The U.S. Treasury Department recently announced it has preliminarily granted BlackRock Inc. (NYSE: BLK), a mega-money-management and risk-advisory firm, a second-round interview to potentially buy toxic assets from beleaguered U.S. banks. The Treasury's plan was to let a chosen few investment firms borrow cheaply from the Fed in order to massively leverage up their capital pools to purchase toxic assets, and then to backstop almost all potential losses with taxpayer money.
This plan was itself crafted in large measure with help from BlackRock.
It's as if the moral hazards of cronyism, leverage, laissez-faire government and the doctrine of too-big-to-fail never happened.
The Background on BlackRock
In 1988, The Blackstone Group LP (NYSE: BX) – then a young-and-aggressive leveraged buyout shop that would eventually go public and is now the largest private equity company in the world – bankrolled a small asset-management startup called Financial Management Group. Heralding its roots out of Blackstone, Financial Management Group later changed its name to BlackRock.
BlackRock was originally run by Ralph L. Schlosstein, a former Lehman Brothers Holdings Inc. (OTC: LEHMQ) managing director of the mortgage-backed bond group, who stepped down as BlackRock's president last year, and Laurence D. Fink, a former First Boston Group [now part of giant Credit Suisse Group AG (NYSE ADR: CS)] and a master-of-the-universe, fixed-income mortgage trader. That the expertise of the firm's founders was in mortgage-backed securities is hardly ironic in this story.
As it happens, the story goes that Fink was one of the early pioneers at First Boston who helped create collateralized mortgage obligations (CMOs) out of fairly transparent mortgage-backed securities. Collateralized mortgage obligations, not unlike a virus, eventually yielded a whole host of spin-off products, now collectively lumped under the banner of collateralized debt obligations, or CDOs. For the most part, CDOs are like IEDs (improvised explosive devices) strewn along the road of once-straightforward securitized products. Sometime, in the not-too-distant future, when you look up the term "toxic assets" in your Barron's "Dictionary of Finance and Investment Terms," the definition will include a picture of the collateralized debt obligation family of products.
In 1994, Blackstone sold BlackRock to PNC Bank Corp. (NYSE: PNC), and in 1999 BlackRock went public (PNC still holds a 34% stake in BlackRock). Also in 1999, under Fink's watchful eye, BlackRock Solutions was formed to provide risk-advisory and risk-management services. And again – not ironically – it is BlackRock Solutions that purports to have the "solution" to valuing toxic assets and the insight on how to manage associated risk with these products – the very same toxic assets that Fink helped to create.
As it turns out, however, BlackRock isn't exactly the Rock of Gibraltar when it comes to its stability of performance, its timing or its risk management – whether that's for its clients, itself, or the U.S. taxpayers.
Back in his First Boston days, Fink sold Freddie Mac (NYSE: FRE) its first $1 billion of collateralized mortgage obligations. Freddie Mac has been a longtime BlackRock client.
We know how well Freddie Mac is doing, now, with its burgeoning mortgage portfolios – it is technically insolvent. Three months before Lehman Brothers went bankrupt, BlackRock aggressively loaded up clients with Lehman stock in the high $20s – not a good move. In September 2008, Fink managed to get his firm a gig evaluating the suspect balance sheet of Morgan Stanley (NYSE: MS) when potential investor Mitsubishi UFJ Financial Group Inc. (NYSE ADR: MTU) was in talks with a desperate Morgan. According to a recent Wall Street Journal article, Mitsubishi later reviewed the BlackRock financial opinion, which helped push the deal through. It's no wonder that Mitsubishi declined to comment on buying $3 billion of Morgan Stanley stock at $25.25 and $6 billion of perpetual noncumulative convertible preferred stock that carries a 10% dividend and a conversion price of $31.25 per share, because the stock subsequently sank to $9.20 and now trades at nearly $30.
About That Expertise…
BlackRock hasn't just been an advisor and manager whose timing has been rocky; it has also been a manufacturer of the very same CDOs that caused the financial meltdown. According to The Journal, "the firm created about $5.5 billion of CDOs in 2007, most of which have defaulted, causing losses of more than 50% for investors."
Another $2 billion deal fell apart in six months and hammered Bank of America Corp. (NYSE: BAC) with a $1 billion loss at the end of 2008. Bank of America owns 47% of BlackRock as a result of its purchase of Merrill Lynch. As fate would have it, Merrill, who helped take BlackRock public in 1999 bought into the company in 2005 as a strategic partner after BlackRock bought Merrill Lynch Investment Managers (an asset management business) for $9.5 billion. When Merrill got hit by the deadly financial flu, it sold itself to an unsuspecting BofA.
All in the family: Bear Stearns, AIG, Freddie Mac and Fannie Mae, opportunity knocks.
In March 2008, as Bear Stearns was crumbling under the onslaught of short sellers and credit-default-swap traders hammering its equity-and-debt securities, J.P. Morgan Chase & Co. (NYSE: JPM) hired BlackRock Solutions to help evaluate Bear's balance sheet and formulate a potential offer. The timing was auspicious. As The Journal reported, "within 48 hours, Mr. Fink was called by Mr. [Timothy] Geithner, then New York Fed president. The request: To switch gears and help the Fed choose which of those Bear assets should be used to collateralize a $29 billion government loan as part of the deal."
Luckily for J.P. Morgan, BlackRock's client, BlackRock segregated the worst assets on Bears' books and advised the bank not to do a deal unless the government did the heavy lifting.
Fink was no less propitious in offering to have BlackRock help with American International Group Inc.'s (NYSE: AIG) toxic assets, when the government came calling. BlackRock, again, was presumed to already have the inside view of the troubled AIG. It was hired to manage $100 billion of AIG's junk.
BlackRock was also called on by the Fed last October to help shepherd the 80% stake the government took in mortgage dinosaurs Freddie Mac and Fannie Mae (NYSE: FNM). I'm talking no-bid contracts here.
When asked about the no-bid contracts to manage hundreds of billions of dollars of government bailout companies, Bloomberg Markets magazine reported that Fink responded: "We had the expertise; we had already evaluated the assets. It's not that we're being opportunistic."
According to the Bloomberg story, "during hearings in Congress in January, [U.S. Sen. Charles Grassley, R-Iowa], an Iowa Republican and ranking member of the Senate Finance Committee, questioned the no-bid government contracts awarded to BlackRock."
Now BlackRock is among an elite group of managers being considered by the Treasury Department to participate in what is being called the– not ironically, a program that BlackRock helped formulate. The potential conflicts of interest are staggering.
Special Inspector General for the Troubled Asset Relief Program (TARP), Neil M. Barofsky, in his latest report to Congress recently described how a conflict of interest would benefit managers participating in PPIP.
"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."
Getting the Gang Back Together
Bank of America owns Countrywide Financial Corp., as well as 47% of BlackRock. And as reported in The Huffington Post: "As if that were not enough financial incest, the former president and other top executives of Countrywide now run a company created by BlackRock, which is profiting mightily by snapping up the sort of distressed loans that they originally had marketed. Leading the pack of vulture capitalists profiting from the misery they inspired is the Private National Acceptance Co. (PennyMac), which BlackRock bankrolled. Stanford L. Kurland, chairman and CEO of PennyMac, is the former president of Countrywide Financial."
With all its supposed expertise in the valuation business of toxic CDOs that it helped create, BlackRock's trust in itself apparently leaves a lot to be desired. The Journal reported that "BlackRock executives say they typically use third-party pricing services and try to minimize the amount of securities they mark based on their own model."
Where will we end up if we are relying on the creators of our financial plague to provide the necessary salutary treatment and manage our wellness when their own interest is self-interest and they really don't know how to manage the valuation or asset disposition process? We are on a merry go-round and headed back to the beginning. Until the government, prodded by outraged and decent Americans, strips the vested inside cabal of money-grubbing Wall Streeters, their lobbyists and congressional lackeys of their power to corrupt the financial landscape and the world's economies, just as surely as it feels like spring now, winter is coming.
The public needs to be loud. We need to demonstrate, to agitate and to stand up together and demand total transparency and a new order that replaces Wall Street interests with those of Main Street Americans.
If we don't act now, when will we have the chance again?
[Editor's Note: Uncertainty will continue to be the watchword in the months to come. R. Shah Gilani – a retired hedge fund manager and a nationally known expert on the U.S. credit crisis – has predicted five key financial crisis "aftershocks" that he says will create substantial profit opportunities for investors who know just what these aftershocks are, and how to play them. In the Trigger Event Strategist, trigger events," as gateways to massive profits. To find out all about these five financial-crisis aftershocks, and about the trigger-event profit strategy they feed into, check out our latest offer.]
News and Related Story Links:
- Money Morning News Analysis:
With Buyout of Merrill, Bankruptcy for Lehman, Wall Street Plays "Let's Make a Deal."
- Money Morning Investigative Series on the Banking Bailouts:
Foreign Bondholders – and not the U.S. Mortgage Market – Drove the Fannie/Freddie Bailout.
- Bloomberg News:
Mitsubishi UFJ Loses $506 Million in One Day on Morgan Stanley.
Troubled Asset Relief Program.
- The Wall Street Journal:
BlackRock Wears Multiple Hats: In the Crisis, Fink's Firm Is Buyer, Seller, Adviser; 'Our Clients Trust Us.'
Neil M. Barofsky.
- Money Morning News Analysis:
Bank of America Gets $138 Billion Bailout as Merrill Takeover Backfires.
- U.S. Treasury Department Press Release: .
- Office of the Special Inspector General's Report to Congress on the Troubled Asset Relief Program (SIGTARP):
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.