Reuters reported yesterday that the New York Fed has hired PIMCO as a collateral monitor for the Term Asset-Backed Securities Loan Facility (TALF). Although the announcement was made with little fanfare—a small update to an FAQ section on the New York Fed's website—it raises additional concerns about the serious potential for conflicts of interest involving PIMCO and other asset managers that are being hired to run the government's bailout programs.
The TALF was initiated last fall by the Fed and Treasury to expand credit to consumers and small businesses by purchasing AAA-rated asset-backed securities. Following several recent expansions, the TALF now has the potential to generate up to $1 trillion in loans in exchange for a wide range of assets, including commercial mortgage-backed securities. (For more background on the TALF, check out pp. 72-82 of the latest quarterly report by the Special Inspector General for the Troubled Asset Relief Program.)
Under the terms of the program, borrowers must post their asset-backed securities as collateral for the loans. According to the New York Fed's FAQs, PIMCO and Trepp will serve as collateral monitors by "providing valuation, modeling, analytics and reporting, as well as advising on these matters." Although Trepp's role will be limited to commercial mortgage-backed securities, it appears that PIMCO "will perform a broader role which encompasses the entire TALF portfolio, including both mortgage-backed and non-mortgage-backed ABS."
As explained in the SIGTARP report (p. 80), these collateral monitors have an important job: if PIMCO or Trepp determines that an asset posted as collateral will perform poorly under certain economic conditions, the New York Fed might decide to decrease its loan to that borrower. So you'd think that the New York Fed would want to pick a collateral monitor that could provide independent, unbiased advice on the valuation of these assets, right?
As it turns out, however, PIMCO may already have a deeply entangled stake in many of these assets, thanks to its involvement in multiple bailout programs as well as its own private investments. Although PIMCO surprised many last month by withdrawing its application for the Public Private Investment Program, it's still serving as an asset manager for the New York Fed's agency mortgage-backed securities purchase program and Commercial Paper Funding Facility. And as of June 30, 2009, PIMCO is managing $982,636,884 in total net assets under its own Mortgage-Backed Securities Fund.
Just to be clear: POGO isn't accusing PIMCO of any blatant misconduct. It makes perfect sense for the government to turn to one of the nation's most successful asset managers to help run the complex bailout programs, and the TALF is no exception. Furthermore, the New York Fed states that the TALF collateral monitors "will not establish policies or make decisions."
Nonetheless, we remain concerned that a few select asset managers like PIMCO and BlackRock have been given such a central role in the government's bailout programs. The SIGTARP has criticized the Fed and Treasury for relying on credit rating agencies to determine the eligibility of assets for the TALF, since the agencies are paid by the issuers of the securities they are rating. But by turning to PIMCO as a collateral monitor, it appears the Fed might be replacing one conflict of interest with another. As PIMCO founder and co-chief investment officer Bill Gross recently admitted to The New York Times, the firm's relationship with the government has become uncomfortably cozy: "You want to shake hands with the government. But maybe it shouldn't be a super-firm handshake."
Even if this cozy handshake doesn't result in major financial losses for the government and taxpayers, there's still an appearance of a conflict of interest, which can be just as bad. By continuing to rely so heavily on deeply entangled asset managers like PIMCO, we fear that the Fed and Treasury are giving the public ample reason to question the government's ability to rescue the financial system.
-- Michael Smallberg