GOLDMAN’S BLANKFEIN: ONE BIG RISK IS THAT THINGS GO RIGHT…

Via Bloomberg TV:

Blankfein on public opinion of Goldman Sachs:

“I think the average American probably had no contact and had never heard of Goldman Sachs before three years ago.  Shame on us in a way for not anticipating how important that would be. We’re an institutional business with no consumers.  It turns out, another name for consumers are citizens and taxpayers.  They became important for reasons that are obvious.  They always should have been important, but it wasn’t part of our audience as we thought about it.  Now we will have to develop those muscles a little better than we have. Shame on us.”

On whether Goldman is still, in the public’s eyes, the “vampire squid”:

“That is hyperbole…it possibly is, but we’ll have to do a better job, getting out there and telling people how important this industry is, what it does when we advise companies on their growth plans and finance their growth plans and manage their assets for them and how important this is for the economy, the markets and obviously society at large.”

On whether Blankfein had to change his priorities since becoming CEO six years ago:

“The last few years in particular have been a lot about having to deal with this risk management complexity of the time leading up to the burst of the financial bubble and of course, there has been some absorption in the aftermath. In the larger strategy, the thing we’re dealing with, which is a very big positive for the world, is the wealth creation that is going on all around the world and that we are engaged in, benefit from, and help to support.  And that might be encapsulated in the expression, the rise of the BRICs.”

On conflicts of interest:

“I think no one who is going to be effective in this business can avoid conflicts of interest coming up. You can do that if you only represent one client in every industry, in which case you won’t really be able to be that effective, knowledgeable, or influential.  You won’t be able to get anything done.”

“If you advise a client today, you have to lend to that client.  If you lend to that client, they have to pay back.  Now you have a stake in the outcome of their business decisions.  You give them advice, but since you are a lender to them, like every bank has to be today, you have conflicts of interest.  They always have to be managed.”

“[Conflicts on interest] have to be managed.  I think there’s a sensitivity to it and you are going to have more prophylactics, more safeguards built, you get more scrutiny, more second-guessing of the decisions you make, which make you more conservative, all to the good.  But if you want to rule out conflicts of interest, you’ll just give advice to one client in one industry and never do any lending or support for the capital structure of the firm.  It’s just not feasible.”

On Arthur Levitt’s statement saying Goldman should stop saying it puts clients first:

“I spoke to Arthur. We have different aspects of our business.  For example, in the market making business, we give prices to our client and a client decides whether to trade or not.  We hope as a result of that exchange, we will make money and not lose money.  If over time we lose money, we will be out of business.  We have other businesses or we are an adviser and other businesses where we are a pure fiduciary.  One of the things we set up to do when we wrote our business standards report is go out and carefully delineate for our audience what our roles and responsibilities are in each segment of our business.  As an adviser, we work for the best interests of our clients.  As a fiduciary, our clients to come first.  As a market maker, we have to protect Goldman Sachs.”

On why Goldman says clients come first when conflicts of interest are inevitable:

“In the context, they mean different things.  In a market making business, the ‘client comes first’ element in our culture is in tough markets, when things are hard and it is risky for us to be the other side of what our client wants to do, we will hold ourselves out as standing out there and doing more than other people would be doing.  When the markets were opening in early 2009, Goldman Sachs was one of the bravest market makers in a very dislocated market.  It didn’t mean we wanted to lose money or we would bid as high as our clients wanted to because we wanted to protect our firm, but we were there for our clients and provided a market.  After 9/11, we were the first firm to make a market for someone who wanted to get out of a position to flatten out their books and reduce their risks.  These things mean different things.  I think Arthur’s comments were reserved for a narrower part of the business.”

On illiquidity in times of dislocation and whether Goldman will be as brave in the future:

“I think that is how market makers like ourselves get prioritized in the minds of their clients, by their willingness to provide the other side of what our clients want to accomplish. Our first duty is to not risk our capital and hurt our shareholders too much or excessively and manage our risks, which I think no one will debate we do pretty well. That expertise is also used to benefit our clients to provide liquidity for the things they want to accomplish.”

On whether being a pure investment bank/securities firm is still the best model for Goldman:

“It suits us just fine, yes. We have a tremendous amount of room ahead of us to expand.  To refer back to the rise of the emerging markets and wealth creation around the world, my predecessors didn’t go to China.  They called it Red China. They didn’t go to Russia or India because there were people in poverty, not people growing their businesses and trading with the rest of the world to the extent they are…In Europe specifically, we are probably a bit of a recession and slower trajectory than people would like.  We are dealing on a near-term basis with a probably what is at best a lower third court-quartile opportunity set.  I wouldn’t make any judgments about the long-term of what this business will be extrapolating from these times as I would not have extrapolated what happened in 2006 and 2007.  We had a 12.2% ROE in what we would regard as a very, frankly relatively poor, opportunity set.”

On what kind of ROE can be generated in a good opportunity set:

“I think there’s a confluence of a lot of changes going on around the world.  Some will be supportive.  Competition is lessening and a lot has been written about how the global institutions are under pressure with respect to their own capital are becoming much more closed in with their own countries and less global.  We’re still a global bank.  Our reputation and our reach into the rising economies is quite strong. That’s a big positive.  We’ll have to hold more capital against the things we do and that’s a positive for safety and soundness but in and of itself, would tend to reduce ROE.  If you net all of these considerations, it is a big unknown.”

On Goldman recently issuing a dividend to shareholders:

“We engage our shareholders a lot. We’re a young public company.  We’re an old company, 140 years old.  But we’ve only been a public company for a dozen years or so. In terms of engaging our shareholders and finding out what they want to do, it’s clear they wanted the predictability of a dividend flow.  We’re still primarily returning capital to our shareholders through share buybacks.  If you do the math, that’s always felt like a better way for us to do it.  But we’ve exceeded to the interest of our shareholders on this as we should.”

On whether it’s a better strategy to use the money to buy back the stock when it’s trading at less than one times book value:

“Personally, we’ve always preferred to do buybacks. We like to reduce the share count, it helps for our ROE per share.  But it’s not that far off and our shareholders like the predictability and the discipline of us feeling the need to reserve some money to set aside as a dividend on a predictable basis, as opposed to buybacks which are a little more episodic.”

On whether Goldman could survive if it didn’t have access to the Fed’s discount window:

“We did not have access to the Fed window as the bank leading up to the crisis because frankly we run ourselves very conservatively. One of the reasons why we came out of that crisis, that moment so well is because we went into so strong.  Today, we carry over $170 billion of liquidity.  We are very highly capitalized among the highest tier in our industry.  We don’t borrow from the discount window.”

On whether it would be better to cease to be a financial holding company and go back to the way things once were:

“On one hand, that has an appeal.  But I think the world needs institutions as big as we are to have a lender of last resort and have the regulation that implies.  Even if we were not a bank holding company today, we would be a SIFI and regulated almost as extensively.  It’s not a question of what we want, it’s how people want us to be.  There is a regulatory and legal commitment to achieving that anyway.”

On whether it’s necessary for some institutions to be too big to fail:

“I think some of the rules being written, specifically to allow institutions to fail, allow for lending to go to those institutions so they can be managed down.  But those will still be failures.  Equity holders and debt holders will be wiped out as a result of it.  The lending that a lender of last resort will provide under some of these rules is lending associated with a wind down, with allowing a failure to occur.”

On what he’s predicting for the markets and global economy:

“I tend to be a little more positive than what I am hearing from other people.  I think the world is a bit bifurcated between what economists are saying and what market people are saying.  Economists looking at all of the deflationary pressures, austerity that is building up, things looming in the distance, tend to be quite negative and they’re doing the appropriate thing, the policymakers, making contingency plans for QE3.  The risk is skewed.  Even if you thought there was a better chance for the world to grow, the consequences of not growing and sliding back are so much greater that you want to build insurance on that side.  A lot of the rhetoric that comes out of the economist point of view and the people of advising policymakers would make you feel a lot more negative.  If you look at how much cash there is, how big a trauma we have had and how we are reversing out of it, it is a lower trajectory of growth, but it’s going in a positive direction.  In some way, markets is economics plus sentiment.  Were there to be a sentiment change, there is a lot of pent-up demand to do things.  I spend all of my time talking to CEOs in this country in this country and outside of this country in addition to policymakers and others.  There is a lot of interest in doing things.  We are unsure of the environment and we’re not executing all of our big plans and ambitions because we would like to see some clarity.”

On what Goldman is holding back:

“Clearly, our fortunes hinge on growth around the world.  A lot of growth is occurring overseas and in the BRICs countries.  We should intend to build out our footprint a little more.  We have been conservative with that because we have to scale our investment relative to the opportunities…But there is a consequence sometimes to being too early and we have to scale that opportunity in the right place.  On the whole, I would think that most pundits that come on the television, I would say 80% of the time they are negative and provocative and that way in a way that jins up interest in their sentiments and if you think about it, the world progresses and moves forward about 90% of the time.  There are a lot of things that could go wrong and it would take a whole show to go through it.  I’m in the risk management business.  But one of the big risks people have to contemplate is that things go right and we get through all these different issues, whether we know about them or other things compensate for them.  We have a big slowdown in Europe, but even China, at its lowest growth, is growing, its growth is equivalent of half the U.K. economy every year.”

On Facebook’s IPO:

“There are a lot of important things happening. If we ever added an S to the end of BRIC to make it BRICS, you might have to throw Silicon Valley in there.”

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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