have a crisis, unfortunately, it's the crisis that pops up every so often that gets... that's a reckoning for all the assets where there's no imposed discipline on getting them properly marked and distributed away from balance sheets.

Of course it's... these things are going to recur. It won't repeat, but it will rhyme. Things will always... it's the nature of things to keep going and possibly go to excess and you try to do it. Look, Dodd-Frank for example, said... it was done when it was implemented and then it's been steadily relaxed since then because what you don't want to do is you don't want to turn the country into a Treasury bill. You can't... if you want to get rid of risk, you're going to get rid of growth. And you don't want to say, 'Gosh, we're going to get rid of the crisis of the 80-year crisis.' We want to make sure that doesn't happen and you won't necessarily make sure you don't have the 80-year crisis, but you'll make sure you won't have the 79 growth years in between. You have to manifest the intention to regulate it so that you'll never have that crisis and then you have to wink to each other, you know that's not possible, but you can't relax. You have to impose that discipline because if you act too cavalier about it, you're going to guarantee the 80-year crisis going to happen every 8 months. So, you're going to have to make that effort supervise, but you have to know that these things are going to happen again. So, the regulators have to do really two things. Take a lot of pains to make sure to avoid the crisis and then to take a lot of pains to create an infrastructure and a system so that when we have the inevitable kind of thing happening again, we have the mechanisms to sort it out. That latter thing we've kind of hurt. Part of the resentment that came out of the Glass-Steagall was we didn't want the Treasury on its own to have certain powers to intervene in the market and save a Bear Stearns and elect not to do Lehman. And so, the Congress has put a lot of limitations and restrictions. That's kind of bad because they're imagining that they're going to implement a system that'll make sure there's never another crisis again, but that's not possible. It'll come out of left field, something we're not thinking about. Might even be just a fat finger that makes some software glitch that means nobody knows the solvency of anybody else and nobody wants to make a payment. And then the only way that people trust anybody to hit send on a payment is for the government to say I'll come in and make sure those payments occur. But something like that will happen. And that's by the way the brilliance of the economy. It's like again, regulated, supervised, worrying about the extremes of it, punishing miscreants who get too close to the line or go over it as a specific deterrent to them, but deterrent to anybody else not to go too far. And manage it that way. But not to have the hubris to think you can manage it and still have a successful economy that could avoid unforeseen risks that spiral out of control.