Goldman Sachs has emerged from the market bust as a trading colossus. New Chief Lloyd Blankfein must fuel growth -- and avoid an unforeseeable blowup.

No wonder this nebbishy Master of the Universe is smiling: Lloyd Blankfein, 52, has spent seven months now as chief executive of Goldman Sachs Group, the richest, shrewdest and most powerful investment bank in the world.

He just earned $53 million. The firm hit $9.5 billion in net income in 2006 -- even as it paid out an astonishing $16.5 billion in compensation to the faithful, most of it in year-end bonuses.

Blankfein, in charge since predecessor Henry Paulson quit in June to become Secretary of the Treasury, inherited growth that would make an Internet venture squeal with delight.

Goldman's earnings set an all-time high for investment banks in 2005 -- then grew 76% last year to set a new record. In 2006 revenue rose 50% to $38 billion (net of interest cost). Its dealmakers handled an industry-high $1.1 trillion in mergers and acquisitions; its wealth managers raked in $94 billion in new customer money. Its stock climbed 55% to hover near $200.

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Yet Blankfein can't sleep some nights, fretful over what could go wrong "when the unforeseeable happens," he says. "What keeps me up nights is how changes in sentiment because of unforeseen events could unravel years of wealth creation."

He adds: "How much wealth would leave how quickly? And what would be the knockoff effects? I worry about scenarios like that."

Fun guy. But you might worry, too. Goldman Sachs, to fuel prodigious profit growth and keep shareholders as giddy as its own bonus-hungry bankers, is more dependent than ever before on income from trading, a volatile, random and risky business.

That means it could be more vulnerable in a worldwide market meltdown. Goldman is, in effect, a giant hedge fund with some consulting services attached. Hedge funds sometimes get into trouble, even when they are run by geniuses. Long-Term Capital Management was run by geniuses.

This is why Goldman, for all its power and potent performance, is valued by a skittish Wall Street at significantly less, pound for pound, than two giants it outperforms: Merrill Lynch and Morgan Stanley. Goldman trades at ten times expected 2007 earnings; Merrill is valued 40% higher, Morgan 20% higher.

Yet Goldman's profit per employee, number one on Wall Street at $360,000, is two to three times that of Merrill or Morgan.

Blankfein should take this dismissive P/E ratio personally. A Goldman lifer since 1981, he took charge of much of the firm's trading operation in the late 1990s and helped make it the centerpiece of Goldman Sachs. Since Goldman went public in 1999, trading revenue has risen fourfold to $25 billion; it grew 50% last year.

Trading now provides 68% of the firm's revenue (and a like portion of profits), up from 43% in 1999. Asset management provides 17%. The smallest slice, 15%, comes from Goldman's birthright, investment banking.

Thus Blankfein and two lieutenants, both of them well-versed in the brash world of traders, now run a high-tech-infused high roller -- one that is trapped inside a 138-year-old firm whose refined, white-shoe gentlemen bankers of yore took public some of America's lasting corporate icons (Sears, Roebuck & Co. in 1906, Ford Motor in 1956).

Some of its old-world gentility remains: Goldman agreed to talk for this story only reluctantly, wary of looking like a braggart.

But Blankfein says Goldman needs all three businesses to fuel its future. The firm has meshed these parts -- trading, asset management, investment banking -- to form a perpetual money machine. Goldman aims to serve as an adviser, trader, asset manager and investor, preferably all in the same deal.

The investment bankers who help corporations raise capital form the "front end of the house," Blankfein says. This is where corporate clients first encounter Goldman. The trading arm can make money for these clients -- and for Goldman's own account.

Asset management can put investors' cash into the deals and stocks of the companies advised by Goldman's investment bankers -- and woo new customers among the newly rich execs at the client companies that Goldman has taken public or sold in the M&A market. Goldman's star players, meanwhile, invest their own personal wealth right alongside all these other bets.

"It's called leverage inside Goldman," says Nomi Prins, a managing director who left the firm in 2002. "It might help set up a fund, be banker to the fund and then turn the chief into a private client. Connecting business is Goldman's business plan."

The firm began dabbling in this approach at the start of the decade and now aims to apply it to almost any deal it can. Inevitably, this sparks complaints that Goldman holds too much power -- and is too quick to wield it. "I don't know anyone who does business with Goldman who doesn't curse them regularly," says Richard Bove, an analyst at Punk, Ziegel & Co. "But they always go back."

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In the sizzling leveraged buyout business, Goldman is both an investor and an adviser -- often at the same time, in the same transaction. In hedge funds Goldman manages $21 billion in client money, making it the biggest player on the planet; this sum does not count the assets it puts into its own trading.

Yet Goldman also handles "back office" bookkeeping for hundreds of outside hedge funds, with $138 billion in combined assets. And it reigns as a leading "prime broker," handling trades for these funds and for itself. A corporate Web page promoting prime brokerage nudges visitors to click to a page on private wealth management, should anyone want to sign on; it says 43% of the Forbes 400 list of richest Americans are clients.

Risky? Quite apart from the risk that some crisis in a currency or stock or credit swap market could cause a meltdown on Wall Street, there is the risk that the public could turn against securities firms, especially those that so visibly wear multiple hats.

Suppose a crack in the market jolts a few million investors. Might some ambitious politician or a pack of plaintiff attorneys go after financial institutions? Then what had been seen as seamless synergy could look more like seamy self-dealing. Contemplate the fall from grace of superstar analyst Jack Grubman of Salomon Smith Barney or the rise of just-elected New York Governor Eliot Spitzer.

Goldman boasts that managing conflicts of interest is one of its skills, but some backlash has erupted. In London last spring BAA Plc., an airport operator, got an unwanted takeover offer, and Goldman approached, offering to help fight off the bid.

BAA spurned Goldman's services -- so Goldman then made a bid itself. Ultimately the original bidder preempted Goldman by buying up $1.9 billion in BAA stock on the open market. Goldman lost out -- and got slammed in the Fleet Street press.

In the U.S. an investor lawsuit pending in a state court in Houston, Tex. argues that Goldman, in advising pipeline operator Kinder Morgan in a going-private buyout last year, shortchanged public shareholders.

In the $22 billion deal, the largest management buyout ever, Goldman's investment bankers were the sole advisers to the buyers -- who included the Goldman Sachs Capital Partners private equity investing pool, and a second Goldman entity; the debt financing was provided by still another Goldman unit, Goldman Sachs Credit Partners. Goldman denies any wrongdoing -- and clearly takes pride in the deal.

Blankfein is utterly undaunted by any of the conflict-of-interest criticisms. He hopes to extend the firm's cozy ways to some of the hottest new markets in the world, the bric countries (Brazil, Russia, India and China); and to midsize companies to which Goldman can cross-sell its services; and to governments looking to privatize highways and airports. His job, he explains rather genially, "isn't to get people to run faster and jump higher. It's to get people to seize new opportunities in today's world."

Lloyd Blankfein ended up in the chairman's suite at Goldman after sneaking into the firm through a back door. Bronx-born and Brooklyn-bred, he grew up in a federal housing project in the blue-collar East New York neighborhood and still betrays a Brooklyn accent. In high school he earned money selling sodas during baseball games at Yankee Stadium. At age 16 he made it to Harvard on financial aid and a scholarship.

"We always felt like we grew up on the other side of the tracks," says an old chum, Howard Schultz, who has known Blankfein since high school. "It gave us an inner drive to want to overachieve." Today Schultz is the billionaire chairman of Starbucks Coffee, and both the coffee chain and Schultz himself are Goldman clients.

Blankfein graduated with a Harvard law degree in 1978, spent three years at a big law firm and applied for a job at Goldman Sachs -- and was summarily rejected. (He also got turned down by the former Dean Witter and by Morgan Stanley.) So in 1981 he joined a small commodities-trading outfit, J. Aron. A few months later J. Aron got bought by Goldman -- and Blankfein was in.

J. Aron brought new blood and trading savvy to Goldman, and the young lawyer spent the next 13 years in sales. By 1994 Blankfein was cohead of trading in currencies and commodities, overseeing everything from coffee and grain futures to precious metals and energy.

In 1997 Blankfein landed the job that would clinch his career: He was tapped to run a trading unit called Fixed Income, Currencies & Commodities.

"That was the inflection point when we saw a unique advantage in stacking the house with quants, analysts and salespeople and piled it on," says one longtime Goldman partner, now retired. The firm keeps secret the details on who, how many and what kind of brainiacs were brought in.

A year later Blankfein watched, up close, the unfolding of one of those unforeseen events he ponders on sleepless nights: the August 1998 collapse of hedge fund Long-Term Capital Management. LTCM had used its $4 billion of equity to place $125 billion in bets on government bonds and take $1.25 trillion in positions in interest rate derivatives.

When Russia defaulted on government bonds and panic spread through Asia's markets, the steeply leveraged edifice collapsed, ultimately requiring a $3.6 billion bailout funded by Wall Street giants.

A year later, in 1999, Goldman did its own initial public offering, despite fears the change would unravel its chummy partnership spirit. And Goldman, pushing for a tech edge, bought Hull Group, a Chicago outfit that was an early user of trading algorithms to electronically search out the best prices across multiple markets.

Blankfein's bond-currency-commodity operation soon was providing more than half of Goldman's booming trading revenue.

His profile rose with it, and he came to be seen, in some eyes, as more Woody Allen than Gordon Gekko -- a genial, funny, regular guy whose self-deprecating style masked a sharp intensity and a knack for nasty infighting when necessary.

By 2002 Blankfein had risen to vice chairman and had expanded his turf to also oversee equities trading. The world's stock markets were in a prolonged slump, but Goldman invested in new growth and more trading technology. It also pushed into asset management, despite investor qualms.

In 2000 Goldman had paid $6.5 billion in cash and stock for Spear, Leeds & Kellogg, a marketmaker at the New York Stock Exchange -- just as trading volumes on the Big Board were collapsing along with stock prices. But Spear held a hidden gem: It had built a computerized trading platform known as RediPlus, and Goldman built this into the centerpiece of its electronic trading business.

These days Goldman's trading arm is the technology and volume leader at the New York Stock Exchange, where it executes 70% of the transactions electronically, versus less than half of trading for its rivals. That edge let Goldman's equities division chop half of its workforce, cutting 2,700 jobs; yet the group's revenue has almost tripled in five years to $8.5 billion.

"There was a lot of pain in reducing head count 50%, but we were quick to see the shift coming and couldn't abdicate our leadership," says Duncan Niederauer, a Goldman managing director in equities.

Goldman also used the global slump to expand abroad, especially in Asia, going on a shopping spree for distressed assets. In 2003 the firm paid $1.3 billion for convertible preferred stock in then troubled Sumitomo Mitsui Financial Group; that investment now is worth $4.9 billion.

The markets' rebound, fueled by the boom in leveraged buyouts and hedge funds, has given Goldman new opportunities to wear myriad hats in the same deal. Its private equity operation is so well-integrated with the rest of Goldman that, last year, Goldman's investment bankers earned $105 million in fees from Goldman's private equity buyouts, Dealogic says.

For one client, KarstadtQuelle, a troubled German retailer, Goldman set up a joint venture with 174 properties. The client retained 49% and Whitehall Group, Goldman's real estate arm, 51%. Then KarstadtQuelle landed a $4.8 billion cash infusion via debt and equity financing -- all of it done by Goldman.

Goldman played a similar multicharacter role in 2005 when the New York Stock Exchange bought Archipelago Holdings. Goldman's chief at the time, Hank Paulson, had helped oust NYSE chief Richard Grasso, who ultimately was succeeded by Paulson's former number two at Goldman, John Thain.

The firm, which owned stakes in both the NYSE and Archipelago, then suggested they merge and served as adviser on the deal -- to both sides. Now the NYSE itself has gone public, and Thain is replacing its antiquated floor-trader model with the electronic wave he pushed at Goldman. Goldman is at once one of the NYSE's largest clients, its second-largest market maker and a shareholder, with a 4.6% stake.

For the next round of growth, Blankfein looks abroad, where Goldman already generates 45% of its revenue. Electronic trading isn't as far along in Europe and Asia. In China Goldman is the only foreign firm licensed to underwrite domestic offerings. As part of its "long-term greedy" mantra, Goldman forged ties at the highest levels as ex-chairman Paulson made dozens of visits to the country.

In the past few years Goldman has led several of China's biggest privatizations, including those of China Mobile Communications, PetroChina and Bank of China. Last April Goldman paid $2.6 billion for a 6% stake in Industrial & Commercial Bank of China, using capital from both Goldman itself and from its wealth-management clients.

Then, in October, the firm's investment bankers took the government-owned bank public on the Shanghai and Hong Kong exchanges, raising $22 billion in the largest initial offering ever and pocketing a fortune in fees; it helped the bank with everything from wealth-management products to ways to manage risk.

Goldman trains ICBC's employees alongside its own. And ICBC's board got a new member: John Thornton, who retired as Goldman's co-president in 2003 to teach at Tsinghua University in Beijing.

As for the 6% ICBC stake, it would now be worth five times as much. A slice of the shares have been sold.

In Japan, where Goldman has invested for 30 years, the firm has been buying once-coveted golf courses at depressed prices, and similarly cheap office buildings and businesses. It has also tapped Norinchukin, the giant ($500 billion assets) farmers' bank, for massive off-balance-sheet financing of M&A deals at a big discount to what rivals pay for capital, says one Goldman alum. "This is Goldman's secret weapon," he says. Goldman and Nochu won't disclose details of their tie.

But this same ex-Goldman person says the firm's penchant for serving in so many capacities on a single deal can create an unwieldy organization and spark internecine squabbles. The London office, he says, has been in disarray since 2004, when 20% of staff quit after cashing in shares following the public offering.

Investment bankers and their counterparts in private equity were competing to grab the same deals, prompting then-chairman Paulson to deliver what the Financial Times called a "Spank from Hank," shuffling some execs as others quit.

The vaunted firm also failed in making bids for ITV, a British broadcaster, and Mitchells & Butlers, a pub chain. Amid the missteps, Goldman fell from its usual perch atop the investment banking league tables in Europe, whose buyout market is even frothier than America's.

A mere flesh wound, Blankfein says: "It's considered newsworthy that there's a place in the world where we aren't number one in M&A," he says. "If it ever became commonplace, we'd have a problem."

To rebuild the Europe front, Goldman in the summer tapped its Asia chief, Richard Gnodde, to be co-president of Europe operations alongside Michael (Woody) Sherwood, Goldman's London trading boss. Gnodde sees a comeback and points to a "defining transaction": the $34 billion takeover by Amsterdam-based Mittal, the world's largest steelmaker and a Goldman client, of its closest rival, Arcelor of Luxembourg.

In ten days Goldman raised billions in bank and debt financing. When Arcelor resisted and turned to a white knight in Russia, Goldman rallied support for Mittal's bid among hedge funds and other big investors, as well as with politicians in Brussels and elsewhere. In the end Arcelor succumbed. "We delivered the right access and messages in every capital city in Europe and, brick by brick, took down Arcelor's defenses," Gnodde says.

Goldman has to stay out ahead of its rivals in trying daring and innovative approaches that push the outer edge of the boundary between what is okay and what may not be. Blankfein tells Goldman folks the job of compliance lawyers is to tell them where that edge is -- because otherwise, "we'd stay in bed with a blanket over our heads" and not try anything.

That edge is where Goldman can reap the richest profits, far wider margins than on the floor of the NYSE. The firm creates ever more exotic new instruments. Lately it has been working on a futures product that would let clients hedge their real estate risk and a derivative for trading in biodiesel futures.

Five years ago, Blankfein says, the urgent topic of discussion would be "whether we needed to merge with a commercial bank. . Now the size of our balance sheet and our ability to finance makes that irrelevant. The world five years from now will be different still. Our job is to make sure that we are still Goldman Sachs, no matter what it takes."

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