Goldman’s Blankenfein: ‘A systemic lack of skepticism’

Remarks delivered yesterday by Goldman Sachs (GS) CEO Lloyd Blankenfein don’t quite get into the mea culpa territory, but clearly get the closest any major Wall Street executive has come to saying “I’m sorry.” Speaking at the Council of Institutional Investors‘ spring meeting in Washington, Blankenfein covered a litany of financial market sins behind the current crisis, and suggested that executive compensation plans should change to better incentivize risk management going forward. “Compensation should reflect an individual’s ability to identify and create value, including his or her contribution to the client franchise, enhancing the firm’s reputation and contributing to the better functioning and efficiency of markets,” he argued. “Equally important, compensation should take into account strict adherence to a firm’s management and controls, especially with respect to a person’s judgment and exercising that judgment in terms of risk in all of its forms.” Saying that “much of the past year has been deeply humbling for my industry,” Blankenfein said that many investment and other bankers had made decisions that appeared “self-serving and greedy.” A large part of those decisions lay in the mortgage finance industry, much of which has been laid to waste in the past 18 months amid a historic industry downturn. “Enormous excess liquidity, strong global economic growth, and low real-interest rates created a desire to find new investment opportunities. Many of the best were thought to be in the housing market,” said Blankenfein. “First, governments, particularly the U.S., explicitly supported homeownership through a variety of government programs and initiatives. Second, mortgage assets were considered relatively impervious to sharp downturns. And lastly, the creation of more flexible and varied mortgage products attracted even more capital in search of higher returns.” I’m not too sure I agree with Blankenfein on the first count, as the market for private capital pretty much dug its own grave around mortgage banking with very little assistance from the government. Nonetheless, Blankenfein’s assesment that the industry as a whole suffered from what he called “a systemic lack of skepticism” rings very true. Mark to market is not the problem Blankenfein’s take on the mark-to-market and asset impairment debate is equally telling here, as the Goldman CEO suggested the problem isn’t the accounting method used, it was in the assumption used to value the “assets” now in quesiton. “I’ve heard some argue that fair value accounting — which assigns current values to financial assets and liabilities — is one of the major reasons for exacerbating the credit crisis. I see it differently,” he said. “If more institutions had properly valued their positions and commitments at the outset, they would have been in a much better position to reduce their exposures. “For Goldman Sachs, the daily marking of positions to current market prices was a key contributor to our decision to reduce risk relatively early in markets and in positions that were deteriorating. This process can be difficult, and sometimes painful, but I believe it is a discipline that should define financial institutions. We mark-to-market, not because we are required to, but because we wouldn’t know how to assess or manage risk if market prices were not reflected on our books.” Put that in your pipe and smoke it, M2M critics. The full text of Blankenfein’s remarks is available here.