TORONTO (Reuters) - Tougher regulation of financial institutions and higher capital ratios at banks are necessary in the aftermath of the global financial crisis, the head of Goldman Sachs (GS.N) on Wednesday, even as he acknowledged that such safeguards carried some costs.
Lloyd Blankfein, chairman and chief executive of the largest U.S. investment bank, said he sees financial regulation evolving now just as it did in the aftermath of the Great Depression of the 1930s.
"You have to go out and you have to take steps. You have to have different regulation, maybe more regulation in certain respects," he said, while addressing a room full of bankers and lawyers on Bay Street - the financial hub of Toronto.
"I think it is absurd to talk about just the burdens of regulation without talking about what's driving people to want to regulate," said Blankfein, who was fielding questions posed by Gordon Nixon, CEO of Royal Bank of Canada (RY.TO).
Regulators across the world are working on tightening rules and creating safeguards in the aftermath of the 2007-2009 global financial crisis, with efforts largely being driven by the Basel Accord. The new Basel III rules will force banks to rely more on equity than debt to fund themselves, so that institutions are better positioned to withstand big losses.
"Banks should have more capital and more liquidity," said the long-time Goldman executive, who was addressing a gathering organized by the Canadian Club of Toronto, but he cautioned that any move to over-regulate also cuts both ways.
"The devil is in the detail: if you attach certain kinds of capital requirements onto securitized products and you make it excessive, then banks won't hold securitized products and then where is the mortgage market going to go in the United States?" he said, arguing that it was the responsibility of bankers to spell out the consequences of regulation and the trade-offs.
While Nixon believes the complexity of financial regulation is having a much more negative impact on economic growth than most regulators will concede, Blankfein argued that politicians feel compelled to reduce the chances that such a crisis will happen again.
"We have to accept the fact that the pendulum may swing a bit far, because of how recent the trauma was," said Blankfein, who has headed the New York-based investment bank for the last six years.
Blankfein was not asked about the recent management shuffles at Goldman, which announced this week that its long-time chief financial officer, David Viniar, would step down in January.
His replacement, Harvey Schwartz, is among a small group of executives who are considered potential candidates to take over when Blankfein, 57, steps down. .
Blankfein's eventual departure as CEO has been a subject of speculation for months. Over the past year, Goldman has been cutting staff to manage costs while moving younger bankers and traders into more senior roles.
Blankfein said Goldman plans to stay the course and remain a wholesale investment bank even though its competitors have branched out.
"We are advisers, we're financiers and asset managers in a wholesale world where our clients are governments, big companies and investment managers and that's what we know how to do," he said.
"We don't know how to do signage for our branches," he added with a nod to Nixon, who heads Canada's largest bank, which has a large retail banking presence across the country.
Despite the challenges facing the global economy, things will work themselves out, said Blankfein, but he warned that growth problems in Europe and China and a possible breakup of the euro zone could make things a lot more difficult.
"The punch line is this: The world is not going to come to an end - we are going to muddle through," he said. "I think the biggest problem that Europe has is growth and the tail risk problem is a real go-off-the-rail, bust-up of the euro."
The so-called "fiscal cliff" - automatic spending cuts and tax increases that will take effect in next year if Democrats and Republicans fail to strike a deal on taxes and debt reduction - is a real problem, Blankfein said.
"You can't austere yourself into a higher GDP ... I'm all for implementing budget changes that accelerate over the long term, but in the short term I wouldn't take too much money away from people or cut back on a lot of expenditure programs," he said, warning that the U.S. economy needs growth, not drastic budget cuts.
When put on the spot on investment advice, Blankfein said in the current environment he'd rather invest in real estate given that central banks across the globe are pumping money into the system to boost economic growth, even at the risk of inflation.
"Inflation is cruel to certain groups, but we've gotten out of it before and we know how to do it. Deflation is much more insidious and much longer," said Blankfein. "So I'll follow the lead of the central banks: if they want asset prices to inflate I'd rather hold (real) assets than financial assets."
Editing by Frank McGurty