Nov. 19 (Bloomberg) -- Meredith Whitney, the analyst who cut her rating on Goldman Sachs Group Inc. last month, said the bank has lost some of its top-performing employees as executives left to start their own investment companies.

“Goldman’s lost a tremendous amount of talent going to set up their own hedge funds,” Whitney, founder of Meredith Whitney Advisory Group, said today in an interview on Bloomberg Radio. “It became a scary prospect of having the government determine what you make,” said Whitney, who also said today that bank stocks are “grossly overvalued.”

The Federal Reserve said last month it will review the 28 largest banks to ensure pay doesn’t create incentives to make the kinds of risky investments that brought the financial system to the edge of collapse, prompting bailouts of firms including Bank of America Corp. and Citigroup Inc. Goldman Sachs Chief Executive Officer Lloyd Blankfein said in May the bank, the most profitable Wall Street firm in history, was having no more trouble than usual in retaining employees.

“I do not at this particular time feel stress” about employees leaving the bank, Blankfein said May 8 at the annual shareholder meeting in New York. “That pressure, if anything, has abated a bit” as hedge funds face their own difficulties, Blankfein said.

Hedge Funds

Hedge funds are mostly private pools of capital whose managers take a share in the profits from speculation on whether the price of assets will rise or fall. Some 140 hedge funds started this year through the third quarter, while 150 funds closed, Eurekahedge Pte, the Singapore-based research firm, said yesterday.

Whitney, 39, lowered her assessment of New York-based Goldman Sachs to “neutral” last month, dropping her only “buy” recommendation among U.S. banks. Whitney said she remains bullish on the company, and cut her rating because the valuation had exceeded prospects for earnings. Goldman Sachs has more than doubled this year on the New York Stock Exchange.

Whitney said valuations for bank shares are too high. “People are expecting something great to happen in 2010, and I think they are going to be severely disappointed,” she said.

Consumer and small business spending won’t rebound soon, Whitney said, estimating about $2.7 trillion in credit lines will be cut. She said she expects this year’s holiday season to be at best “flat” versus last year.

Small Businesses

Goldman Sachs this week announced a $500 million charity program with billionaire investor Warren Buffett to provide assistance to 10,000 small U.S. businesses. The firm is trying to dispel criticism from lawmakers and consumer advocates who say outsized pay packages contributed to the collapse of the credit markets last year.

Goldman Sachs allocated $16.7 billion for compensation and benefits in the first three quarters, or enough to pay each employee $527,192 for nine months’ work.

Kenneth Feinberg, the Obama administration’s special master for executive compensation, said last week he was “very concerned” about the possibility government-imposed pay cuts may drive talent away from bailed-out companies. Feinberg has no say in Goldman Sachs’s compensation policies because the bank has paid back the government’s bailout money.

Feinberg has ordered pay cuts averaging 50 percent for the top 25 executives at Citigroup, Bank of America, American International Group Inc. and four other companies that took U.S. bailout money. He will rule on pay structures covering the next 75 highest-paid employees at those firms by year-end.

John Mack and Kenneth Lewis, the CEOs of Morgan Stanley and Bank of America, said earlier this year that pay limits tied to federal rescue funds have prompted some top employees to leave. Lewis said at his company’s annual meeting that the bank had lost “strong revenue generators.” Mack, speaking at his annual meeting, called departures at Morgan Stanley an “exodus,” then said that was “too strong a word.”

To contact the reporters on this story: Josh Fineman in New York at jfineman@bloomberg.net; Thomas R. Keene in New York at tkeene@bloomberg.net

Last Updated: November 19, 2009 10:58 EST