BlackRock to the Rescue (Again)

The Wall Street Journal reported this morning that BlackRock is in the running for a new contract to help state insurance regulators perform risk analysis on insurers’ investments, prompting Agnes Crane at Reuters to ask: “Is BlackRock going to rule the world?”

As Crane points out, BlackRock—the country’s largest publicly traded asset management firm—has already enjoyed a cozy relationship with several government agencies that are working to address the financial crisis. At the moment, BlackRock is already providing risk and analytics support for the New York Fed’s $1.25 trillion agency mortgage-backed securities purchase program. BlackRock is also the asset manager for all three of the New York Fed’s Maiden Lane transactions, which were formed to facilitate JPMorgan’s acquisition of Bear Stearns and to restructure the New York Fed’s support to AIG. (A recent New York Times investigation revealed that three of BlackRock’s contracts with the New York Fed were no-bid, including one in which fees were not established until after the contract was awarded.) Finally, BlackRock has raised over $500 million in private capital in order to purchase and manage legacy securities as part of the Treasury Department’s Public-Private Investment Program.

And now, according to the Journal, BlackRock is on a short list of companies that are under consideration to receive a “high-profile” contract from the National Association of Insurance Commissioners (NAIC). If it wins the contract, BlackRock will be analyzing the risk of mortgage-backed bonds owned by insurers, a job previously performed by credit rating agencies, which have fallen out of favor recently due to allegations of inflated ratings.

Another company that is reportedly under consideration for the contract is PIMCO, which has also played a central role in advising the government on its bailout programs, and has been on POGO’s watch list due to its potential conflicts of interest.

To understand why hiring a company like BlackRock or PIMCO could raise the risk for conflicts of interest, just take a look at BlackRock’s latest quarterly SEC filing. As of June 30, 2009, BlackRock is managing a whopping $1.37 trillion in assets, including $510 billion in bonds, $317 billion in cash products, $330 billion in stock funds, and $52 billion in alternative investments such as hedge funds. The company also advises clients on $166 billion in assets, including many of the same types of assets that it would be evaluating for the NAIC. And these numbers will soon be increasing thanks to BlackRock’s recent acquisition of Barclays’ investment unit, which, according to Bloomberg, will create a “company overseeing $2.7 trillion in assets—more than the Federal Reserve.”

A BlackRock spokesperson assured the Journal that the company has “very strict policies and procedures in place to protect confidential client information and manage any potential conflicts of interest.” They’re almost certainly referring to the company’s internal firewalls, which supposedly separate the employees working on the government contracts from the employees managing the firm’s private investments. But in a letter POGO sent to Congress in May, we questioned how effective these firewalls are in protecting the government from conflicts of interest, especially given the magnitude of private investments managed by BlackRock and similar firms.

We certainly understand why the NAIC is fed up with the credit rating agencies, which suffer from their own conflicts of interest since they receive funding from the issuers of the securities they evaluate. But we hope the NAIC will think twice before trusting any risk analysis from a private firm like BlackRock that has a massive financial stake in the market for mortgage-backed bonds.

-- Michael Smallberg

Comments

[Michael Smallberg]

Thank you for your comment, Observer, Jr.

Just to be clear: we are not accusing BlackRock of any intentional misconduct, and we haven't uncovered any evidence of a direct financial conflict. As we wrote in our letter to Congress in May, "it's perfectly understandable that the government is relying on the expertise of these private fund managers to assist with the complex tasks of asset management and valuation," and nobody is more experienced than BlackRock when it comes to managing and valuating mortgage-backed assets.

Our concern is that, even if strong internal firewalls were put in place—and we're skeptical about how effective these firewalls really are—BlackRock would still have a natural incentive to overvalue assets that it owns or is managing for its private clients. In the case of the Public-Private Investment Program (PPIP), private asset managers like BlackRock are being given tremendous power to set the price of assets in an illiquid market, as noted in a recent report by the Special Inspector General for the Troubled Asset Relief Program (SIGTARP):

"By their nature and design, including the availability of significant leverage, the PPIF [Public-Private Investment Fund] transactions in these frozen markets will have a significant impact on how any particular asset is priced in the market. As a result, the increase in the price of such an asset will greatly benefit anyone who owns or manages the same asset, including the PPIF manager who is making the investment decisions....

The incentives [to overpay for an asset] exist, for example, even if the fund manager does not own MBS [mortgage-backed security] X but is merely managing other funds that hold MBS X, as the manager earns fees based on the value of that fund, a value that would, in this example, be significantly overstated (temporarily) as it can increase the value of that fund based on valuing, or "marking" the MBS X at the inflated “market” price that it set. The conflict can even exist if the manager holds or manages equity tied to the value of the banks from which the MBS are being purchased; here, using PPIF funds to overpay for bank assets may increase the bank’s stock price, thus giving a greater profit to the fund manager."

And in the case of the PPIP, Treasury isn't even requiring the asset managers to implement internal firewalls, which is why the SIGTARP continues to report about the potential for conflicts of interest and taxpayer losses in this program.

So in response to your question, we didn't mean to suggest that BlackRock has done any damage. We just want the government and the NAIC to implement stronger conflicts of interest policies in order to prevent the damage from happening in the first place.

[Observer, Jr.]

I share some of your skepticism, if not the knee-jerk emotion that there must be wrongdoing here. So, Mr. Smallberg, what evidence is there that there are, indeed, conflicts of interest not subject to mitigation? Potential conflicts of interest? Be specific, please. In the past, what evidence is there that conflicts you cite worked against the public good? or even investors? What was the damage? Again, please be specific. Being skeptical is fine, and there is reason to be on our guard, but see if you you can back up your fears and somewhat of a tendency to indict with some real facts. POGO can be excellent in marshalling facts, even if the conclusions are highly arguable among reasonable people.
So, let's just start with the facts underlying your assertion.