By Dawn Lim and Gregory Zuckerman
The Federal Reserve's giant program of corporate bond buying is about to kick in. It will hand a critical new role in propping the struggling economy to a business with increasing clout in the financial world: money management.
The central bank has tapped BlackRock Inc. to help it direct money into both new and already-issued corporate bonds, assisting the Fed in its recently adopted role as lender of last resort for businesses. The Fed is expected to launch the program in coming days.
The Fed also has given Pacific Investment Management Co., or Pimco, the job of helping it purchase commercial paper, or companies' short-term borrowings. That program is already up and running.
The two firms could eventually invest hundreds of billions of central-bank dollars.
Their role as agents of the Fed's intervention is the latest chapter in a decadelong shift in the financial power structure, with the largest asset managers gaining ground on Wall Street banks.
A few leading asset managers have become critical conduits for directing the money of individuals, pension plans and endowments into U.S. companies. BlackRock and Pimco are shareholders and debtholders in thousands of companies on behalf of funds they manage.
The shareholder votes they control and their role as creditors give them powerful levers. The two collectively manage more than $8 trillion, across markets from bonds to private equity.
They oversee money in exchange-traded funds and traditional mutual funds that are held mainly by individuals. The firms run all kinds of funds and managed accounts. In these, a client entrusts the money-management firm with cash that the firm invests in line with the mandate it's given, whether betting on individual companies, targeting certain industries or mirroring a market.
Although money-management firms played roles in the 2008 financial crisis, helping to handle toxic assets for the Fed, their remit in the new crisis is far bigger. They will be central players in what is expected to be a multitrillion-dollar overall program of central-bank support to the economy and markets, a program that will help decide which businesses survive the pandemic.
"Here's a chance for asset managers to show they could be powerful partners in the recovery," said Ben Phillips, a principal at Deloitte consulting arm Casey Quirk. "They're organizing capital, as opposed to using their own balance sheet, and can think longer term."
They are taking on new importance as the biggest investment firms have pushed back on the idea that their reach brings unintended risks for financial systems. Asset managers have successfully fought against the label as "systemically important financial institutions" and the regulations that come with it.
BlackRock will steer as much as $750 billion into the corporate debt market for the Fed.
"BlackRock is acting as a fiduciary to the Federal Reserve Bank of New York," a firm spokesman said in a written statement.
"BlackRock will execute this mandate at the sole discretion of the Bank, and in accordance with their detailed investment guidelines," he said, "in order to provide broad support to credit markets and achieve the government's objective of supporting access to credit for US employers and supporting the American economy."
Former government officials encouraged administration officials not to hire banks for the corporate-bond buying, said people familiar with the matter. They believed that money-management firms, by not being in the business of arranging debt offerings or maintaining an inventory of bonds for clients, would be best positioned to be impartial.
Also suiting them for the Fed operation, the biggest investment firms have experience managing central bank money, have systems to cordon off work for different clients, and can make informed purchases because they sit in the middle of a stream of information about buying and selling all kinds of securities, the former officials said.
In early March, when data signalled market strains a few weeks after the first U.S. coronavirus cases, Fed staffers examined the tools used in the 2008 crisis. They also laid the groundwork for potentially having the central bank act much more broadly.
Through March's extreme market volatility, Fed and government officials were on the phone with investors at BlackRock and Pimco as well as Goldman Sachs Group Inc.'s asset-management arm, JPMorgan Chase & Co.'s investment team and State Street Corp., said people familiar with the outreach. They consulted prominent investors such as Mohamed El-Erian, chief economic adviser to Pimco parent Allianz SE.
The officials tapped all kinds of networks to understand what was happening in the commercial paper market; the state of the "repo" market where firms borrow and lend cash and Treasurys; and how the bond market was doing. There was deep trouble in almost every corner of the bond world by mid-March. Junk bonds, investment-grade bonds, Treasurys -- all saw shortages of buyers.
During the week of March 15, a Fed official phoned Scott Simon, a former Pimco head of trading and portfolio management, for perspective. Mr. Simon advised the official to regard mortgage real-estate investment trusts as coal-mine canaries signaling danger. Mortgage REITs, which borrow and invest the proceeds in mortgages, and which rarely play a meaningful role in the overall economy, saw their share prices tumble.
Mr. Simon also pointed to an exchange-traded fund, BlackRock's iShares iBoxx $ Investment Grade Corporate Bond ETF, which was among a swath of bond ETFs trading at steep discounts to the values of the bonds inside them. He said the gap was a sign the bond market was frozen.
"If you don't fix" the market for top-rated bonds, "it will get away from you," he told the Fed official, according to a person close to the matter.
During one of the worst weeks in Wall Street history, BlackRock Chief Executive Laurence Fink went to Washington and huddled with President Trump as a pandemic with no equivalent in modern history roiled markets. Stocks fell more than 7% the day they met, March 18, and trading almost stopped in several bond markets, making it hard for corporations as well as cities to raise needed cash.
The Fed had said it would intervene substantially in money-market funds, and would shift its purchases of Treasury bills toward a broader range of maturities. Then on March 23 it unveiled sweeping measures. It said it would purchase all kinds of bonds, pledging to do whatever was needed to shore up the economy.
The Fed works with outside firms if it believes they bring speed and expertise the central bank can't provide on its own. Moving fast, it tapped BlackRock's financial markets advisory business to buy corporate bonds for it, without a tender process that would let others bid for the job.
That arm of BlackRock, separate from its money-management business, worked for the Fed in handling assets of American International Group Inc. and Bear Stearns Cos. after both collapsed early in the financial crisis.
The issue was who could get a program up and moving fast, said a former senior U.S. official who was an informal adviser to Treasury officials and other policy makers as they formulated plans.
The Fed first focused on the highest-rated companies, those least likely to default. It wrestled with a question: What about companies that would be highly rated except that coronavirus-related troubles had cut them to junk? Would it be right to leave them out? When the Fed said on April 9 it would buy fallen-angel bonds too, its word sparked a bond rally long before any Fed buying.
As part of its role, BlackRock would buy bond ETFs. Fed officials saw this as a way to buoy broad swaths of the market rapidly, said a person with knowledge of their thinking.
Rivals cried foul. Some economists and finance commentators voiced concern the Fed mandate would allow BlackRock to boost its own ETFs.
"If you're an asset manager working for the Fed, your own funds should be excluded from the purchases," said Nouriel Roubini, an economics professor at the New York University's Stern School of Business and chief executive of Roubini Macro Associates.
During a call with analysts April 16, BlackRock's Mr. Fink bristled at the suggestion the Fed mandate was a bailout for the ETF industry or his firm. "I think it's insulting," he said. "What we're doing with governments is based on great practices."
The Fed will use predetermined rules to guide its investments, to avoid picking winners and losers, said people familiar with the matter.
The central bank said in preliminary disclosures that BlackRock would assess its own ETFs on equal footing with those of competitors, and the firm won't charge fees on investing in any ETFs. BlackRock will credit income it could earn on the Fed program's holdings of the firm's ETFs back to the central bank. There would also be limits on how much of any one ETF could be bought.
That hasn't stopped investors from trying to get in ahead of the Fed. In April, traders rushed into corporate-bond ETFs, including the one Mr. Simon flagged. They briefly drove the ETF's price sharply above the bonds' value. The gap between its price and the net asset value of its underlying bonds has since narrowed.
The central bank gave Pimco a commercial-paper role similar to what it had in 2008, and disclosed no limit on total purchases of the short-term corporate debt. The Fed did give banks one job -- processing emergency loans for businesses. State Street will hold custody of assets for a number of Fed programs.
Other firms will be allowed to bid on BlackRock's and Pimco's work for the Fed as soon as this summer, said people familiar with the plans.
(MORE TO FOLLOW) Dow Jones Newswires