This month, Wall Street watchers might feel as if they are living in Groundhog Day. Now, as in 2008, markets are melting down. Once again, the US Federal Reserve is frantically innovating to stop a financial freeze. And, as these wild policy experiments unfold, a familiar figure is also back in the frame: Larry Fink, chief executive of BlackRock, the $7tn asset management behemoth.
Twelve not-so-long years ago, the Fed turned to BlackRock to manage the Maiden Lane vehicle that it created to hold assets from the defunct insurer AIG and also Bear Stearns. On Tuesday, it again tapped BlackRock’s Financial Markets Advisory, its consultancy arm, only this time to run three vehicles the Fed will create to buy corporate debt from the primary and secondary markets, and also commercial mortgage-backed securities.
Is this replay a smart move by the Fed? The answer depends on if you have a wartime or peacetime perspective. In calm market times, as existed a month ago (remember that?), Tuesday’s announcement would look very odd.
Never mind that the Fed has used BlackRock before, or that Mr Fink is fabulously well-connected. What is more notable is that BlackRock received this mandate without a contest. Moreover, his asset management firm has such a humungous footprint that it will inevitably collide with those Fed vehicles.
Take the $140bn world of investment grade US corporate bond exchange traded funds. On Monday the Fed pledged to invest in some ETFs to support corporate funding flows. However, as it happens a BlackRock-run ETF, called LQD, is the biggest of this type. The price of LQD, like other ETFs, has already rallied since the announcement. If the Fed does a broad ETF programme, LQD will probably be part of that mix.
This leaves some BlackRock rivals muttering about conflicts of interest — and non-American regulators caustically pointing out that since 2008 Mr Fink has been adept in persuading US regulators to refrain from sweeping regulatory reforms on asset managers, such as his.
Fair enough. But the problem the Fed faces is that it does not have the luxury of operating in peacetime; it is fighting a war to stop a financial freeze. Thankfully, the White House is letting Fed officials experiment as flexibly as they did in 2008, contrary to earlier fears among policy veterans such as Hank Paulson, the former US Treasury secretary, that the Fed’s hands would be tied.
However, even with this freedom, Fed officials face a practical problem: they do not have all the resources they need in terms of manpower and skills.
Consider, again, corporate debt. The Fed says it will only buy investment grade credit, to limit possible losses. But, as Scott Minerd of Guggenheim points out, “There are approximately $1tn worth of investment-grade corporate bonds that are in danger of being downgraded”. Indeed, $36bn of Ford debt has already become junk.
Fed officials hope they can offset these risks by using a $30bn Treasury fund to absorb future losses. But it is also imperative to have external managers, given that the Fed has never exposed itself to such credit risk. And while numerous financial groups have asset management or consultancy skills, none has the combination on BlackRock’s scale.
For the key thing to understand about the canny Mr Fink is that he has not only spent the past decade building a highly visible asset management company, he has also quietly used the Maiden Lane experience to make FMA dominant in its consultancy space. It has 280 staff, and has quietly worked for numerous public institutions, including the UK Treasury and European Central Bank.
As a result BlackRock has extensive “expertise with purchasing large amounts of all relevant types of corporate debt issuance and corporate bonds in the secondary market”, as the New York Fed notes. In plain English, BlackRock’s experience and data base make it a natural Fed partner — if it can manage those potential conflicts of interest.
Can it? Both sides insist so. BlackRock officials stress that its asset manager and consultancy units are separated by strict Chinese walls. Fed officials point out that BlackRock’s mandate is only a short-term contract, and thus will be reviewed soon. Most important, the $2tn stimulus bill in Congress stipulates that details of Fed’s actions must be published after a seven-day lag.
If honoured, this should provide transparency about trades and BlackRock’s fees, in a welcome contrast to what happened in 2008. “We’ve learnt from the past,” insists one Fed official. “We won’t repeat the mistakes.”
Maybe so. But 2008 also shows that decisions that seem sensible in the heat of war can spark furious political backlash later. If Fed officials, and Mr Fink, want to minimise these risks, it will be crucial to maintain transparency and conduct proper beauty parades when normality returns. If, or when, we return to that point, US regulators will then need to ask another question: why did they let the asset management world become so concentrated that the ever-present Mr Fink reigns supreme?
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