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Jan. 13 (Bloomberg) -- Lloyd Blankfein, chief executive officer of Goldman Sachs Group Inc., mounted a defense of his firm amid a grilling today by members of the Financial Crisis Inquiry Commission.

Goldman Sachs is a market-making firm that acquired securities, including mortgages, that were repackaged and sold to clients, and sometimes at a loss, Blankfein told commission Chairman Phil Angelides in response to questioning.

“We represent the other side of what people want to do,” said Blankfein, 55. “Because we had this risk, because we were accumulating positions which, by the way, we acquired from clients who want to sell them to us, we have to go out ourselves and provide and source the other side of the transactions so that we can manage our risk.”

Chiefs of Bank of America Corp., Morgan Stanley and JPMorgan Chase & Co. defended their firms’ actions and blamed the crisis on conditions such as low long-term interest rates and U.S. government policies that encourage and subsidize home ownership. Blankfein bore the brunt of three hours of questions on issues ranging from short-selling to its dealing with insurer American International Group Inc.

Angelides pressed Blankfein on Goldman Sachs’s sale of mortgage-backed securities, its requests to the credit-rating companies for the highest rating while betting the securities will later fail.

“It sounds to me a little bit like selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars,” Angelides told Blankfein. “It doesn’t seem to me that that’s a practice that inspires confidence in the markets.”

SEC Probe

The Securities and Exchange Commission and brokerage regulators are examining how Wall Street firms bet against mortgage-linked securities to profit as their clients took losses, people familiar with the matter said in late December after report.

Blankfein and the other executives testified in the first day of hearings of the commission, led by Democrat Angelides, the former California Treasurer, and Bill Thomas, a Republican who is a former congressman from California. The commission was created by Congress to examine the causes of a collapse that roiled global markets and led to a $700 billion U.S. government bailout of the nation’s banks.

“Many firms were too highly leveraged, took on too much risk and did not have sufficient resources to manage those risks effectively in a rapidly changing environment,” Morgan Stanley Chairman John Mack, 65, said. “The financial crisis has also made it clear that regulators simply didn’t have the visibility, tools or authority to protect the stability of the financial system as a whole.”

Risk Management

JPMorgan’s focus on risk management and prudent lending, helped the firm avoid setbacks experienced by other companies, said Jamie Dimon, 53, JPMorgan Chase’s chairman and CEO.

The CEOs lead two days of hearings that include Federal Deposit Insurance Corp. Chairman Sheila Bair, SEC Chairman Mary Schapiro and attorneys general from Colorado and Illinois. The panel has six members appointed by Democrats and four by Republicans and has the power to subpoena witnesses and documents.

Blankfein said the firm’s practice of marking assets to market daily helped it decide to cut risk earlier than some rivals. Goldman Sachs was the biggest U.S. securities firm before it and Morgan Stanley converted to banks during the crisis, gaining lending support from the Federal Reserve.

By contrast, Bank of America CEO Brian Moynihan, 50, said mark-to-market accounting exacerbated the crisis as thinly traded assets often had to be recorded at fire-sale prices, triggering losses and further sales.

Downward Cycle

“The market began to anticipate this downward cycle, and question companies or structures that would become subject to it, in a self-fulfilling way,” Moynihan said in his remarks.

Dimon echoed Moynihan’s concern about mark-to-market accounting.

“Although we are a proponent of fair-value accounting in trading books, we also recognize that market levels resulting from large levels of forced liquidations may not reflect underlying values,” Dimon said.

Congress is considering a financial regulatory overhaul, with the Senate crafting legislation after the House passed a measure last month with rules for derivatives, powers to break apart financial firms whose collapse would threaten the economy and a Consumer Financial Protection Agency. The banking industry and the nation’s biggest business lobby have fought to scale back the legislation.

Financial Profit

All of the executives provided prescriptions for how regulators and the government should deal with banks whose failure could put the economy at risk -- the so-called too-big- to-fail institutions.

Blankfein, who heads the fifth-biggest U.S. bank by assets, proposed that regulators require firms to submit to continuing public “stress tests” to examine whether they have adequate capital. Regulators may require companies to raise so-called contingent capital if stress tests deem they need more capital.

Automatic Recpaitalization

“Making recapitalization automatic if capital levels fall below a public threshold would minimize systemic risk and force shareholders and bondholders to bear the burden of the firm’s mistakes, not taxpayers or the economy,” Blankfein said.

Dimon called for a regulatory authority that would manage failures of large financial institutions in such a way that shareholders and creditors would be at risk.

“A regulator should be able to terminate management and boards and liquidate assets,” Dimon said. “There is much that can be learned from the process by which the FDIC closes banks today,” he said, referring to the Federal Deposit Insurance Corp.

Moynihan said the size of banks shouldn’t be limited and legislation to separate consumer and investment banking -- like the Glass-Steagall law that was overturned in 1999 -- shouldn’t be revived.

“Those arguing for a return of Glass-Steagall are effectively arguing that Bear Stearns was a more stable entity than JPMorgan Chase,” he said. “I don’t see how that is tenable.”


--With assistance from Lorraine Woellert in Washington and Margaret Popper in New York. Editors: Steve Geimann, Gregory Mott