The Role of BlackRock in the Financial Crisis

During the historic year that has been 2008, many of the largest financial institutions in the United States have fallen victim to the financial crisis that has hit the American economy. Other than financial troubles that have resulted in bailouts by the federal government, purchases by other companies, or filings for bankruptcy, what links companies such as AIG, Lehman Brothers, Merrill Lynch, Fannie Mae, and Freddie Mac? The answer is BlackRock. During the historic year that has been 2008, many of the largest financial institutions in the United States have fallen victim to the financial crisis that has hit the American economy. Other than financial troubles that have resulted in bailouts by the federal government, purchases by other companies, or filings for bankruptcy, what links companies such as AIG, Lehman Brothers, Merrill Lynch, Fannie Mae, and Freddie Mac? The answer is BlackRock. As the turmoil and upheavals in the financial industry continue, BlackRock sits right in the middle of the whole crisis.

What is BlackRock? BlackRock (BLK) is a major American investment management company that manages more than $1 trillion in assets through mutual funds, pension funds, 401(k) plans, and other investment vehicles. Founded in 1988 as the Financial Management Group within the private equity firm Blackstone Group, it was separated into an independent company in 1992 under the name BlackRock by Larry Fink, the current CEO of the company. BlackRock was purchased by PNC Financial in 1995 and four years later, in 1999, the firm went public. In recent years, BlackRock has undergone significant growth through various mergers and acquisitions. These transactions include the purchase of mutual fund business State Street Research Management from MetLife in 2005, a merger with Merrill Lynch Investment Managers in 2006, and the acquisition of fund-of-funds company Quellos Capital Management in 2007. Today, the New York City-headquartered BlackRock employs around 6,000 employees and operates 35 offices in 18 countries.

As credit-ratings agencies such as Moody’s and Standard & Poor’s have lost credibility during this credit crunch, BlackRock is well regarded in the industry for its ability to examine a financial institution’s balance sheets and provide an accurate valuation. For instance, BlackRock recently worked with UBS to help the Swiss giant unload a $20 billion portfolio of mortgage-backed securities. In fact, Treasury Secretary Hank Paulsen tabbed BlackRock as a candidate to manage the Troubled Asset Relief Program (TARP), part of the $700 billion bank bailout package. Whether a client survives or not, BlackRock receives payment in the form of a pre-negotiated flat fee. Nevertheless, in these unprecedented times, the survival of one of its clients is regarded as a win for BlackRock.

Ironically, CEO and Chairman Larry Fink’s career is closely intertwined with collateralized mortgage obligations (CMO), which along with other asset-backed securities, have been one of the major impetuses for the current financial crisis. A CMO is a type of mortgage-backed security in which a pool of bonds is divided into different components, or tranches. The tranches each have their own risk characteristics and maturity ranges; thus, repayments from the securities are used to retire bonds in a specified order. For instance, in a CMO with A, B, and C tranches, investors in class A are paid off first, then investors in class B, and finally, investors in class C. Working as a bond trader at First Boston in 1983, Fink sold his first mortgage-backed security to Freddie Mac to help the company unload $1 billion in mortgages. In the ensuing years, Fink became a rising star at First Boston for his expertise in CMOs during their nascent years. As mortgages grew into a multi-trillion dollar industry, dangerous side effects began to arise: the distance between the original borrowers and the investors of the mortgage-backed securities grew wider and wider, so the Wall Street firms trading the securities became less and less aware of whether the loans would actually be paid off by the original borrowers.

Luckily for BlackRock, due to Fink’s expertise in mortgages and his understanding of their hidden dangers, the company was prepared for the mortgage crisis last year. BlackRock Solutions, an in-house team created to help troubled companies analyze their portfolios, was founded in 2000; in 2006, as the current crisis was about to hit, the company began advising credits to unload mortgage-backed securities. The analytical capabilities of BlackRock are enormous; with 2,000 computers lined up row after row and an army of analysts that includes physicists, nuclear engineers, electrical engineers, economists, MBAs, and accountants, BlackRock Solutions runs millions of risk models a day to help answer the million dollar question for many companies these days: How much money is the collapse of the debt markets going to cost our company?

BlackRock itself has not been immune to the current economical crisis, however. When Merrill Lynch, which owned a 49% stake in BlackRock, was bought by Bank of America, Bank of America then became the new largest shareholder in BlackRock. On November 17th, 2008, BlackRock notified its employees that job cuts would soon be made in order to reduce expenses in the current market environment. In a memo to employees, BlackRock stated, “Expense policies and business practices will be tightened. However, it was not possible to reduce costs and achieve re-engineering efficiencies to the extent necessary without considering cuts in staffing. Some positions across the firm will be eliminated.” This follows in the footsteps of other leading money managers, such as Fidelity Investments, Janus Capital Group, Legg Mason Inc., and Putnam Investments, that have also recently announced headcount reductions. At the end of September, BlackRock had $1.26 trillion in assets under management, down from $1.43 trillion at the end of June. At the same time, the stock price of BlackRock is down 40% for the year.

In the end, what separates BlackRock from other firms is not that it can analyze risk; many companies can run risk models. BlackRock distinguishes itself from other firm in that on one hand, it is not an investment bank, so it does not trade for itself and compete with its clients and yet, on the other hand, it offers such a broad range of services that it dwarfs most other independent risk-assessment companies. Thus, in this current whirlwind of economic turmoil, BlackRock sits well-positioned to help analyze and provide solutions to the deepening troubles of the economy. With no clear end in sight, it is a safe bet that going forward, BlackRock will continue to be a key player in helping to bring the U.S. economy out of its current troubles.