While the stock market was swooning on Monday, Henry Paulson’s Treasury Department issued a series of press releases detailing how it will choose asset managers to carry out the $700 billion purchase of “troubled” securities. Any thought that this process would be open to a wide range of participants was shattered by Treasury’s requirement that any applicant already be involved in managing at least $100 billion in dollar-denominated fixed-income assets.
This means that the bailout will be handled exclusively by a small number of firms that are already major players in the money management business. It also means that it is almost inevitable that these firms will have conflicts of interest while working for the feds.
We can identify the tiny universe of these players by looking at a list compiled by Institutional Investor magazine. It shows that as of the end of 2007, there were two dozen firms that managed $100 billion or more in the domestic fixed-income segment. Here are the top ten:
- Allianz Global Investors of America (parent of Pimco) – $424.5 billion
- BlackRock – $423.2 billion
- Legg Mason – $328.2 billion
- Prudential Financial – $245.7 billion
- Vanguard Group – $239.4 billion
- Fidelity Investments – $183.1 billion
- Goldman Sachs Group – $180.0 billion
- Franklin Resources – $158.4 billion
- MetLife – $158.1 billion
- Bank of New York Mellon Corp. – $155.0
The buzz in the financial world is that Pimco and BlackRock have already submitted applications (the deadline was yesterday) and are likely to be chosen. They are among the firms on the list with the biggest potential conflicts of interest.
Pimco has been an aggressive investor in mortgage-backed securities (MBS) over the past year. In September 2007 it announced the creation of a whole fund devoted to distressed debt. In May 2008 it bought a $2.55 billion MBS portfolio from Israel’s Bank Hapoalim. In August 2008 Pimco was reported to be increasing its distressed-debt portfolio by $5 billion. BlackRock purchased a $15 billion portfolio of subprime mortgage securities from UBS last May.
Pimco and BlackRock are not the only fixed-income money managers heavily exposed to MBS and subprime investments. Legg Mason, for example, posted its first quarterly loss ($255 million) in 25 years earlier this year. The deficit came about after it was forced to pump nearly $2 billion into its money market funds to cover MBS-related losses. Legg Mason’s Western Asset Management (WAMCO) unit made some bad MBS bets, prompting several pension funds to terminate its services.
Whether they’ve done well or poorly in their MBS investments for private clients, these money managers should not have the federal bailout put in their hands. They could use their position either to try to make up for their losses or maximize returns from the distressed debt they purchased at bargain-basement prices.
Treasury has announced interim conflict-of-interest guidelines that would not exclude firms such as these from participating in the bailout. More likely is that they would simply disclose their conflicts and then be given a green light to proceed. Whether they end up doing more to benefit their public client or their private ones is an open question.