BlackRock’s Rise: How did it become the king of asset management with a value of $11.5 trillion?

Orijinal source: Mansa Finance

Edited by: lenaxin, ChainCatcher

BlackRocks capital tentacles have penetrated more than 3,000 listed companies around the world, from Apple, Xiaomi to BYD and Meituan, and its shareholder list covers core areas such as the Internet, new energy, and consumption. While we use food delivery apps or subscribe to funds, this financial giant that manages $11.5 trillion in assets is quietly reshaping the modern economic order.

BlackRocks rise began with the 2008 financial crisis. At that time, Bear Stearns was in a liquidity crisis due to 750,000 derivative contracts (ABS, MBS, CDO, etc.), and the Federal Reserve urgently commissioned BlackRock to evaluate and dispose of its toxic assets. Founder Larry Fink led the liquidation of Bear Stearns, AIG, Citigroup and other institutions with the Aladdin system (risk analysis algorithm platform), and monitored Fannie Maes $5 trillion balance sheet. Over the next decade, BlackRock has built a capital network across more than 100 countries through strategies such as acquiring Barclays Asset Management and leading the expansion of the ETF market.

To truly understand the rise of BlackRock, we need to go back to the early experiences of its founder Larry Fink. Finks story is full of drama, from a genius financial innovator to falling to the bottom due to a failure, to getting back on his feet and eventually building the financial giant BlackRock. His experience can be called a wonderful financial epic.

From Genius to Failure: The Early Years of Larry Fink, Founder of BlackRock

The post-war baby boom and real estate boom in the United States

After the end of World War II, a large number of soldiers returned to the United States. Nearly 80 million babies were born in the past 20 years, accounting for one-third of the total U.S. population. The baby boomers were keen on investing in stocks and real estate and consuming in advance, which caused the U.S. personal savings rate to drop to the lowest level of 0-1% per year.

Back in the 1970s, the post-war baby boomers in the United States gradually entered the age group of over 25, triggering an unprecedented real estate boom. In the initial mortgage market, banks entered a long repayment cycle after lending. The banks ability to lend again was limited by the repayment situation of the borrower. This simple operating mechanism was far from meeting the rapidly growing loan demand.

The invention and impact of MBS (mortgage-backed securities)

Lewis Ranieri, vice chairman of Salomon Brothers, a famous Wall Street investment bank, designed a groundbreaking product. He packaged together thousands of mortgage debts held by banks and sold them to investors in small pieces, which meant that banks could quickly recover funds and use them to issue new loans.

As a result, the banks lending capacity was greatly amplified, and this product immediately attracted the investment of many long-term capitals such as insurance companies and pension funds, which greatly reduced the mortgage interest rate. At the same time, it solved the needs of both the financing and investment sides. This is the so-called MBS (Mortgage Backed Securities) mortgage-backed bonds (also known as: mortgage-backed bonds). However, MBS is still not sophisticated enough. This is equivalent to cutting the pie into pieces indiscriminately and dividing the cash flow equally, like a pot of stew. It cannot meet the differentiated needs of investors.

The Design and Risks of CMOs (Collateralized Mortgage Obligations)

In the 1980s, a rising star who was more creative than Ranieri appeared in the First Boston Investment Bank: Larry Fink. If MBS is a pie that is equally divided, then Larry Fink added a process. He first cut the pie into four layers of thin pancakes. When repayment occurs, the principal of Class A bonds is repaid first, followed by the principal of Class B bonds, and then the principal of Class C bonds. The most imaginative is the fourth layer, which is not the principal of Class D bonds, but the principal of Class Z bonds (Z-Bond). Before the repayment of the first three classes of bonds, Class Z bonds will not even have interest, but will only be recorded but not paid.

The interest will be added to the principal and compounded until the principal of the first three bonds is fully repaid. Only then will the income from the Z bonds begin to be paid. The risk and return of AZ are linked. This product, which separates the repayment schedule into levels to meet the differentiated needs of different investors, is the so-called CMO (collateralized mortgage obligation).

It can be said that Ranieri was the one who opened Pandoras box, and Fink opened the box within the box. At the beginning of the invention of MBS and CMO, Ranieri and Fink could not have anticipated how drastically these two products would affect the worlds financial history. At the time, the financial community only regarded them as genius creations. At the age of 31, Fink became the youngest partner in the history of First Boston, the worlds top investment bank. He led a team of Jews known as Little Israel. A business magazine listed him as the top five young financial leaders on Wall Street. Once CMO was launched, it was widely sought after by the market and created huge profits for First Boston. Everyone thought that Fink would soon be promoted to the head of the company, but it was precisely the last step of Finks journey to the top that led to a collapse.

Black Monday and the $100 million lesson

Both MBS and CMO face a very thorny problem. When interest rates rise sharply, the repayment period will be extended, which will lock in investment and miss high-interest financial management opportunities. When interest rates fall sharply, the early repayment trend will cut off cash flow. Whether interest rates rise sharply or fall sharply, it will have a negative impact on investors. This phenomenon of being blocked at both ends is the so-called negative convexity, and Z bonds further amplify this negative convexity. Longer duration is very sensitive to interest rate changes. From 1984 to 1986, the Federal Reserve cut interest rates continuously, reducing 563 BP (basis points) in two years, and finally created the largest drop in 40 years. A large number of borrowers chose to replace new contracts with lower interest rates, resulting in an unprecedented repayment wave in the mortgage market.

In the CMO issuance, Finks team had a large backlog of unsold Z bonds, which became the crater that was about to erupt. These Z bonds were originally priced at around $150, but after recalculation, they were only worth $105, which was enough to destroy the entire mortgage securities department of First Boston Bank.

Even worse, Finks team had been shorting long-term government bonds to hedge risks, and on October 19, 1987, the famous Black Monday occurred again – the stock market crash, with the Dow Jones Industrial Average plummeting 22.6% in one day. A large number of investors flocked to the government bond market for risk aversion, causing the price of government bonds to soar by 10 points in one day. Under this double blow, First Boston eventually lost $100 million. The media once praised, The sky is the limit for Larry Fink. But now, Larry Finks sky has collapsed. His colleagues no longer talk to Fink, and the company does not allow him to participate in any important business. This subtle expulsion method eventually made Fink resign voluntarily.

Larry Finks Triumph and Failure at First Boston

Fink was used to living under the spotlight and understood that Wall Streets love for success far outweighed humility. This well-known humiliation was unforgettable for him. In fact, one of the reasons why Fink worked so hard to issue CMO was that he hoped First Boston could become the number one institution in the mortgage bond field. To do this, he had to compete with Ranieri, who represented Salomon Brothers, for market share.

When Fink first graduated from UCLA, he applied for a job at Goldman Sachs. He was rejected in the final round of interviews. It was First Boston that accepted him when he was most eager for an opportunity, and it was First Boston that taught him the most realistic lesson on Wall Street. Almost all media outlets later reported on this incident, saying arbitrarily: Fink failed because of the wrong bet on interest rate increases. But later, an eyewitness who had worked with Fink at First Boston pointed out the key to the problem. Although Finks team also established a risk management system, calculating risks with the level of computers in the 1980s was like using an abacus to calculate big data.

The Birth of Aladdin System and the Rise of BlackRock

The creation of BlackRock

In 1988, just days after leaving First Boston, Fink convened a select group at his home to discuss his new venture. His goal was to build the most powerful risk management system ever created, because he would never allow himself to be in a situation where he could not assess risk again.

This elite group personally selected by Fink included four of his colleagues at First Boston. Robert Capito has always been Finks loyal comrade-in-arms; Barbara Novick is a smart portfolio manager; Bennett Grubb is a mathematical genius; Keith Anderson is a top securities analyst. In addition, Fink poached his good friend Ralph Thorstein, who was President Carters domestic policy adviser, from Lehman. Thorstein brought in Susan Wadner, who was once the deputy director of Lehmans mortgage department. Finally, Hugh Frater, executive vice president of Pittsburgh National Bank, joined. These eight people were later recognized as the eight co-founders of BlackRock.

At that time, what they needed most was a start-up capital, so Fink called Blackstone Groups Stephen Schwarzman. Blackstone is a private equity firm co-founded by former U.S. Secretary of Commerce (former Lehman CEO) Peterson and his colleague Stephen Schwarzman. In 1988, when corporate mergers and acquisitions were booming, Blackstones main business was leveraged buyouts, but opportunities to conduct leveraged buyouts were not always available. So Blackstone was also looking for diversified development, and Stephen Schwarzman was very interested in Finks team, but it was well known that Fink had lost $100 million at First Boston. Stephen Schwarzman had to call his friend, Bruce Wasserstein, the head of First Bostons mergers and acquisitions business, for his opinion. Wasserstein told Stephen Schwarzman, To this day, Larry Fink is still the most talented person on Wall Street.

Schwarzman immediately issued Fink a $5 million credit line and $150,000 in start-up capital, and a division called Blackstone Financial Management Group was established under the Blackstone Group. Finks team and Blackstone each held 50% of the shares. Initially, they did not even have an independent workplace and could only rent a small space in the trading hall of Bear Stearns. However, the situation developed far beyond expectations, and Finks team repaid all the loans shortly after opening. And within a year, the fund management scale was expanded to $2.7 billion.

Development of Aladdin system

The key reason for their rapid rise was a computer system they built, which was later named the asset liability and debt derivative investment network. The five key initials of its core functions are combined to form the English word Aladdin, which is a metaphor for the mythical image of Aladdins magic lamp in One Thousand and One Nights, implying that the system can provide investors with wise insights like a magic lamp.

The first version was coded on a $20,000 bit system workstation, placed between the refrigerator and coffee machine in the office. This system, which used modern technology as risk management technology and replaced traders experience judgment with massive information calculation models, was undoubtedly ahead of its time. The success of Finks team was like winning the jackpot for Blackstones Su Shiyi. But the equity relationship between them also began to break down.

Parting ways with Blackstone

As the business scale expanded rapidly, Fink recruited more talents and insisted on allocating shares to new employees. This caused Blackstones shares to be diluted quickly, from 50% to 35%. Su Shiyi told Fink that Blackstone could not transfer shares endlessly. In the end, Blackstone sold its shares to Pittsburgh National Bank for $240 million in 1994, and Su Shiyi personally cashed out $25 million, just as he was divorcing his wife Ellen.

Business Week joked: Su Shiyis profit was just enough to make up for the divorce compensation to Allen. Many years later, Su Shiyi recalled his breakup with Fink and thought that he did not make 25 million but lost 4 billion US dollars. The reality was that he had no choice. In fact, looking back at the logic of the whole thing, you will find that Finks dilution of Blackstones shares seemed more like intentional.

Origin of the name BlackRock

After Finks team became independent from Blackstone, they needed a new name. Su Shiyi asked Fink to avoid the words black and stone. But Fink proposed a slightly humorous idea to Su Shiyi, saying that the development of J.P. Morgan and Morgan Stanley after the separation complement each other, so he plans to use the name Black Rock to pay tribute to Blackstone. Su Shiyi agreed to this request with a smile, and this is the origin of the name BlackRock.

Since then, BlackRocks asset management scale has gradually climbed to US$165 billion in the late 1990s. Their asset risk control system is increasingly relied upon by many financial giants.

BlackRock鈥檚 rapid expansion and technological advantages

In 1999, BlackRock was listed on the New York Stock Değişme. The leap in financing capabilities enabled BlackRock to rapidly expand its scale through direct mergers and acquisitions. This was the starting point for the transformation from a regional asset management company to a global giant.

In 2006, a significant event happened on Wall Street. Stanley ONeal, president of Merrill Lynch, decided to sell Merrill Lynchs huge asset management department. Larry Fink immediately realized that this was a once-in-a-lifetime opportunity, so he invited ONeal to a restaurant on the Upper East Side for breakfast. The two talked for only 15 minutes and signed the merger framework with the menu. BlackRock eventually merged with Merrill Lynch Asset Management through an equity swap. The new company was still named BlackRock, and its asset management scale soared to nearly $1 trillion overnight.

One of the important reasons for BlackRocks incredible rapid rise in the first 20 years is that they solved the problem of information imbalance between buyers and sellers. In traditional investment transactions, buyers obtain information almost entirely from the marketing of sellers, and investment bankers, analysts, and traders who belong to the seller camp monopolize core capabilities such as asset pricing. This is like going to the market to buy vegetables. We cant know more about vegetables than the vegetable sellers. BlackRock uses the Aladdin system to manage investments for customers, so that you can judge the quality and price of a cabbage more professionally than the vegetable sellers.

The savior of the financial crisis

BlackRocks key role in the 2008 financial crisis

In the spring of 2008, the United States was in the most dangerous moment of the worst economic crisis since the Great Depression in the 1930s. Bear Stearns, the fifth largest investment bank in the United States, was in dire straits and filed for bankruptcy in federal court. Bear Stearns trading partners were all over the world, and if Bear Stearns collapsed, it would most likely cause a systemic collapse.

The Federal Reserve held an emergency meeting and at 9 a.m. that day, it formulated an unprecedented plan, authorizing the Federal Reserve Bank of New York to provide JPMorgan Chase with a special loan of US$30 billion to directly acquire and custodian Bear Stearns.

JPMorgan Chase offered a $2 per share acquisition price, which almost caused the Bear Stearns board of directors to revolt on the spot. Bear Stearns stock price had reached $159 in 2007. The $2 price was an insult to this 85-year-old old giant, and JPMorgan Chase also had their concerns. It was said that Bear Stearns still held a large number of illiquid mortgage assets. The so-called illiquid mortgage assets were simply bombs in the eyes of JPMorgan Chase.

All parties involved in the operation soon realized that this acquisition was extremely complicated and that there were two issues that needed to be resolved urgently. The first was the valuation issue, and the second was the issue of toxic asset divestiture. All of Wall Street knew who to find. Geithner, president of the Federal Reserve Bank of New York, found Larry Fink. After obtaining authorization from the Federal Reserve Bank of New York, BlackRock entered Bear Stearns to carry out a comprehensive liquidation.

They worked here 20 years ago, renting offices in the trading hall of Bear Stearns. The story gets very dramatic here. Larry Fink, who took the center stage as a firefighter, is the absolute godfather of the housing mortgage securities industry. He himself is one of the initiators of the subprime mortgage crisis.

With the assistance of BlackRock, JPMorgan Chase completed the acquisition of Bear Stearns at a price of about $10 per share, and the well-known name of Bear Stearns was declared dead. However, the name of BlackRock became more and more famous. The three major US rating agencies, SP, Moodys, and Fitch, had awarded AAA ratings to more than 90% of subprime mortgage securities, and their reputation was ruined during the subprime mortgage crisis. It can be said that the valuation system of the entire US financial market collapsed at that time, and BlackRock, with its powerful analysis system, became an irreplaceable executor in the US rescue plan.

Bear Stearns, AIG, and the Feds rescue

In September 2008, the Fed started another bailout plan with a more severe situation. The stock price of AIG, the largest insurance company in the United States, fell by 79% in the first three quarters, mainly because the $527 billion credit default swaps they issued were on the verge of collapse. Credit default swaps, referred to as CDS (Credit Default Swap), are essentially an insurance policy. If a bond defaults, the CDS will pay for it. But the problem is that buying CDS does not require you to hold a bond contract. This is equivalent to a large group of people who do not have cars being able to buy unlimited car damage insurance. If a car worth 100,000 yuan has a problem, the insurance company may have to pay 1 million yuan.

CDS was used by these market gamblers as a gambling tool. At that time, the scale of subprime mortgage bonds was about 7 trillion, but the CDS guaranteeing the bonds was as high as tens of trillions. At that time, the annual GDP of the United States was only 13 trillion. The Federal Reserve soon discovered that if Bear Stearns problem was a bomb, then AIGs problem was a nuclear bomb.

The Federal Reserve had to authorize $85 billion to urgently buy 79% of AIGs shares. In a sense, AIG was turned into a state-owned enterprise. BlackRock once again obtained special authorization to conduct a comprehensive valuation and liquidation of AIG and became the executive director of the Federal Reserve.

With the efforts of many parties, the crisis was finally contained. During the subprime mortgage crisis, BlackRock was authorized by the Federal Reserve to operate the rescue of Citigroup and supervise the $5 trillion balance sheet of Fannie and Freddie. Larry Fink is recognized as the new generation of the king of Wall Street. He has established close ties with US Treasury Secretary Paulson and New York Federal Reserve President Geithner.

Geithner later succeeded Paulson as the new Treasury Secretary, and Larry Fink was nicknamed the underground Treasury Secretary of the United States. BlackRock has transformed from a relatively pure financial enterprise to a political and business enterprise.

The birth of a global capital giant

Acquisition of Barclays Asset Management and Dominance in the ETF Pazar

In 2009, BlackRock had another major opportunity. The famous British investment bank Barclays Group, which was in operational difficulties, reached an agreement with private equity firm CVC to sell its iShares fund business. The deal had already been reached, but it included a 45-day bidding clause. BlackRock lobbied Barclays, saying: Instead of selling iShares separately, it is better to merge all of Barclays Groups asset businesses with BlackRock as a whole.

In the end, BlackRock acquired Barclays Asset Management for $13.5 billion. This transaction is considered to be the most strategically significant merger and acquisition in the history of BlackRock, because iShares, which was under Barclays Asset Management, was the worlds largest issuer of exchange-traded open-end index funds at the time.

Exchange-traded index funds have a more concise name: ETF (Exchange-Traded Fund). Since the bursting of the Internet bubble, the concept of passive investment has accelerated its popularity, and the scale of global ETFs has gradually exceeded 15 trillion, which has brought iShares into the pocket. BlackRock once occupied 40% of the US ETF market share. The huge amount of funds determines that assets must be widely allocated to diversify risks.

On the one hand, it is active investment, and on the other hand, it is passive tracking through products such as ETFs and index funds. It is necessary to hold all or most of the company shares in the sector or index components. Therefore, BlackRock holds extensive shares in large global listed companies, and most of their clients are large institutions such as pension funds and sovereign funds.

BlackRock鈥檚 influence in corporate governance

Although in theory, BlackRock only manages assets for clients, it has a very strong influence in actual implementation. For example, in the shareholders meetings of Microsoft and Apple, BlackRock has repeatedly exercised its voting rights and participated in the voting of major issues. If you count the large companies that account for 90% of the total market value of US listed companies, you will find that BlackRock, Vanguard, and State Street are either the largest or second largest shareholders in these companies, and the total market value of these companies is about 45 trillion US dollars, far exceeding the US GDP.

This phenomenon of highly concentrated equity is unprecedented in the history of the global economy. In addition, asset management companies such as Vanguard are also renting the Aladdin system provided by BlackRock, so the actual amount of assets managed by the Aladdin system is more than 10 trillion US dollars more than the amount of assets managed by BlackRock.

The Light Bearer of Capital Order

In 2020, during another market crisis, the Federal Reserve expanded its balance sheet by 3 trillion to rescue the market. BlackRock once again served as the Feds royal steward, taking over the corporate bond purchase plan. Many BlackRock executives left and joined the U.S. Treasury and the Federal Reserve. After leaving the U.S. Treasury and Federal Reserve officials, they worked at BlackRock. This revolving door phenomenon of frequent two-way flow of political and business personnel has aroused very strong public doubts. A BlackRock employee once commented, Although I dont like Larry Fink, if he leaves BlackRock, it would be like Ferguson leaving Manchester United. Today, BlackRocks asset management scale has exceeded 115 trillion U.S. dollars. Larry Finks wandering between the political and business circles has daunted Wall Street. This double orange confirms his deep understanding of the industry.

The real financial power lies not in the trading hall, but in the grasp of the nature of risk. When the trio of technology, capital and power sound, BlackRock has transformed from an asset manager to a lamplighter of capital order.

This article is sourced from the internet: BlackRock’s Rise: How did it become the king of asset management with a value of $11.5 trillion?

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