One article provides insight into BlackRock’s history of success: How was the king of asset management made?

Source: Mansa Finance  Editor: lenaxin, ChainCatcher

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

BlackRock's rise began with the 2008 financial crisis. At that time, Bear Stearns fell into 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 Mae's $5 trillion balance sheet. Over the next decade, BlackRock 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. Fink's 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 creating the financial giant BlackRock, his experience can be called a wonderful financial epic.

From Genius to Loser - The Early Experience of Larry Fink, Founder of BlackRock

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 20 years, accounting for one-third of the total population of the United States. The baby boom generation was keen on investing in stocks and real estate and consuming in advance, which caused the lowest personal savings rate in the United States to drop to 0-1% per year."

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

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 claims in the bank and sold them to investors in small pieces, which meant that the bank could quickly recover funds and use them to issue new loans.

The result was that the bank's lending capacity was dramatically amplified, and this product immediately attracted the investment of many long-term capitals such as insurance companies and pension funds, causing mortgage interest rates to drop significantly. 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 securities (also known as mortgage-backed bonds), but MBS is still not sophisticated enough. This model is equivalent to cutting the pie into pieces without distinction and dividing the cash flow equally, like a pot of stew. It cannot meet the differentiated needs of investors.

Design and Risks of CMO (Collateralized Mortgage Owned Securities)

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 is added to the principal and compounded until the principal of the first three levels of bonds is fully repaid, and then the income of the Z-level bonds will be paid. The risk and return are linked from A to Z. This product that separates the repayment schedule step by step and meets the differentiated needs of different investors is the so-called CMO (collateralized mortgage obligation).

It can be said that Ranieri is the one who opened Pandora's box, and Fink opened the box in 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 world's financial history. At that 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 world's top investment bank. He led a Jewish team 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 Fink's journey to the peak that collapsed.

Black Monday and the painful lesson of $100 million

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

In the CMO issuance, Fink's team had a large backlog of unsold Z bonds, which became a 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, Fink's team had been shorting long-term government bonds to hedge risks, and on October 19, 1987, the famous Black Monday in history occurred again - the stock market crash, with the Dow Jones Industrial Index plummeting 22.6% in one day. A large number of investors rushed into the Treasury market for risk aversion, causing Treasury prices to soar 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 Fink's sky has collapsed. 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 on his own initiative.

Larry Fink's glory and failure in First Boston

Fink is used to living under the spotlight and knows that Wall Street's love for success far outweighs humility. This well-known humiliation will be unforgettable for him. In fact, one of the reasons why Fink worked hard to issue CMO was that he hoped that First Boston could become the number one institution in the field of mortgage bonds. For this, he had to compete with Ranieri, who represented Salomon Brothers, for market share.

When Fink first graduated from UCLA, he first 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 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 crux of the problem. Although Fink's team also established a risk management system that year, calculating risks with the level of computers in the 1980s was like using an abacus to calculate big data.

The Birth of the Aladdin System and the Rise of BlackRock

The Founding of BlackRock

In 1988, just a few days after leaving First Boston, Fink organized an elite group to his home to discuss his new business. His goal was to build an unprecedentedly powerful risk management system, because he would never allow himself to fall into a situation where he could not assess risks again.

This elite group personally selected by Fink included four of his colleagues at First Boston. Robert Capito has always been Fink's loyal comrade-in-arms; Barbara Novick is a strong-minded 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 Carter's domestic policy adviser, from Lehman, and Thorstein brought Susan Wadner, who was once the deputy director of Lehman's 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, and Fink called Schwarzman of Blackstone Group. 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, Blackstone's main business was leveraged buyouts, but opportunities to conduct leveraged buyouts were not always available. So Blackstone was also looking for diversified development. Stephen Schwarzman was very interested in Fink's team, but it was well known that Fink had lost $100 million in First Boston. Stephen Schwarzman had to call his friend, Bruce Wasserstein, the head of First Boston's mergers and acquisitions business, to ask for his opinion. Wasserstein told Stephen Schwarzman, "To this day, Larry Fink is still the most talented person on Wall Street."

Schwarzman immediately issued a $5 million credit line and $150,000 in start-up capital for Fink, and a department called Blackstone Financial Management Group was established under the Blackstone Group. Fink's 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. Fink's team repaid all loans shortly after opening. And within a year, the fund management scale was expanded to US$2.7 billion.

Development of the Aladdin System

The key reason for the rapid rise was a computer system they built, which was later named "Asset Liability and Debt & Derivative Investment Network". The five key initials of its core functions are combined to form the English name: Aladdin, which is a metaphor for the mythological image of Aladdin's magic lamp in "One Thousand and One Nights", implying that the system can provide investors with wisdom and insight like a magic lamp.

The first version was coded on a $20,000 bit system workstation and placed between the refrigerator and coffee machine in the office. This system, which uses modern technology as risk management technology and replaces traders' experience judgment with massive information calculation models, is undoubtedly at the forefront of the times. The success of Fink's team is equivalent to winning the jackpot for Blackstone's Su Shimin. But the equity relationship between them also began to break.

Parting ways with Blackstone Group

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

Business Weekly joked: "Su Shiyi's income was just enough to make up for the divorce compensation to Allen." Many years later, Su Shiyi recalled the 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 Fink's dilution of Blackstone's shares was more like intentional.

The origin of the name BlackRock

After the Fink team became independent from Blackstone, it needed a new name. Su Shiyi asked Fink to avoid the two 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 split complemented each other, so he was going 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.

After that, BlackRock's asset management scale gradually climbed to 165 billion US dollars in the late 1990s. Their asset risk control system is increasingly relied on by many financial giants.

BlackRock's rapid expansion and technological advantages

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

In 2006, a significant event occurred on Wall Street. Merrill Lynch President Stanley O'Neal decided to sell Merrill Lynch's huge asset management department. Larry Fink immediately realized that this was a once-in-a-lifetime opportunity, so he invited O'Neal 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's name is still BlackRock, and its asset management scale soared to nearly $1 trillion overnight.

An important reason for BlackRock's 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 can't know vegetables better than the vegetable sellers. BlackRock uses the Aladdin system to manage investments for customers, allowing you to judge the quality and price of a cabbage more professionally than the vegetable sellers.

The Savior of the Financial Crisis

BlackRock's 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 a desperate situation and filed for bankruptcy in the federal court. Bear Stearns' trading partners were all over the world. If Bear Stearns collapsed, it would most likely cause a systemic collapse.

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

JP Morgan Chase proposed a takeover bid of $2 per share, which almost caused the board of directors of Bear Stearns to revolt on the spot. You know, Bear Stearns' stock price reached $159 in 2007. The price of $2 is simply an insult to this 85-year-old old giant, and JP Morgan Chase also has their concerns. It is said that Bear Stearns still holds a large number of "illiquid mortgage assets". The so-called "illiquid mortgage assets" are simply bombs in the eyes of JP Morgan Chase.

The parties involved in the action soon realized that this acquisition was extremely complicated and there were two problems that needed to be solved urgently. The first was the valuation problem, and the second was the problem of toxic asset divestiture. All 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 an office in the trading hall of Bear Stearns. You will find the story very dramatic here. You should know that Larry Fink, who took the center stage as a fire captain, is the absolute godfather of the field of housing mortgage securities. 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. The name of BlackRock became more and more famous. The three major rating agencies in the United States, S&P, Moody's, and Fitch, once awarded AAA ratings to more than 90% of subprime mortgage securities, and their reputation was ruined in the subprime mortgage crisis. It can be said that the valuation system of the entire US financial market collapsed at that time, and BlackRock, which has a powerful analysis system, became an irreplaceable executor in the US rescue plan.

Bear Stearns, AIG and the Fed's rescue

In September 2008, the Fed launched another rescue 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, 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 without 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.

CDS was used by this group of market gamblers as a gambling tool. At that time, the scale of subprime mortgage bonds was about 7 trillion, but the CDS that guaranteed 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 the problem of Bear Stearns was a bomb, then the problem of AIG was a nuclear bomb. The Federal Reserve had to authorize $85 billion to urgently acquire AIG by purchasing 79% of its 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 also authorized by the Federal Reserve to operate the rescue of Citigroup and supervise the $5 trillion balance sheet of the two housing agencies. 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 jokingly called the underground Treasury Secretary of the United States. BlackRock has gone from a relatively pure financial enterprise to a political and business one.

The birth of a global capital giant

Acquisition of Barclays Asset Management and the dominant position in the ETF market

In 2009, BlackRock ushered in another major opportunity. The famous British investment bank Barclays Group fell into operational difficulties and reached an agreement with private equity company 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 alone, it is better to merge all the asset businesses of the Barclays Group with BlackRock as a whole."

In the end, BlackRock included Barclays Asset Management in its territory at a price of US$13.5 billion. This transaction is considered to be the most strategically significant merger and acquisition in the history of BlackRock's development, because iShares, which is under the jurisdiction of Barclays Asset Management, was the world's largest issuer of exchange-traded open-end index funds at that time.

Exchange-traded open-end 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, taking iShares into its 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 of the sector or index constituent stocks, so BlackRock holds a wide range of shares in large global listed companies, and most of their clients are large institutions such as pension funds and sovereign funds.

BlackRock's 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 the three giants 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 amount of assets actually 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 Federal Reserve's 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 don't like Larry Fink, if he leaves BlackRock, it would be like Ferguson leaving Manchester United." Today, BlackRock's asset management scale has exceeded 115 trillion U.S. dollars. Larry Fink's wandering between the political and business circles has daunted Wall Street. This double orange color confirms his deep understanding of the industry.

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