Oxstones Investment Club™By Sheelah Kolhatkar and Sree Vidya Bhaktavatsalam, BusinessWeek,
As chairman and chief executive officer of BlackRock (BLK), Larry Fink controls more money than Germany has GDP. BlackRock is the world’s biggest asset management firm, a $3.45 trillion powerhouse that’s the largest counterparty on Wall Street, on track to pay investment banks $1 billion in fees this year. It manages $1.4 trillion for state pension funds in New York, New Jersey, and California, among others, invests $240 billion for central banks and sovereign wealth funds such as the Abu Dhabi Investment Authority, and in the U.S. stock and bond markets, it’s responsible for a massive amount of trading volume each day. BlackRock serves as the U.S. Treasury Dept.’s go-to source for private sector financial expertise and managed at least $150 billion in toxic assets on behalf of U.S. taxpayers after the 2008 bailouts of American International Group (AIG) and Bear Stearns. While running the company is a team effort, Fink, 58, is BlackRock’s brain, and BlackRock, increasingly, is Wall Street’s.
“There’s no bank, no sovereign wealth fund, no insurance company that’s as large as BlackRock,” says Ralph Schlosstein, a co-founder who left in 2007 and is now CEO of investment bank Evercore Partners. “BlackRock today is one of, if not the, most influential financial institutions in the world.”
In light of all this, it’s surprising how few people beyond Wall Street are familiar with Larry Fink and BlackRock. Founded in 1988 as a bond trading shop, BlackRock has somehow reached financial omnipotence while remaining out of the public eye, escaping the scorn, and the acclaim, so often heaped on the nation’s premier investment bank, Goldman Sachs (GS). Although BlackRock competes with Goldman’s much smaller asset management unit, the two firms are fundamentally different because trading, not investing, makes up most of Goldman’s business, and Goldman is known as a place where executives achieve mind-boggling wealth. BlackRock is focused on the less lucrative work of investing money for individuals and institutions such as pension plans, endowments, and foundations through mutual funds, exchange-traded funds, and separately managed accounts. It makes most of its money through old-fashioned management fees rather than by taking positions for itself. On Wall Street, where boring is suddenly better, Fink is the newly minted nerd king.
Still, there are two things that Goldman has, or used to have, that Fink and his BlackRock co-founders—Rob Kapito, 53, Susan Wagner, 48, and Charles Hallac, 46—covet: a prestigious brand and a permanent spot in the public consciousness.
On an October afternoon, recognition is very much on Fink’s mind as he prepares to address his 8,900 worldwide employees in one of his quarterly “state of the state” pep talks. The atmosphere crackles inside the company’s seventh-floor conference room in Manhattan, where an oval table and a wall of monitors show live footage of BlackRock offices around the world, giving the place the feel of the White House’s situation room. One end of the table remains conspicuously empty until two young men in blue dress shirts sit down. “Dude,” jokes a third, seated on a bench against the wall, “you realize Larry’s gonna be sitting right there? Can you handle the pressure?” The two scramble into other chairs.
Moments later, Fink walks in with a slightly sheepish affect and takes his seat. “Good morning, everyone,” he says, holding a single sheet of paper. “I’m not here to tell you we’re perfect. We have problems, as all firms do.” He talks about BlackRock’s quarterly performance (“We grew by 9 percent”); the company’s recent, slightly troubled integration of Barclays Global Investors, the U.K.-based money manager BlackRock bought for $15.2 billion in 2009 (“It’s clear to me that we have a firm that’s more cohesive than ever”); and the current share price (“I think the market is dead wrong in terms of where our stock is trading”). The rhetoric is hardly soaring, but Fink exudes confidence. He tries to excite his audience with descriptions of the firm’s success and power and the need for all employees to try harder. “We have a giant responsibility,” he says. “We have to not just focus on $3.4 trillion of assets being managed, but who we’re managing for—maybe it’s your parents, maybe it’s a school teacher or a fireman. … We are connected to the entire world in what we do.”
Finally, Fink returns to one of his favorite themes, an issue that drives him and keeps him awake at night: the chronic underappreciation of his company. “We need to continue to build the BlackRock brand,” he says. “And, hopefully someday, your families will know what BlackRock is.”
As the financial crisis turned the Wall Street power structure on its head, BlackRock offered something valuable—the ability to analyze risk, especially bond risk, and mortgage bond risk in particular. The company had been collecting data on mortgages since 1994, when the market was much smaller than it is today. Suddenly, the possession of all this information made BlackRock important beyond its size. As bank executives and government officials woke up to the horror of toxic mortgage debt hiding in balance sheets around the world, BlackRock was one of the few entities that could actually figure out what the stuff was worth—and could do so without presenting a competitive threat. “Expertise would have been irrelevant without the trust,” says Terrence Keeley, a former managing director of UBS, which hired BlackRock to analyze a $22 billion portfolio of debt that it later sold to the firm. The company helped the Treasury Dept. and the Federal Reserve with the government-backed buyout of Bear Stearns by JPMorgan Chase (JPM) as well the bailouts of AIG, Citigroup (C), Fannie Mae (FNM), and Freddie Mac (FRE). BlackRock was also lucky, because asset management firms have barely been affected by the new post-crisis regulations that are causing terror across boardrooms.
While it made its share of mistakes before and after the crisis—including significant losses in funds that invest in real estate and mortgage-backed securities—the company has only gained power and prestige since 2007 and this year is expected to earn almost $2 billion on $4.7 billion of revenue. Last year, Fink was one of the highest-paid chief executives on post-bailout Wall Street, with $15.9 million in compensation, according to data from the Securities and Exchange Commission, while Goldman CEO Lloyd Blankfein got $862,657, down from $40.95 million in 2008.
One of the ways BlackRock became so huge—swamping its nearest competitors, State Street and Pimco—was by swallowing other companies. In 2004 it purchased State Street Research & Management (no relation to State Street) for $375 million from MetLife (MET); two years later it acquired Merrill Lynch’s investment unit for $9 billion, bringing its assets above the $1 trillion mark. In February, while BlackRock was digesting Barclays, it filed paperwork with the SEC reporting stakes of more than 5 percent in 1,800 companies, temporarily paralyzing the SEC’s electronic database.
As it expands its reach into equity and bond markets around the world, the company wants to introduce its own trading platform, which would help BlackRock match buy and sell orders to save money for clients, reducing its dependence on Wall Street brokers and cutting the fees it sends to them each year. BlackRock has also started a capital markets unit to help its customers invest directly in corporate debt offerings, which will allow it to negotiate better terms. “With $3 trillion-plus in assets, it’s safe to assume BlackRock can pull it off,” says Marc Irizarry, an analyst at Goldman Sachs.
Things haven’t been all daffodils, though, and recently BlackRock has been in the headlines for the wrong reasons: On Dec. 7, Massachusetts’ state pension fund pulled $1 billion from BlackRock, citing dissatisfaction with its performance and the departure of key executives. Investors withdrew $64 billion from the company’s funds in the first half of this year, and BlackRock’s shares have plummeted 26 percent.
There are those who say BlackRock, as with Goldman Sachs before it, has too much sway over the financial system. Others suggest that its ascent is part of an inevitable reshaping of Wall Street. “The balance of power has shifted generally to buyers as opposed to sellers, and people like BlackRock, who control large investment funds, will find themselves in a position of power,” says Peter Solomon, a former vice-chairman of Lehman Brothers who now runs his own investment bank, Peter J. Solomon Co. “What they do with that power would be worth noting. You see the White House calling them, and I can guarantee that they’re not totally passive with their influence.”
When BlackRock rearranged its offices earlier this year, expanding onto several additional floors on East 52nd Street, Fink decided not to radically redecorate his new space. “Same furniture, exactly the same maker,” he says, gesturing around the room and chuckling. No $2 million renovation? “No. I don’t believe in that.”
Perched on a cream-colored armchair in his office, Fink is a disarming presence. Leaning forward with elbows on knees, his face reacting to questions with cartoonishly exaggerated expressions, he’s less like a master of the universe than a master of the water cooler—albeit one who discourses on unemployment rates and the intricacies of quantitative easing. Despite his protestations, the surroundings are hardly shabby. In addition to the L-shaped desk sprinkled with family photos (he and his wife, Lori, have three children and live primarily in Manhattan, although they also own homes in North Salem, N.Y., an hour north of the city, and Aspen). There are potted orchids, shelves of books displayed like trophies, and paintings from Fink’s personal collection of American folk art on the walls.
Fink brushes off the Goldman Sachs comparison—”They’re in such a different business,” he says. “I don’t want to be in that business.” But the recent history and fates of the two companies are inextricable. BlackRock raised $126 million in an initial public offering, to little fanfare, in September 1999—the same year Goldman staged its own splashy $3.7 billion IPO. Eleven years later, BlackRock’s stock is up 1,110 percent, compared with a 200 percent increase in Goldman’s shares. Fink is a warmly received guest of politicians and policymakers in Washington, some of whom wouldn’t risk being caught chumming around with Blankfein.
“I think in some cases, people could be a little frightened of us,” Fink says. “Goldman Sachs is a great partner of BlackRock’s, and yet we compete bitterly against each other, too, in the asset management side. We use them as a counterparty, and we do a lot of trades with them.” But, he says, “we are very different. This is who we want to be.”
Proprietary trading helped banks rake in enormous gains during the stock market boom that peaked in October 2007. Fink believes that BlackRock shouldn’t use its balance sheet for anything but co-investments alongside investors, a distinctly un-Goldman-like strategy. He says he rejects the idea of expanding BlackRock’s reach by moving closer to an investment bank or securities firm approach—no need to be a coyote when you’re already a colossus. “Wall Street’s about velocity of money,” Fink says. “And as velocity of money became more and more important, relationships became less and less important, and as Wall Street started to realize they could make more money by ‘balance sheeting’ things, it became less client-centric. … I wanted to do something different, and that was being client-centric.” Every Wall Street firm insists that its customers come first—it is the first of Goldman Sachs’ “Business Principles”—but at BlackRock this is built into its structure as a money manager for client investors.
One consequence of BlackRock’s prominence is that, like Goldman Sachs, the firm has to work to avoid the perception of arrogance. As implementation of the financial reform bill is being worked out by various regulatory agencies in Washington, BlackRock, in what seems like an audacious move to some, has lobbied to be excluded from the definition of a “systemically important” firm to avoid more stringent regulatory oversight, arguing that it does not have balance sheet risk. “When you’re big enough, you do pose a systemic risk. Like Fannie and Freddie, their portfolios are so large, any move they make moves the market,” says Janet Tavakoli, a structured finance consultant and frequent critic of the company. “BlackRock can’t have it all ways, and so far they’ve escaped without so much as a whisper about their reputation, which right now isn’t looking too good from where I sit.”
BlackRock has also proven that it won’t be shy about confronting the world’s biggest financial institutions to defend its turf. In October the company was part of a group including Pimco and the New York Federal Reserve that sent a letter to Bank of America (BAC), then BlackRock’s biggest shareholder, seeking to force the bank to repurchase soured mortgages packaged by its Countrywide Financial unit into $47 billion of bonds. Bank of America reduced its stake in BlackRock from 34 percent to about 7.1 percent as federal regulators pushed it to improve its balance sheet. Fink refuses to discuss the demand letter, except to say that his firm has a duty to ensure that the securities purchased on behalf of BlackRock’s clients are what the bank claimed they were.
None of the controversy surrounding the company prevented it from effectively becoming an adjunct of the U.S. government. As the financial system creaked under the weight of toxic mortgage debt in 2007, Fink and other BlackRock executives became regular sounding boards for Timothy Geithner, then chairman of the Federal Reserve Bank of New York, and Federal Reserve Chairman Ben Bernanke. (Both have remained in regular contact with Fink, according to phone records made public by the agencies.) BlackRock’s first assignment came as the subprime mortgage collapse triggered withdrawals from a money-market fund managed by the Florida Local Government Investment Pool. BlackRock was chosen over JPMorganChase, Goldman Sachs, and Barclays (BCS) to salvage the fund by separating the good assets from those that couldn’t be sold, for a $125,000 fee.
As Bear Stearns fell apart in March 2008, JPMorgan Chase CEO Jamie Dimon had a BlackRock team of 50 analysts work through the weekend to evaluate Bear Stearns’ most illiquid assets. At the end of the weekend, Geithner called Fink to ask him to manage $30 billion in bad mortgage debt that had been carved out from Bear Stearns’ books before its healthier parts were sold to JPMorgan. BlackRock played a similar role with AIG, Fannie Mae, and Freddie Mac.
The fees that BlackRock earns from these assignments were disclosed last year after Senator Chuck Grassley (R-Iowa) and others expressed outrage over the lack of competitive bidding in the awarding of the government contracts and the potential for conflicts of interest. BlackRock is set to earn at least $120 million from the Fed over a three-year period. In July, Grassley reiterated questions about the dual role of BlackRock in advising the Federal Reserve and being one of the eight investment firms selected to buy assets under the Public-Private Investment Program. In a letter to Neil Barofsky, the special inspector general of the Troubled Asset Relief Program, Grassley asked the auditor about any findings the agency has made about potential conflicts of interest.
While BlackRock was advising the government on the value of some toxic assets, it and other firms such as Pimco were buying similar securities through their investment units. The company also drew $3.8 billion from the Fed’s Term Asset-Backed Securities Loan Facility, or TALF. The firm has repaid all but $221 million of the funds to the government. (BlackRock says it made use of the program, but only to give its fund clients the investment opportunity. It also says that its investment funds don’t have access to information that isn’t publicly available and that it has procedures in place to wall off its advisory and fund units.)
“If it were a calmer period, would there have been a better process? Maybe,” says Fink. “We were in these moments where four hours made a difference. I would like those people who criticize to have been there to witness what was going on at that time.” He adds: “This could be some of my hubris, but I believe we might have been the only firm that could have done it.”
BlackRock was born in 1988 out of a concept that’s obvious now but was somewhat novel at the time: Risk management is crucial. “I think we caught an idea before people recognized that it was an important idea,” Fink says. “We believe that fully understanding what you’re investing in is very important.” Asked where this lightning bolt came from, Fink laughs and says: “Losing money.”
Fink grew up in Van Nuys, Calif., the son of a shoe salesman and an English professor. He attended the University of California, Los Angeles business school before joining First Boston (now part of Credit Suisse), where he traded bonds in the 1980s. His work slicing and pooling mortgage bonds, then selling them to investors as securities called collateralized mortgage obligations, has today mushroomed into a $2 trillion market. Fink’s department became the most profitable at First Boston, and at age 31 he was made the youngest-ever managing director at the firm, as well as the youngest member of its executive committee. His rise ended abruptly in 1986, shortly after his 33rd birthday. During the first quarter, an investment he’d made had resulted in a $100 million profit; the following quarter, though, his division lost more than $100 million as interest rates fell unexpectedly. Fink says he became a pariah.
“I knew intellectually how much risk we were taking, but I didn’t have the tools to truly understand it,” he says. “We were loved when we made the hundred-plus million dollars the first quarter; they hated us when we lost $100 million. … We should have been fired for making all the money and not understanding how we were making it! It was a big lesson, at 33 years old.”
He left First Boston under a cloud less than two years later and started BlackRock with Schlosstein, a former Lehman trader. The firm began its life in the headquarters of its first financial backer, the Blackstone Group, which gave BlackRock a $5 million line of credit for a 40 percent stake. The fledgling firm’s mission was obscure but simple: to help investors understand the risks in their bond portfolios. “In April of 1988, people would say, ‘risk management for bonds?’ They looked at us like we were crazy,” says Wagner, who joined the firm at its inception and is now a BlackRock vice-chairman. “Today, that model has been validated.”
The firm accumulated about $20 billion in assets by 1994, but while business was picking up, the relationship between BlackRock and Blackstone became tense. Fink had a falling out with Blackstone co-founder Stephen Schwarzman that same year over BlackRock’s independence, resulting in the sale of BlackRock to PNC Financial Services Group of Pittsburgh for $240 million. The real breakthrough for the company came in 1995, when it helped General Electric value and dispose of a $10 billion portfolio of distressed mortgage securities, saving $1 billion for GE and establishing BlackRock’s reputation. By 2000, Fink saw a chance to build out the firm’s analytics into a separate business, called BlackRock Solutions. The unit offers a risk management system called Aladdin and now employs more than 800 people with degrees ranging from economics and engineering to mathematics and nuclear physics.
Aladdin can analyze stocks, bonds, and derivatives, though what makes it particularly valuable is the work it can do on mortgage-related bonds, the area that Fink helped develop in the 1980s. The system categorizes and assigns a value to each mortgage bond in an investor’s portfolio based on location, Zip Code, and dozens of other criteria, says Hallac, a co-founder and the head of BlackRock Solutions, which accounts for about 5 percent of the firm’s fees. On a green-and-white computer screen on his desk, he demonstrates what clients see when they log into the Aladdin system: the value that BlackRock has assigned to each individual security they’ve invested in, while modeling the value of the security for scenarios such as a repeat of the 2008 credit crisis, a falling U.S. dollar, or the breakout of an Asian flu pandemic. As the financial crisis worked its way through the system, Aladdin was a big reason why BlackRock was summoned by governments and financial institutions around the world.
By 2008, BlackRock was in a fortunate position: It had started moving away from the riskiest bonds two years before and came through the worst market since the Great Depression without posting a loss, although not all of its investors fared as well. The firm managed to squeeze out a profit of $54 million in the last quarter of 2008, as the collapse of Lehman Brothers and the ensuing market paralysis shocked Wall Street. This put the company in a good position to pounce on Barclays, a deal that was hatched by Fink lieutenant Kapito at a Yankees game. Goldman Sachs, meanwhile, lost $2.1 billion in the last three months of 2008, its first-ever quarterly loss. The investment bank also accepted $10 billion in bailout funds from the U.S. government that year.
BlackRock isn’t immune to outside forces. Investors in the preferred shares of its closed-end funds saw their investments frozen as the auction-rate market collapsed in 2008. Some distressed debt strategies, created before the market meltdown, sank millions of dollars into loans that continued to lose value as markets tanked. And for all its expertise in evaluating fixed-income assets, BlackRock’s own long-term track record in the area has been mediocre. In the three years ended Sept. 30, funds representing only 55 percent of BlackRock’s fixed-income assets had beaten their respective benchmarks.
“BlackRock had a bit of a stumble in their bond funds in 2008, as there was a failure to anticipate that the global unwind would take out everything except government bonds,” says Eric Jacobson, a Morningstar fund analyst in Chicago. “I think the lesson they and many others learned is that ultimately, despite a good risk-management system, it’s the quality of active management that will carry you to the next step.”
Critics such as Tavakoli also argue that BlackRock’s dismal performance as a manager of certain collateralized debt obligations (CDOs) during the height of the real estate bubble raises questions about whether the company should be trusted with massive amounts of government assets. According to Tavakoli’s research, several deals worth billions overall that BlackRock put together went bust; problems in the mortgage market were already evident, and financial institutions were scrambling to keep the securitization money train running by executing deals that were sure to fail. “When I look at their track record with CDOs, I think there were gravely serious questions,” she says. “They’re too close to the problem to merit getting any no-bid [government] contracts.”
In response, BlackRock says that, “given the magnitude of the Great Recession and the corresponding collapse in real estate markets, we are disappointed with the return experience of CDOs with real estate exposure.” The company had about $9.6 billion in CDO assets as of Sept. 30 of this year. Fink says he thinks the government will end up making money on the toxic AIG and Bear Stearns assets BlackRock managed.
In one of the company’s most public humiliations, it also lost money in Stuyvesant Town-Peter Cooper Village, a Manhattan apartment complex acquired by in 2006 by BlackRock’s real estate unit and Tishman Speyer Properties. One of BlackRock’s investors, the California state pension fund, lost $500 million on the deal, prompting Fink to personally apologize to CalPERS’ board. “For the clients for whom we made mistakes, we’re guilty,” Fink says. “It still gnaws at me that we failed them.”
Back in his office, Fink is less than dire about the future of the teachers and firefighters whose causes he likes to publicly champion. “I’m much more constructive than the consensus,” he says, “I never felt the economy was going to have this V shape; I always talked about the swoosh economy. And that’s what it is. It’s still the Nike swoosh economy. At the end of the swoosh it goes up. It’s just a longer swoosh part, and that’s where we are.”
How far he rides that swoosh is a question of increasing importance, and the subject of much speculation. Fink acknowledges that the time is coming when he won’t run BlackRock anymore. He aspires to someday enter public service if the right opportunity presents itself, though he isn’t specific about what that opportunity might be. As he ruminates on the future, he jumps up to fetch a blue binder from his bookshelf. “We do a 360 review of every leader,” he says, opening the book. “This is really intense stuff.”
He starts to read an anonymous comment contributed by another BlackRock executive: “Overall, I’d give Larry a 96 out of 100,” he begins. Then, “I worry about Larry. I love that he’s client focused, but one day he’s going to keel over. In flying all around the world, he insists on taking commercial transportation. We should probably get him a plane.”
Kolhatkar is features editor for Bloomberg Businessweek. Bhaktavatsalam is a reporter for Bloomberg News.
Tags: Blackrock, client focused, great ideas, Great Minds, Larry Fink, money management, mortgage bonds valuation, portfolio analytics, risk management