Over the past few weeks, BlackRock has been the target of increased scrutiny due to its deeply entangled role in the bailout: thanks to a slew of contracts from the New York Fed, many of which were no-bid, the firm is now in a position to buy, sell, manage, and valuate toxic assets, both for the government and for its own private clients. But BlackRock is hardly the only company that's been able to form a cozy relationship with the government during this economic downturn.
This weekend, The New York Times featured an in-depth profile of Pacific Investment Management Company (PIMCO) and its founder and co-chief investment officer, Bill Gross. The article provides some interesting background on PIMCO's unparalleled success in the bond market and on Gross's personal eccentricities (he's been known to take investment lessons from the blackjack table and to strategize while standing upside-down during his yoga routine). At the same time, the article paints a disturbing picture of PIMCO's wide-ranging influence on the government's bailout programs, highlighting many of the concerns POGO has raised about the Fed and Treasury's reliance on private asset managers with intricately conflicted financial interests.
PIMCO is now playing a central role in the government's bailout programs. It's one of four firms hired by the New York Fed to manage its $1.25 trillion agency mortgage-backed securities purchase program. It's serving as an asset manager for the New York Fed's $130 billion Commercial Paper Funding Facility. According to the Times, during Bank of America's controversial acquisition of Merrill Lynch, PIMCO advised the Fed that Merrill wouldn't survive without a capital infusion or government assistance. And it has applied and is widely expected to be selected as an asset manager for Treasury's Legacy Securities Program (LSP), part of the Public Private Investment Program (PPIP).
Of course, as the Times article points out, it's "perfectly logical" for the administration to turn to one of the nation's most successful asset managers to help run the government's complex bailout programs, and nobody has accused PIMCO of any blatant wrongdoing. In fact, the New York Fed's investment agreements with PIMCO for the agency mortgage-backed securities purchase program and the Commercial Paper Funding Facility contain provisions that seek to mitigate any organizational or personal conflicts of interest that might arise due to PIMCO performing similar services for its private clients.
But as we pointed out in our letter to Congress last month, these conflict of interest provisions tend to rely heavily on self-disclosure and internal firewalls that supposedly prevent communication between the employees working for the government and the employees managing the firm's private investments. Gross's description of PIMCO's firewall isn't exactly reassuring:
He almost never personally buys and sells bonds. Pimco has dozens of traders who do this for him here. “There's the mortgage desk over there,” he says, pointing to a group of well-scrubbed young people hunched over computers. “We've been buying some mortgages this morning. That's our baby, so to speak. That's our bag.”
He immediately adds that this mortgage trading operation is completely separate from the one on the floor below, where traders are working on behalf of the Fed. [note: he previously stated that the private traders are "housed in a different building."] He says he can't even visit that floor himself anymore without a company lawyer at his side. The last time he did was in December, when he wished the traders happy holidays.
“I said, 'Merry Christmas,' ” Mr. Gross recalls. “The lawyer said, 'Mr. Gross says Merry Christmas.' Right then and there, I knew that communications were basically severed. That's the way the Fed wants it.”
He says he assumes that Pimco traders working on behalf of the government don't talk to their peers trading for Pimco's own accounts. Then again, he said he doesn't know for sure what happens after hours.
“I don't drink beer with these guys; I have no idea what happens in the privacy of their own homes,” he says.
Even if PIMCO can somehow maintain a robust internal firewall, the Times article acknowledges that money managers "have a legal obligation--a fiduciary responsibility--to put the interest of their investors before anyone else." And there's still the troubling appearance that the firm has received preferential treatment thanks to its cozy relationship with the government--for instance, PIMCO managing director Paul McCulley has stated that it's part of his job to maintain close relations with Fed and Treasury officials, and has even boasted that he's on a first-name basis with Treasury Secretary Tim Geithner and Fed Chairman Ben Bernanke.
It appears that PIMCO's close ties to the government have paid off handsomely. As early as September 2008, Gross was calling on the government to stabilize the financial system by purchasing troubled assets. A few days later, Treasury announced its plan to purchase mortgage-backed securities from Fannie Mae and Freddie Mac. After Gross raised concerns about the government's initial proposal to rescue GMAC, the financial division of General Motors, the Fed changed its plans and agreed to guarantee all of the GMAC debt held by PIMCO and others. And for months now, Gross has put forth a proposal to have private asset mangers purchase and manage troubled assets for the government, and even offered that PIMCO would work for free to run such a program. This idea eventually evolved into the administration's Public Private Investment Program (PPIP), and as mentioned above, PIMCO is now likely to serve as one of the PPIP asset managers.
Of course, we're sure it's just a coincidence that over 60 percent of Gross's $150 billion Total Return Fund is invested in the same type of mortgage bonds that are being targeted by the PPIP. We're sure it's also just a coincidence that Treasury's initial terms for the program required that the private asset managers already have $10 billion in eligible assets under management, virtually guaranteeing that the job would go to big players such as PIMCO. And while Gross calls the PPIP a "win-win-win" for private investors, banks, and taxpayers, he also admitted to the Times that since the government is generously leveraging the PPIP investments, it's the government that will have to absorb the losses if the investments go bad:
"It's just like in blackjack," he says. "That puts the odds in your favor. If you don't bet too much and if you stay at the table long enough, the odds are high that you are going to go home with some extra money in your pocket."
This is exactly why the Special Inspector General for the Troubled Asset Relief Program, as well as several members of the Congressional Oversight Panel, have sounded the alarm that the PPIP could result in "catastrophic losses" for the government. In other words, taxpayers have good reason to be concerned about Gross's enthusiastic support.
And even Gross concedes that the relationship between PIMCO and the government has become uncomfortably cozy: "You want to shake hands with the government. But maybe it shouldn't be a super-firm handshake." As Treasury finalizes the terms of the PPIP and any future bailout programs, we hope that Congress and the bailout watchdogs will pay close attention to make sure PIMCO isn't giving taxpayers the finger while it shakes hands with the government.
-- Michael Smallberg