Sixty years of financial evolution culminated in a wild melee during the crisis of 2007-9. In its purely human dimension, senior figures of the industry resembled warriors from many and various tribes fighting a nighttime battle. They had trouble distinguishing friend from foe.
So did bystanders, investors and taxpayers alike. When chaos subsided, who had won – and how? Or to put it slightly differently, who, if anyone, is standing on the ethical high ground on Wall Street?
My sense is that the financial journalist Suzanna Andrews had it about right when she wrote in Vanity Fair last year that Laurence Fink, 57, chief executive of BlackRock Inc. (BLK), has become “the most important man in finance today.”
Never mind the last man of whom something like that that could be said – Sandy Weill, the volcanic force who in the 1990s built Citigroup (C) into the mess it is today. Before him, Paul Volcker’s identity in public affairs – disinterested, farsighted – was established by his leadership in a crisis thirty years ago.
It’s not that which has happened to Fink. Thirty years ago he was one of a handful of entrepreneurs who invented the securitization industry, creating the market for mortgage-backed securities. Today he runs a public company, with market capitalization of around $40 billion. So he can hardly be described as disinterested.
He does, at least, speak for investors – all different kinds of them. BlackRock’s clients include pension plans, charities, foundations and endowments, central banks, sovereign wealth funds, insurance companies, financial institutions, corporations and third-party fund sponsors, retail and high-net-worth investors – practically the whole gamut of those who seek the services of financial intermediaries. (California-based Pacific Investment Management Company – PIMCO – is a close competitor, as are various European and Asian asset managers.)
In that sense, BlackRock role today may more nearly resemble that of the two businesses that were formed by the 1933 breakup of the merchant bank known colloquially as the House of Morgan. J.P Morgan & Co, a commercial bank, and Morgan Stanley & Co., an investment bank, helped set the ethical tone on Wall Street for the next fifty years – the days when that was considered a compliment. It is scarcely the only company in the asset management business. BlackRock is, however, the most successful.
It was because BlackRock demonstrably understood better than anyone else the intricacy and interdependence of financial markets that the firm emerged almost unscathed from a crisis that overwhelmed many other participants. Wall Street firms turned to BlackRock for advice in the desperate periods of recombination during the crisis.
Moreover, the firm emerged with few, if any, significant conflicts of interests – unlike similarly solvent Goldman, Sachs (GS). So it was BlackRock whom the Federal Reserve Bank of New York and the Treasury Department hired to manage the government’s interests in various aspects of the bailout: the sale of Bear, Stearns to J.P. Morgan (JPM); the bailout of AIG; the rescue of Citigroup; and the takeover of Fannie Mae (OTC:FNMA) and Freddie Mac (OTC:FMCC).
And it was to BlackRock that Peter Fisher and Kendrick Wilson repaired after their government service. Fisher, longtime executive vice president of the New York Fed, had served most recently as Treasury Undersecretary; and Wilson, a former executive at Goldman and Lazard Freres & Co., played a crucial role during the crisis as Treasury’s ears on Wall Street for five months. Neel Kashkhari, a former Goldman executive who oversaw the TARP lending program as interim Assistant Secretary for Financial Stability, left the Treasury for PIMCO, and NOT for BlackRock, as EP briefly earlier asserted.
This is, I think, something fundamentally different from the parade of Goldman, Sachs executives who went down to Washington to join the government over the last eighteen years. These two are, I hope, Treasury men going to New York – a case, perhaps, of rallying to the flag.
Journalist Andrews’ profile (“Larry Fink’s $12 Trillion Shadow,” in April 2010) was necessarily highly personalized. This was Vanity Fair, after all. And indeed, Fink is clearly a managerial phenomenon. The story of how he and a team of co-founders built Blackrock from a First Boston breakaway in 1988 into what last year became the world’s biggest money manager, looking after more than $3.5 trillion for clients, will make fascinating reading eventually, when it is finally told in a fully-reported book (or, more likely, books). Five years as a wholly-owned subsidiary of Blackstone Group, the private equity firm, was the crucial step along the way. (Vanity Fair’s article is still the only proper profile of Fink, though doubtless several more are in the works).
Nobody builds a company as highly technological as BlackRock by himself, however, so my ears perked up the other day at the Massachusetts Institute of Technology when BlackRock’s chief risk officer, another of its co-founders, described the creation of the firm. I have transcribed here only a small portion of what Bennett Golub had to say. If you have time, go to time-stamp 36.00 here in Friday’s second session and listen to him for yourself for ten minutes.
At one point, Golub described how in 1984, after months of receiving rejection letters from investment banks (“No one could figure out what [applied economics and finance] had anything to do with”), he joined a little investment bank that had a problem: its mortgage trader had left, leaving behind a three-quarters-written model. Thus he quickly found himself working on collateralized mortgage-backed-securities, a relatively new market at the time. “Three months of 80-hour weeks later, we had one of the first CMO models that came into the system.”
So suddenly I went from, “Who are you?” to “Oh, I build CMO models and I have an MIT PhD.” Everyone wanted to talk to me. I was a popular guy. So I went off and joined a major investment bank and created in 1985 a financial engineering group. That was my name because we actually had engineers and we actually were engineering CAD-CAM type software to design new types of mortgage-backed securities. We would actually grind it out just the way you would expect an MIT team to do, studying all the parameters, tuning these things up, calibrating them precisely to exactly what various investors wanted who were trying to extract arbitrage in the process
It was sort of a great gig, but what happened is the business started to change in the course of three years, from what I called making money the old-fashioned way, earning it, working really hard doing this stuff, to [when] people discovered you could do something else, which is you could actually obfuscate. In other words, if you could hide the risk, you could actually get people to pay you for things that probably maybe they shouldn’t be paying you for.
I really didn’t think that was such a great thing to do, and it made us get this idea that there could be an opportunity for a little mortgage boutique to be started. We had this idea that we would bring sell-side analytics to the buy-side. That was the core idea, that we were going to be able to understand the same way that financial engineers who created them did.
And that little boutique is today known as BlackRock.
The rest of the story of how the company built its business is too complicated to go into here. There were trials of scale: knowing what you owned, discovering how it behaved, was expensive, Golub said. BlackRock started branching out into more and more securities, but its risk management component, the flip-side of financial engineering, couldn’t afford to hire as many of the high-priced analysts and accountants necessary to do the job. It was either get much more volume or get out of the business, Golub concluded.
So at a certain point BlackRock began selling to its competitors the technology and software it had worked so hard to build, in the grand old tradition of making money on the side by selling pans to gold prospectors. (“The comeback was, just because you dump the equipment bag at the gate of any old team doesn’t mean they become the Yankees.”) And so BlackRock grew, acquisition after acquisition, managing to keep its skirts clean and at the same time doing better than the rest. Golub, with Conan Crum, draws some lessons in “Reflections on Buy-Side Risk Management After (or Between) the Storms” in the Spring 2010 issue of The Journal of Portfolio Management.
I don’t think this story is yet very widely understood. Things happened so quickly in 2008 that the new landscape will take years to become familiar. It’s easy enough to understand why a buyer’s agent can be a big help when looking for a house – especially in a time when caveat emptor has been freely translated to mean Anything Goes. The same principle applies to financial markets. As the dust settles from the crisis, it will become clear that the old Madisonian tactic – set factions to oppose factions – is producing some heartening results after all.