Inside the Next Financial Crisis with Lloyd Blankfein

On this episode of The Forum, hosted by CNBC’s Becky Quick, Lloyd Blankfein, former Chairman and CEO of Goldman Sachs, joins Sonali Basak, Chief Investment Strategist at iCapital, for a wide-ranging conversation on financial markets, systemic risk, and the forces that shape economic cycles.

Blankfein reflects on the lessons of the 2008 financial crisis, the rise of private credit, and why periods of stability can often create the conditions for future market disruptions. Drawing on decades of experience at the center of global finance, he shares his perspective on risk, regulation, asset valuations, and the warning signs investors and policymakers should be watching today.

New episodes of The Forum with Becky Quick drop monthly. Subscribe for exclusive conversations with global policymakers, business leaders, and thought leaders shaping the world economy.

Host: Becky Quick

Guests: Lloyd Blankfein (Speaker), Sonali Basak (Moderator)

Produced by: AMZG Media

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Transcript

SPEAKER_00 0:02

I'm Becky Quick of CNBC, and your host of the forum. I'll be guiding you through exclusive conversations among some of the world's global leaders. Conversations previously held behind club doors, but today we invite you in. The Economic Club of New York serves as the premier forum for nonpartisan discussion dedicated to connecting the world's brightest minds with preeminent public and private sector leaders. A nonprofit, 501c3, the club is a 115-year-old platform for the conversations that help shape the future of our world. The Economic Club of New York, brightest minds, critical conversations, the catalyst for innovation.

SPEAKER_03 0:39

If you had to do it all over again and change something about not just the culture of Goldman, but the culture of Wall Street, what would it be?

SPEAKER_02 0:45

Well, you know, I'm I'm a markets guy, so I'm more in the responder net to what happens. I take certain things, you know, certainly I think things fall the way they are for a reason. What would I like? I'd like the birds to, you know, 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 I do think that I think 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, great responders, and of course gets killed by the reviewers and the pundits who have after acquired information to look back and say, aha, I thought, oh God, that's not what I would have done. Just like nobody voted, nobody voted for Nixon except he won in a landslide. Everybody remembers everybody, everybody always remembers being right because they're pundits, and pundits don't have PLs. People with P ⁇ Ls can't walk away from their, you know, can't deny 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 inevitably. 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 you're gonna and that's gonna 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 over time the memory of the trauma, of the of the reckoning, of the crisis ebbs, and people get a little bit more sporty, which is what's happening today, and could talk about today. And again, dimmer memories, people retired, new people came in who only read about the financial crisis or the tech bubble and 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 ship shape again, and it takes another couple of years for that to go. And that's what, guess what? That's why we have a business cycle, and that's why we have historical cycles. It's because, and that's you know, can you imagine if we all lived forever and we kept our memories intact forever? You know, what would we we what would we have? We'd be afraid to do anything.

SPEAKER_03 3:06

So you it's no secret that you've been quite critical about the shift of activity since 2008 into private markets.

SPEAKER_02 3:13

No, no, not 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 underregulated, private credit funds. Not everything was done off balance sheet. No, so I'm not I'm an observer of it, and I was uh commented on what the you know what the risks of that are that people are underestimating.

SPEAKER_03 3:35

So what do you think is the biggest risk, and do you think it's a big enough risk to face another systemic issue as we did in 2008?

SPEAKER_02 3:42

Look, let me be clear. I going back to what I just said about cycles, in this kind of cycle, when you start feeling good and sprielier and get less disciplined about it, and as you know, when 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 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 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 kind of getting kind of aged on balance sheets. So that must mean for people who are highly motivated to sell them or not selling them because the price isn't being met, because they're probably marketing. So look, 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 you know 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, you know, engulf and get out of control. That's a little bit like kind of you know a burnoff. 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 who says, Oh my god, the price of oil is gonna 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, you know, it could be a credit event, like a bad, you know, some highly, highly leveraged fund can't make a payment or something like that. It could be an insurance regulator that looks at the balance sheet, 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 the you're gonna be these assets are gonna be sustained to make the we're gonna 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.

SPEAKER_03 7:14

So I have some specific questions about this because I think the post-2008 financial industry is really misunderstood. If you were a betting man, would you think I am a betting man? You know, would you believe that the private credit system coming out of this moment, if you do see the Tenders starting to erase some of the froth, do you think it becomes a much bigger system coming out of this, or does it plateau?

SPEAKER_02 7:38

Well, Goldman Sachs in two, you know, prior to 2008, was not regulated as a bank holding company. But there's always regulatory arbitrage is 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 you know, 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 that's you know a part of the market. It creates a problem in the system. Again, it might not be the spark, but it's part of potential. 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 you know 16 banks represented. And by the way, if they had five represented, they could add 75% of all the loans that are outstanding, get together and say, okay, show of hands, who has this, who has that, what are we going to do about it, and blah, blah, blah. Today, because of the distribution and the wider net that they'd have to have, they'd have to take out uh City Field and have a meeting there and stand on second best 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 they've set up uh 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 draw 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 um 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, you know, the loose cigarette butt at this point. That's what I would work on if I were, you know, regulator today. I'd be worried about getting rid of all the mismarked uh 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 spending 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 uh is because they're not getting distributions. They have to sell their limited partnership interests. I I don't want to like be picking on that. There are other things also, and again, I don't think that that's hyper-critical 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, this, you know, every guy quotes from The Godfather, so forgive me. Remember that scene in The Godfather where they where they go and that they're talking that there's about to be another mob war, and he, you know, one of the old capos puts his arm on the said, ah, don't worry about it. We have to have these wars every 10 years ago to get rid of all the grudges and bad feelings that build up over 10 years. I think we have to have a crisis, you know. Unfortunately, it's the crisis that pops up every so often that gets that's a reckoning for all the assets that where there's no imposed discipline on getting them properly marked and and distributed away from balance sheets.

SPEAKER_03 11:02

To that end, do you ever worry that the hedge fund industry could face another LTCM style event given how big a lot of these multi-strat firms have gotten, given how big they are in critical markets?

SPEAKER_02 11:13

No, nothing will ever happen. Of course it's you know, these things are gonna recur. It won't be it, you know, it won't repeat, but it will rhyme. You know, things will always, it's the nature of things to keep going and possibly go to excess. And you try to do, look, Dodd-Frank, for example, said, you know, was done when it was implemented, and 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 don't want to, you can't, if you want to get rid of risk, you're gonna get rid of growth. And you don't want to say, gosh, we're gonna get rid of the crisis of the of every you know, 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 you can't relax, you have to impose that discipline because if you say, you know, if you act too cavalier about it, you're gonna guarantee the 80-year crisis is gonna happen every eight months. So you're gonna have to make that effort supervised, but you have to know that these things are gonna 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 sterns 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 not, they're imagining that they're gonna put in an they're gonna 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 you know 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 one way but something like that, you know, 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 you know, as a specific deterrence to them, but deterrence to anybody else, not to go too far, blah, blah, blah, and and you know, manage it that way, but not to think 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.

SPEAKER_00 14:06

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SPEAKER_03 14:21

So moving on to kind of another echo of 2008. You know, some would argue that when you look at the Fed's balance sheet, the expansion really took off in the wake of 2008 and then really compounded in the wake of COVID as well. There was a really famous op-ed in 2014, the Asset Rich Income Poor Economy. This was written by Kevin Walsh and Stanley Druckenmiller. Do you agree that that crisis era tool has compounded inequality?

SPEAKER_01 14:47

So I have to read that op-ed now to the idea stands, right? What's the question? Sorry.

SPEAKER_03 14:52

The idea here is that by using these tools to expand the Fed's balance sheet, that we've helped asset owners in terms of people who own stocks rather than the small business owner who is.

SPEAKER_02 15:03

Well, the Fed balance you're talking about the Fed balance sheet. The Fed balance sheet expanded to get long rates down. The Fed, you know, has monetary policy that affects short-term rates, but the long-term rates do what it wants. You can affect short-term rates and it not necessarily have the same effect on long rates. Sometimes the people who buy our bonds think that what the Fed is doing in the short term to lower rates will be inflationary, and so our long-term lenders demand higher interest rates, not lower interest rates, even as short rates come down. So, you know, and so I know how why the Fed balance sheet, the Fed balance sheet was one of the tools that were made to stimulate the economy. By the way, one of the good things, because I said all the things I'm worried about, one of the good things today, if we had a problem, is that we probably, you know, famous last words, touch wood, it's not necessarily that it would be accompanied by a banking crisis. In the 08 situation, we had a recession, but we also had a banking crisis. That was really bad. Because at the end of the day, the Fed doesn't, you know, government doesn't lend money to people, the Fed doesn't lend, it's the banking system that does. And if the banks are in distress, money they get gets husbanded and goes to refilling the coffers and their reserves, and it doesn't do anything for the economy for a long time as they replenish their own reserves. Today, banks are pretty much flush. There's not a bad situation. So, and the other things that's going on, interest rates are close to, you know, three, of course, four percent, and they're not zero, so rates can be taken down. And the Fed's balance sheet, while high, is lower than it has been. It's been taken down. That's another thing that could be done. The Fed could also stimulate part of the curve where people actually really do do the borrowing, the longer end. And so the tools for sorting out a problem are much more available today than they were in, you know, that they have been for a long time. So that's the other again, two things you have to worry about. How to avoid the problem and having the instruments and the and the awareness to deal with the problem when it arises. I think the latter we're in good we're in better shape for.

SPEAKER_03 17:06

The real reason I asked this too is because we're being a new Fed chair, come to office and take uh a lot of potentially large changes. You think about the effort to potentially reduce the balance sheet over time. Do you think that he could do so without creating a taper tantrum?

SPEAKER_02 17:21

Well, you're talking about the Fed balance sheet, you're not talking about the balance sheet of the United States.

SPEAKER_03 17:25

We can talk about the yeah.

SPEAKER_02 17:27

Yes, he'll, you know, by the way, he's new, but he's not that new. He's been writing for a long time. He was on the, you know, he was on the on the board before, so it's not like you know, it's not it's not a pig in the poke. He's been around. I think the Fed's, you know, balance sheet is just a matter of the Fed's long balance sheet is just a matter of you know tampering with the yield curve. And by the way, right now, people are financing the United States. You know, everybody's concerned appropriately with the size of you know our debt, national debt, which keeps getting increased by our growing, you know, not our contracting, but our growing deficit, which is adding to that, and that's creating a lot of anxiety. And that situation I'd best described by uh, you know, I think it was Hemingway who said, you know, how does someone go bankrupt? You know, how did so-and-so go bankrupt? It was the answer was slowly and then all at once. Right now we're in the slowly part of it because, in fact, slowly not even happening. The, you know, the we're getting financed easily. There's no, you know, you the dollar is a reserve currency. You worry about the all-at-once part where people stop financing it, because I think our creditors can legitimately worry that the U.S. can default on its debt. And how does the U.S. default on its debt? We borrow in dollars and we print dollars. So how can you default? You're always going to have dollars to pay back. But what will those dollars be worth? So the way the U.S. defaults on its debt is it borrows dollars now, and after 10 years, we return dollars that aren't that don't have the purchasing power that they had at the beginning of the time. And that's how the U.S. defaults, that's how a country defaults when it borrows money in its own currency. The safety of that, the credit, the the instrumentality, the institution that our creditors look to to defend the purchasing power of the dollar is the Fed. And so this kind of assault on the independence of the Fed, that just makes our creditors think that they're gonna get defaulted to. And so, therefore, you know, it's like you know, you're gonna lend to your brother-in-law and you wonder if he's ever gonna pay you back. You're either not gonna lend to him or you're gonna have a very high interest rate if you do. And so that's what everybody should be, you know, should be afraid of. And you really want the Fed standing there as a bulwark and know nothing that undermines the idea in the minds of our creditors that the Fed won't protect the purchasing power of the dollar.

SPEAKER_03 19:47

And are you surprised at all by how resilient the markets have been in the face of Brent roughly $115 a barrel heading into now nearly the $10 million?

SPEAKER_02 19:59

I am uh yes, you know, fully yes. And it's not just the price of oil. If you have, you know, you just think of all the stuff that's been thrown out, and you have to say, you know, you have to start with accepting the resilience and work backwards from that and say, what is it about the U.S.? Because the U.S. has demonstrated its resilience over and over again. You don't have to look at the current environment, you can go in the aftermath of the financial crisis. Another time when the United States was ground zero for the problem, and yet the economy recovered more completely and faster. I would say the Europeans have never recovered from that crisis, yet at ground zero we have, and you could go back and say, in this country you can easily, you know, it's a different social contract. Here you can fire people if you want to reshape your business. So if you get, you know, we have uh, you know, labor is almost a commodity here. People can bring up their workforce, and today Meta, which is not doing so badly, contracts its workforce by 8%. Europe, you can't, you know, Europe you can't do. It's a different social contract, and they would look, they would look in horror about what companies are allowed to hear. There they would protect the workforce. It'd sometimes take years to be able to fire something, let alone the public relations disaster would be if a country if a company suggested that it was going to go fire workers. As a result, they have more people on payrolls, less unemployment than they other would, but over the long term, more unemployment because their companies are less resilient, more zombie companies, more assets on balance sheets that really should be sold, terminated, recycled into other more productive activities like we would do here. And they would look in Europe, you'll look at America and say, look how they are willing to miserate their workers. They'll fire these people without any regard for what they're gonna do over the years. And here we're focused on the fact that two years later we hire those people back into a much better business that has a chance to. Grow a lot better than the zombie business set that they were laid off from or the opportunity set that they were laid off from.

SPEAKER_03 22:07

Tell us how you really feel about Europe.

SPEAKER_02 22:08

No, no, it's a different. I'm trying to make it, I'm trying to say that people can look at these things in different ways. I live there. And they would reflect on the social contract in the US, horrified that we would so easily lay off people and not put the burden on companies to keep them on payroll, train them for jobs that they're not necessarily suited for, rather than hire new people who could go to work the next day. They look at the way we do that and are just as legitimate in their, you know, in their in their environment, their culture, and they take that point of view. I do point out, though, that ours probably leads to more polarization, disunity. The kind of show trials you see and the hearings you see in Washington gets reflected in our national politics, but a much higher growth rate. Usually, where the biggest economy, usually you associate size with sloth and inability to react and move quickly, where the biggest economy moves the fastest, most resilient, most likely to foster innovation. And theirs is kind of stickier and have probably in the short term, in any given moment, had less unemployment than they otherwise would, except over time, have less efficient, worse-performing businesses, and therefore lower growth and lower unemployment over time. What do you choose?

SPEAKER_00 23:31

You've been listening to the forum by the Economic Club of New York, a nonprofit 501c3 dedicated to connecting the world's brightest minds for critical nonpartisan conversations. Be sure to subscribe now to be alerted to future new episodes. Would you like to be a part of the conversation at the Economic Club of New York? Learn more about membership, the New York City and National Fellows programs, and other opportunities for engagement in the club at www.econclubny.org. I'm your host, Becky Quick. Thanks for listening.