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Oct 08, 2009


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.

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