"We prepare for the worst things we can think of"

Last year Lloyd Craig Blankfein was nominated as Chairman & CEO of Goldman Sachs by his predecessor Hank Paulson, now Secretary of the US Treasury. Both gentlemen were in Mumbai last fortnight (with slightly different agendas). The 53-year-old chief of the most revered bank on Wall Street was ranked #6 in Fortune’s 2006 listing of the 25 Highest-Paid Men, with a total compensation of $54.3 million. He could take home that much because 2006 was a record-breaking year for Goldman in each of its businesses. The ongoing year may be a slightly different story, with some of Goldman’s hedge funds recording huge losses, courtesy the recent credit squeeze in the US. In this exclusive interview with BT’s Executive Editor Brian Carvalho and Assistant Editor Mahesh Nayak, Blankfein unravels a bit—not all—of the mystery that shrouds Goldman, and talks about how the firm makes big bucks, and how it occasionally loses big bucks, too. Excerpts:

A lot is made of Goldman Sachs’ size, its heady growth, its huge salaries, and the millionaires it has created. But there’s still plenty of mystery—about what exactly the bank does—that surrounds it. How does Goldman actually make all this money?

We advise governments, and companies and in some cases individuals— on their businesses, how to put businesses together, what their business strategy should be, how they should affect their strategies.

This can be done by acquiring companies, by applying capital in their businesses. We occasionally advise them to get out of businesses, if strategies have failed.

 In addition to the advice we give, we also provide the financial wherewithal to accomplish the advice we give. In addition to all this, we also use our own capital to help finance businesses, and even invest with our clients as their partners.

For a long time, the advisory part of Goldman’s business—mergers & acquisitions, underwriting etc.,—occupied centre stage. Of late, however, we see that activities like trading and hedging are in the limelight. Has this been a conscious transformation?

There has been a transformation, but not to subordinate the advisory part. It’s just that the things we do for our clients have expanded. I’d say that over time we have evolved from a pure advisory firm—we were never just advisory; we always had our trading activity.

Like other financial institutions, like big commercial banks, we provide financing to help effect it (our advice). In recent years, we found that that our clients wanted—in fact, demanded—that we provide the full service of giving advice and also provide financial needs.

As a result of that, we lend, we underwrite risk, we co-invest—these are all principal activities, but they are all principal activities that are focussed on accomplishing the client’s objectives. And we profit as well from those objectives. But we wouldn’t (profit) if we weren’t accomplishing their objectives.

How significant are the proprietary trading activities of Goldman Sachs?

They do form a huge chunk. But when you say proprietary trading it sounds like private equity/hedge fund activity. Let me give you a bigger category: Principal risk-taking.

When we take such risk, I don’t think it is proprietary trading. We didn’t take huge credit positions because we were speculating in credit. We took those credit positions because we’re in M&A businesses for our clients, and we finance those transactions. We make capital commitments to them so that they can get their deals done. Now that’s a principal risk that’s on our balance sheet. We can make money on it, and we can lose money on it.

 That will go into our P&L. Now, do you consider that proprietary trading or would you look at it as a client-facilitation principal business? Most of our risktaking is like that—client-facilitation risk-taking. That’s the bulk of our business…that credit extension comes right out of our M&A franchise.

If we didn’t do that business, we would not have an M&A franchise, if we did not have an M&A franchise, we wouldn’t do that business. It gets reported in the sales and trading line because it’s a risk, but it’s a risk that comes out of our corporate business.

Our client business would be three quarters of our business… We have some activities where we take proprietary risk: I think this will go up—let’s buy it, I think this will fall—let’s go short. That’s very small.

Goldman Sachs is known to have its unique culture. How different would you say is this culture from the other Wall Street banks? And has there been any change in this culture, ever since Goldman went public in the late nineties?

Our culture has been one where we have very very talented people who have to subordinate a certain amount of their ego to become part of a team. People can be perfectly good and perfectly successful, but if they can’t do that, they won’t necessarily be successful at Goldman Sachs.

But if they can do that, they can become very successful and who knows—a lot of people after 20 years in Goldman Sachs go out and become dazzlingly successful as individuals. But while people are at Goldman Sachs, they have to throw in with the overall organisation and the team. That’s very important because it’s very easy for an institution to have one very large figure, or three very large figures looming, but when you have 100 or 200 such figures, all those egos could be in conflict with each other. It’s then a challenge to get so much talent to focus in one place. We, I think, have done a good job—as good a job as anyone else—in accomplishing that.

If you ever need any kind of proof of the kind of talent we have at the firm, just look at what they do when they leave the firm. So many of them go into government, so many of them become big hedge fund operators, some of them become big philanthropists after leaving Goldman. But when they were at the firm, they had to subordinate their confidence to make an effective team. And not everybody can do that.

That culture has not changed (since going public). People (still) join Goldman Sachs because it’s a great platform to leverage, and it really allows people to fulfil their professional capabilities. We still have strivers at the firm who want to succeed, who want to build a reputation at the firm—that hasn’t changed.

 The one thing that has changed at the firm since going public is that the firm has become a lot bigger. We needed to get a lot bigger. We needed to go into more countries—here we are in India— could we have funded our growth around the world and in emerging markets had we not had a much bigger company?

Could we have had a bigger company by staying a private partnership? Secondly, if we had to accomplish our clients’ objectives, we had to finance them and use capital. We did not have a big balance sheet as a private company. Becoming public allowed us to grow.

We wouldn’t have been formidable today (if we hadn’t gone public). We could have been Goldman Sachs, we could have been small, niche, boutique—we could even have been happy, as a smaller company, but we couldn’t have been the influential firm that we are around the world, if we hadn’t done it (gone public).

Bigness carried with itself some consequences. It means that we have to run a lot harder to go around the world, to make a one-firm homogenous culture over such a wide distribution. We kill ourselves to do that. I and all the senior people spend a lot of time travelling, cutting the firm into smaller pieces.

One week I will run around and speak to all the Managing Directors of the firm (recently Goldman promoted a record 299 people to the post of Managing Director, the secondhighest designation at the firm; 57 per cent of them are outside the Americas, and 19 per cent are women); one week I will go around and speak to all the people in investment banking; one day I will address the women; or the Asians as opposed to the Europeans.

We are always dividing the firm into smaller and smaller pieces, so that they feel like they are in a smaller firm. The people in our Los Angeles office know what we are doing in India, and know the names of a lot of our people in India.

Goldman Sachs is a pretty flat organisation. If you want to preserve the culture of the firm, you have to make the firm seem small. A few thousand people have to feel that they have a direct relationship with me. And they do.

It’s been quite a transformation for you personally, too. You have a background of trading, and now you are also meeting clients. How did that transition happen?

Actually, I started in a client-facing business of the firm. I was a marketing manager, and a sales manager. I got to be in charge of trading because from the sales side I got a promotion to sales & trading.

So I didn’t start my life in the firm working myself up from a small trader to a big trader to a bigger trader as I became manager of sales & trading from the distribution side.

So I have always been engaged on the client side. I have been on the managing committee of the firm for the last 12-13 years. Before I became CEO, I was President & COO, and in that role I engaged more on the investment banking side—that takes me back 4-5 years.

There was certainly a change when I became Chairman & CEO a year-and-a-half ago, because there is a lot of focus given to the person at the top. But I had global responsibilities when I was the #2 person, and I was well-known to our clients, and well-known to the firm, but I did not have a public profile with the press and with a wider group that I have today.

That’s taken some adjustment, but in terms of what I do and how I think, and my strategies, and my contact with clients—that has been familiar to me for a long time.

Your image in the media hasn’t exactly been similar to that of your predecessors— you’re not portrayed as a typical Ivy League-type, but perhaps somebody who lives more by his wits. Is that an accurate perception?

I don’t know…actually it’s funny, I am an Ivy League-type, but I must be a little different because I am not dying for you to say that (laughs). I try to keep that a secret, but I am an Ivy League-type—I went to Harvard for crying out loud! You may be right a little bit—if they were looking for somebody to play a movie version of what they would think to be a Wall Street-type, I am not sure they would pick me to play that part. I don’t know—you will have to tell me.

You’re known to make statements like “the graveyard is full of indispensable people.” Is that something you say pretty often?

I say things like that, but don’t always say that—that’s too many syllables! My hobby, and what I studied in school, is history. Anybody who studies history has to be impressed by the lack of predictability, the hubris of people thinking that growth will continue in a pattern… if history is full of something, it is full of disappointment and surprises.

I just know that there’s change around every corner, there are threats, and one thing I won’t be sure of is what I never anticipated. I am not an insecure person, but it is perfectly rational to be humble—not because of insecurity—because everybody knows that you are going to get things thrown at you that are hard to handle.

I can’t get too caught up in the trajectory of success. I don’t mind talking about the past, and I don’t even mind laying claim that the organisation has done some excellent things. I can tell you what our present intentions are to do excellent things in the future. (But) not everything works out.

 Here’s something else that I say a lot: “At the end of the day, all we can do is the best we can do.”

In your last annual report, you also said: “In absolute terms we plan for the worst.” In the light of the current turmoil in the US markets, that statement has an ominous ring to it…

There’s some arrogance in that statement. That statement has its basis in the fact that I can predict what the worst is. But the fact is that theworst is always what you can’t predict. We prepare for the worst things we can think of. The message in that statement is that we are not relying on the world staying the same, and we are not relying on all conditions being good. I think success and good circumstances take care of themselves.

I think my entire job is in some ways to prepare and get the organisation equipped to deal with adverse conditions. Obviously, some part of the job is strategic—we have to get assets in the right place—but our organisation and the people we have are totally equipped to get themselves into the right places.

The biggest responsibility I have is to ensure that the organisation does not get discombobulated by unforeseen events.

In this period when there are credit squeezes and credit crunches, the money you lose is not necessarily the worst thing. The worse thing is the discombobulation that takes place in trying to fix yourself. Whilst you are trying to fix yourself and sort yourselves out and recover, you are missing opportunities.

 The best position we could be in at a time like this is to be rational, not distracted, and therefore best able to take advantage of opportunities that the markets offer, and best able to serve our clients in case they’re in distress.

Goldman has been hit by the recent credit turmoil…

Of course, we’re hit—everybody’s been hit, it’s part of the landscape. And we respond to it. Our P&L speaks for itself: We announced that we lost something close to over a billion-and-a-half dollars through loan commitments.

Fortunately, in that same period we made a lot of other money that compensated in some ways, and so we were able to exceed people’s expectations. But I’d rather have not lost the billion and a half dollars.

How big a hit has the US economy as a whole taken because of the credit turmoil? Are we looking at a long-term slowdown, or are we moving into a full-blown recession?

The US economy is under pressure. But it may be the economy contributing to the events in the market (the credit squeeze and the subprime crisis), not the market events contributing to the economy— they’re interrelated.

But it’s the whole macroeconomic situation— the housing sector along with the consumer and the retail sector— that’s affecting people’s view of credit.

The US economy has clearly slowed—that’s not a matter of opinion; that has already happened. People are now focussed on whether that slowdown leads to a recession. There is certainly a significant possibility of that happening.

But it doesn’t have to happen, and I believe the US Federal Reserve is acting very responsibly in guarding against inflation—which is not a dominant concern—but also to address the slowdown in the overall economy which is a more predominant concern now.

The policies of the official sector are positive. I think it’s more likely we have a slowdown and don’t go down into a recession.

Do these recent events in the US hasten your strategy for emerging markets like India, or is your recent thrust a part of the overall game plan chalked out many years ago?

We have always been thoughtful about emerging markets, but sometimes that thoughtfulness has led us to avoid making big commitments. We were able to operate for a long time (in emerging markets) without having a big footprint.

For example, in India. But over the last few years we decided that the pattern of wealth creation and growth in some of the emerging markets, particularly in India and China, has gone beyond a tipping point. We see that there are different characteristics about the surge in growth this time.

In the past it’s been fuelled by investments coming from outside into the country. Now entrepreneurs inside the country are looking outside to make investments as they build businesses and seek to make Indian businesses global.

A class of entrepreneurs here is building worldclass companies, by any standards. That, for the first time, has made it very interesting for us to make a commitment to be a major participant in the growth of the economy.

For 10 years we were on the ground in India only through a joint venture— a joint venture in which we were a minority, and a joint venture in which we did not have our name on the door.

 Now we are unabashedly Goldman Sachs India. And that’s been for a little more than a year. In that year we have built ourselves into over 100 people, done significant transactions, and actually become quite engaged in the life of the economy.

We have been active in advisory, and in private equity, where we have invested over a billion dollars in the past year…the thing that attracts us is not the size of an economy but the growth of an economy.

In your view is the Chinese market overheated, and are there signs that things could go wrong?

We are a believer in the China story, but I think there are signs of stress everywhere. Any economy that’s growing at 11.5 per cent will show signs of overheating—even one growing at 9.5 per cent is going to have signs of overheating, and even your own government is worried about the rupee going higher in value.

You have real estate that’s doubling and trebling in 12-18 months in Mumbai…When you’re growing that fast, you outstrip infrastructure; when you’re growing so fast, and investing capital so quickly, not every decision is going to be right, and chances are you may find that capital has been invested in places where you won’t get a return.

There are always things to worry about.

We are happy, but we are also worried. But you could find a cloud around every silver lining!