SPIEGEL Interview with Goldman Sachs CEO: 'We Didn't Realize How Bad Things Would Get'

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SPIEGEL: You say that Goldman did things better than many others in advance of the crisis. What was your biggest mistake?

Blankfein: Goldman Sachs has traditionally been strong in business with mergers and acquisitions. We also provide financing for acquisitions by companies ...

SPIEGEL: ... and through private equity funds, which shortly before the crisis financed corporate takeovers at astronomical prices using almost exclusively borrowed money.

Blankfein: When this market for so-called "leveraged finance" was booming, we wanted to remain competitive and maintain our market share. We extended even larger lines of credit to our clients and did so at the same time as lending terms were getting easier. When companies like Chrysler began to falter, we acted quickly, but we did not act quickly enough, which was a mistake.

SPIEGEL: Was that your only mistake?

Blankfein: Another area where we didn't act fast enough was real estate. We recognized that property markets were eroding, but we didn't realize how bad things would get or how quickly the decline would happen.

SPIEGEL: How did the massive excesses in the real estate market come to be in the first place?

Blankfein: Owning a home is part of the American way of life. And the dream of home ownership was furthered politically, through tax deductions for mortgage payments and the easing of credit terms, to give two examples.

SPIEGEL: But, without cheap money from the Federal Reserve Bank, the US's central bank, the real estate bubble would never have been possible.

Blankfein: I will not dispute that easy money policies contributed to the crisis, but they were not the only cause. There were many reasons, and it is difficult to rank them in order of significance.

SPIEGEL: Will we see a significant rise in inflation over the next five years?

Blankfein: The central banks are currently pumping liquidity into the markets, and thus consciously accepting inflationary risks. At the same time, however, they are also bolstering the economy. And, do you know what? It may just be that these people are doing an extraordinarily good job. Still, it is risky. If the surplus liquidity is not siphoned off soon enough, inflation will result. But I would not discount the possibility that that the central bankers are doing exactly what needs to be done.

SPIEGEL: Do you invest in gold?

Blankfein: I am not bullish on gold.

SPIEGEL: Another problem of the financial system is the sheer size of the banks. What should politicians do to prevent a systemic crisis, like what resulted after Lehman, in the event of another bank failure?

Blankfein: If I were a regulator I would establish an early warning system to ensure timely identification of accumulating risks. The basis for this should be effective accounting to reflect the value of securities at market prices. As a matter of fact, I think that this alone would almost suffice as an early warning system. I would also regularly meet with my colleagues from other countries to discuss tendencies and trends in the markets and the financial industry - again with the aim of recognising irregularities as quickly as possible. Moreover, I would require the banks to maintain more capital. I would also want to establish a resolution process for a troubled bank -- the equivalent of a quarantine room -- so that the problem couldn't spread.

SPIEGEL: How do you foresee that happening?

Blankfein: With that, I mean a system or institution under whose umbrella a beleaguered bank can be temporarily saved. This institution would ensure that the bank is able to meet its obligations -- and that it doesn't trigger a conflagration.

SPIEGEL: Wouldn't it be much easier to simply limit the size of banks? After all, the danger of systemic contagion is less when the banks are smaller.

Blankfein: So what is "too big to fail"?

SPIEGEL: When a bank is so large that in the event of insolvency, it could take the entire financial and the entire economic system along with it into the abyss. The state would then rescue the financial institution with taxpayer money.

Blankfein: The size of the bank is not the most important factor. Whether a certain risk is bundled at a single bank or spread across several is completely irrelevant. That doesn't diminish the size of the risk. In fact, this would only change the problem from "too big to fail" to "too many to fail."

SPIEGEL: Wouldn't another way to avoid such crises in the future be a reinstatement of the Glass-Steagall Act, which stipulates the strict differentiation of banks that accept customer deposits from investment banks, which can, among other things, develop, sell and trade in highly speculative capital market products?

Blankfein: No, I think you are assuming that this crisis was caused solely by highly complex derivative products. It wasn't. Just look at a typical bank balance sheet. Most banks value their loans at the price at which they were issued. This applies to corporate and consumer loans, mortgages and credit card debt. All seemingly bread-and-butter transactions. And then there are a few derivatives and some more complex products.

SPIEGEL: What are you trying to say with that?

Blankfein: This crisis was not just caused by complex derivatives.

SPIEGEL: What caused it, then?

Blankfein: Too much money was lent to people who had bitten off more than they could chew. When the bubble burst and recession hit, default rates went through the roof

SPIEGEL: When will the recession be over? Will the growth curve be shaped like an L, or a V or a W?

Blankfein: I think that we are returning to health and that growth will begin to pick back up. Emerging market countries have held up better than any of us expected in the crisis, which will also fuel growth. But despite the initial signs of recovery, there will be more job cuts -- and that will have an impact on the sentiment of the people. Consequently, we have to be prepared for setbacks. However, I am generally optimistic.

SPIEGEL: Will all of the measures now being implemented by politicians really be enough? Or will it take something like a new morality in your industry?

Blankfein: I think so. As an industry we have an obligation to constantly reassess the way in which we do business. We have an obligation to ensure the safety and soundness of the financial system. We have an obligation to our clients and to society as a whole.

SPIEGEL: Isn't it necessary for you to demonstrate your social responsibility once again in the wake of this crisis?

Blankfein: I agree with you 100 percent.

SPIEGEL: Mr. Blankfein, we thank you for this interview.

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• Part 1: 'We Didn't Realize How Bad Things Would Get'
• Part 2: 'I Would Establish an Early Warning System'