Sunday 16 December 2018

Master of the Universe

The root-and-branch report by the leading global investment manager has helped change the face of Irish banking forever

Larry Fink is one of the most powerful men in global finance and this week his firm BlackRock's report helped change the face of Irish banking forever.

All eyes this week were on the results of the stress tests on the Irish banks' loan books. The tests were carried out on behalf of the Central Bank by US investment and consulting firm BlackRock.

Unlike last July's stress tests, which were carried out by European Committee of Bank Supervisors and gave both AIB and Bank of Ireland a clean bill of health, BlackRock didn't pull its punches. It carried out a root-and-branch review of the Irish banks' loan books, which included processing the details of millions of individual loans through its powerful computer systems.

BlackRock's findings don't make for pleasant reading. It calculates that the Irish banks are looking at total losses of up to €40bn on their current loan books. Throw in the near-€60bn which the Irish banks, including Anglo and the Irish Nationwide, have already written off on bad loans and that brings the total to at least €100bn, almost a quarter of their peak end-2007 loan book of just over €400bn.

Just how unpalatable BlackRock's loan-loss projections, which cover the entire life of the loans, were was evidenced by the fact that the Central Bank also published its own, much lower, loan-loss projections for the period 2011 to 2013.

Loan losses

While BlackRock expects the Irish banks' loan losses to range from €27.5bn under its base scenario to €40bn under its stress scenario, the Central Bank is pencilling loan losses ranging from €20bn under its base scenario to €27.7bn under its stress scenario for the period to the three years to the end of 2013.

However, even after putting the best possible gloss on the numbers, the Central Bank has determined that the Irish banks will require an additional €24bn of fresh capital, with the original six banks shrinking to just two. This will bring the total cost to the taxpayer of bailing out the Irish banks to €70bn, making this country's banking collapse by far the most expensive in recorded financial history when measured as a proportion of our economic output.

The bad news from BlackRock didn't come cheap. While Central Bank governor Patrick Honohan refused to say how much the firm had been paid for its trawl through the entrails of the Irish banks' loan books, he did concede that the bill came to "tens of millions" of euro.

While paying a fortune for bad news is never a pleasant experience, the truth is that we didn't have any choice. After last July's fiasco, when the rapidly worsening problems of the Irish banks forced the Government to seek an EU/IMF bailout just four months later, the market was in no mood for another whitewash. Coming clean, no matter how awful the facts, was the only option.

When it comes to analysing the loan books of distressed banks no one has more experience than BlackRock. During the 2008 financial crisis it was the adviser of choice to the Federal Reserve and the US Treasury.

BlackRock advised the US Treasury on the disposal of the $30bn of toxic assets it took over following JP Morgan's purchase of near-bankrupt investment bank Bear Stearns in March 2008. Then in June of the same year insurance company AIG called in BlackRock to analyse its $77bn credit default swap portfolio.


This assignment positioned BlackRock right at the heart of the financial meltdown unleashed by the collapse of investment bank Lehman Brothers three months later.

After Lehman, doubts about the quality of the hundreds of billions of dollars of mortgage-backed securities created by Wall Street at the height of the US housing boom reached panic proportions.

Suddenly all eyes were on the credit default swaps, the instruments used by holders of mortgage-backed securities to insure their investments, that had been written by AIG.

After the US government effectively seized control of AIG in September 2008, BlackRock was kept on by Uncle Sam to advise it on what to do with the $100bn of assets, including the now infamous credit default swaps, it had taken over.

And the contracts from the feds just kept pouring in. BlackRock was also appointed to advise the US government on the mortgage portfolios of Fannie Mae and Freddie Mac, the mortgage giants that also had been virtually nationalised in September 2008.

With Fannie and Freddie having a combined balance sheet of $9 trillion this meant that when the $3.2tn directly managed by BlackRock is taken into account, the company is either directly or indirectly responsible for managing more than $12tn of assets. This makes BlackRock by far the largest fund management firm in the world.

BlackRock's success in securing government contracts inevitably aroused the jealousy of its competitors. However, Fink, the son of a Los Angeles shoe-shop owner is a lifelong Democrat, so political considerations were hardly a factor in winning contracts from a Republic administration.

What seems to have swung the business its way was the fact that with Goldman Sachs being the only major investment bank left standing and both the then Treasury Secretary Hank Paulson and his chief adviser Ken Wilson being former Goldman partners, it was inconceivable that Goldman would get the contracts.

This was even before it emerged that Goldman was the major beneficiary, to the tune of more than $20bn, of the disastrous credit default swaps written by AIG. While Paulson decreed that the swaps be paid in full, the resulting controversy rendered "Golden Sacks" toxic in Washington.

Adding further spice to this particular witches' brew is the fact that there is little love lost between BlackRock and Goldman. Unlike most investment banks, which also trade on their own behalf, BlackRock only trades on behalf of its clients. While it uses Goldman to execute trades on its behalf, it refuses to employ it for investment banking, ie advisory, purposes.

After graduating from UCLA with a bachelor's degree in political science and an MBA in real estate finance, the 23-year-old Fink joined First Boston as a bond trader in 1976. Over the following decade, he was one of the creators of securitisation, where pools of mortgages, car loans, credit-card receivables and other loans are sold to investors.

Then, after a decade of non-stop success, it all went terribly, horribly wrong. In 1986 he bet that interest rates would rise but they fell instead costing First Boston $100m.

Fink suddenly went from hero to zero and was forced out of the firm in 1988 with a First Boston spokesman helpfully telling the 'Wall Street Journal' that: "He (Fink) did not have the option of staying in his current job." Ouch!

Fink quickly learned from his mistake. He became obsessive about monitoring risk. Today BlackRock, the investment management firm he founded in 1993 after five years with rival investment manager Blackstone, uses more than 5,000 computers to constantly analyse risk.

The industry-leading expertise BlackRock developed in monitoring risk led to the creation of a separate subsidiary, BlackRock Solutions, to advise clients, including the Irish Central Bank, on their risk strategies.

By using BlackRock's services, the Irish Government has bought itself time to sort out the Irish banks. However, with the eurozone financial crisis showing no signs of easing, don't be surprised to see other single-currency countries employing BlackRock's expertise as they seek to reassure nervous investors.

Irish Independent

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