BlackRock Is Bailing Out Its ETFs with Fed Money and Taxpayers Eating Losses
wallstreetonparade.com
wallstreetonparade.com
Since BlackRock is allowed to buy up its own ETFs, this
means that taxpayers will be eating losses that might
otherwise accrue to billionaire Larry Fink’s company and
investors
BlackRock has also said they will be waiving the ETF fund management fee.
Broadly speaking? Ok well what happens to the AUM when the market goes up or down? More or less AUM. More or less money no?
Am I missing something? Wouldn't they have a ton to lose during these times?
> Today, BlackRock has been selected in more no-bid contracts to be the sole buyer of corporate bonds and corporate bond ETFs for the Fed’s unprecedented $750 billion corporate bond buying program which will include both investment grade and junk-rated bonds.
Seems like a nice setup. Especially now.
A critical distinction though is that the Fed isn't buying BlackRock's bonds. They are buying bonds that are represented in BlackRock's exchange traded funds that are meant to mirror prices of real bonds.
You're not wrong that it's a sweet set up. It's better to be in BlackRock's place. It is better to be buying coronovirus bonds for the government rather than selling them to the government. The latter implies your company is under severe cash flow pressure.
You shouldn't be distrustful of BlackRock because they maximize their revenue when they maximize their AUM. If they maximize their AUM, that probably means that your income is maximized as well.
Blackrock is the largest asset manager in the world. They manage $7.4 trillion. They're also one of the biggest providers of low cost index funds for retail investors.
There's nothing nefarious about them running the Thrift Savings Plan. It's basically a 401K program for federal government workers (the public sector's equivalent, anyway). It's a really good program with great expense ratios and plenty of passive index funds. The idea that they'd be using employee funds to manipulate the stock market through future purchases is ludicrous.
What exactly is "not fully understood" about Blackrock's role in the "outlandish valuations" of Apple and Microsoft? Blackrock is the #2 shareholder in each, after Vanguard, and owns 6.3% and 6.8% respectively. Much of that is in index funds like the iShares S&P 500 ETF or the Russell 1000 Growth ETF.
I don't know what the original post's argument was on this but you could make an argument that the growth of passive investing largely caused by Blackrock and Vanguard has led to stretched valuations in a lot things. The mere fact that these companies make it easier and cheaper to invest means there's more money floating around chasing fewer and fewer shares given less public companies since Sarbanes-Oxley and the rapid growth of PE/M&A.
Your argument is a more reasonable one to consider. I hear it sometimes (especially from underperforming active managers), but I haven't seen much evidence of it.
It's a seductive line of reasoning -- that passive funds are dumb money that buy at any price and therefore let stocks run up to unreasonable levels.
You could also take the other side of it though -- that active managers get caught up in manic buying that causes bubbles, but passive index funds are price insensitive and hold stocks forever, so they let companies focus on long-term growth.
I think there is probably a point where too much passive investing might make markets less efficient, but we're not close to that yet. There are still a lot of active funds out there. It was only last year that passive reached 50% of US equities. It's also probably self-correcting -- if markets become less efficient at price discovery, it gives active managers more opportunities to find undervalued stocks and generate more wealth, which will encourage more active management.
In practice I think they're just another type of investor. It's not like that source of demand disappears without passive funds. If retail investors weren't putting their money in passive funds they'd be putting them in old school active funds like they used to do.
The decline in the number of public companies in the 21st century is a whole other can of worms. Smaller companies just don't go public as much anymore. I don't think you can attribute it to passive investing though. I think most of it has to do with two factors: (1) it is more expensive to be a public company today due to increased disclosure and compliance costs, as you stated, but more importantly (2) the market for private funding has matured with the growth in VC, PE, and private lending so companies can stay private longer.
Additionally it’s important to look at how the ETFs work. I believe the ETFs in question here are LQD and HYG for investment grade and high yield respectively. These ETFs track the iboxx indicies for IG and HY. Even if the Fed is buying BlackRocks ETF, this bolsters the prices of the individual bonds, which then moves indices higher, thereby also moving up other provider’s ETFs along with the entire fixed income market. Given this is the case, one should pick the most liquid ETF for each asset class (Ideally all ETFs should be purchased weighted by the NAV or trading volume of each ETF), in that case it would be BlackRocks for US fixed income.
The Fed has also said that they don't want to influence market share of ETFs so that's been interpreted as some sort of benchmark per manager. I believe Blackrock was around 50% of qualifying ETFs outstanding at the time. The Fed published purchases to date last week which has a pretty decent breakdown: https://www.federalreserve.gov/monetarypolicy/files/smccf-tr...
Also, the Fed has not purchased a single corporate bond yet so the "majority of the money" has gone to ETF purchases so far; the vast majority of the facility's capital is currently sitting in Treasuries.
The mere announcement of investment grade ETF purchases re-opened the primary markets without the Fed spending a penny. High yield primary markets were completely shut for a week before the Fed said that they would purchase fallen angel bonds and HY ETFs. The whole purpose of these facilities is to make sure funding markets function properly and ensure that companies that would have been fine without the pandemic will be fine now; not bail out distressed companies that are going to go out business anyway.
I don't even know what you're talking about with bank failures on this. The Volcker Rule really gutted bank prop trading and banks barely have any of this stuff on their balance sheets. It's a big portion of the reason why there was a massive lack of liquidity during the first quarter of the year.
They’re supporting lending. Not lending per se. The term of art is transmission mechanism, if you want to read on this further.
Buying through ETFs lets the Fed support loan and bond prices, which encourages lending. Put another way, a dollar lent to a corporate produced $1 of lending. A dollar spent boosting prices can support more than $1 in lending.
ETFs are simply an efficient way to do this. (Equity markets are more efficient than the corporate bond markets. ETFs offer equity-like execution for bond-like risk.)
BlackRock is just the administrator, and derives no benefit beyond their management fees. The direct benefit is to the sellers of the constituent bonds (whether individually or as part of the ETF), who get a higher price. There's also indirect benefit to the non-selling owners of the bonds, since that stops the price from dropping to the point they'd get a margin call and be forced to sell. That indirect benefit is the primary goal of this program, to avoid forced, cascading, 2008-style deleveraging. The Fed isn't trying to directly support the issuers (though the issuers do benefit from functioning capital markets, if they do choose to raise more money at this time).
The $75B allocated for losses is just an accounting placeholder; they don't know what the losses or gains will be. Historically these kinds of programs have often ended up net profitable, though that's not that point.
The Fed also is absolutely trying to directly support issuers through these facilities and ETF purchases are an important part of this. Primary issuance is dictated by where secondary markets are trading and if some of the most liquid corp instruments (ETFs) are trading extremely wide or at a huge discount to NAV (like they were before these facilities were announced) then primary issuance will either be much more expensive or completely closed.
Operationally, it’s much more difficult to get the bond purchases rolling because they have to get individual issuer certifications before making any purchases. This is a restriction created by Congress and had it not been in place, they would be buying bonds right now. They are likely going to make some modifications to the facility in order to streamline this process because it’s preventing them from achieving the main goal of it: buying bonds.
The certifications are an interesting additional detail that I wasn't aware of. So if I understand correctly, the program wrote one set of rules for purchases of individual bonds, and then a different set of rules for purchases of ETFs. It allocated more money for individual bonds, but the Fed discovered that those rules meant that no issuers wanted to participate. So the Fed instead purchased ETFs.
I think I'd still say that makes the ETFs more convenient? Certainly that's true under those rules; and to the extent those different rules exist for good reason (e.g., because with a diversified and liquid index, it's easier to avoid both the appearance of political favor and the actual thing), that seems fundamentally true too. So I don't see what that changes in my initial statement, though it's interesting that it happened "by accident" instead of by design.
Yes, thank you for pointing out.
> The certifications are an interesting additional detail that I wasn't aware of. So if I understand correctly, the program wrote one set of rules for purchases of individual bonds, and then a different set of rules for purchases of ETFs. It allocated more money for individual bonds, but the Fed discovered that those rules meant that no issuers wanted to participate. So the Fed instead purchased ETFs.
The rules were not spelled out at the time of the announcement; including the part on personal certification by the issuer. If you look to the ECB corporate program for example, they do not require issuer certification and that was seen as a model for the operations of this.
Without getting too deep into things, Congress wanted to make sure that US companies benefited from this and that's part of the certification process. Additionally, certification requires attesting that the issuer has not received money under the CARES act and while it's not been publicly stated, it's suspected that's one of the reasons why personal issuer certification is required.
While all of this was evolving, PPP launched and there was a lot of backlash on large corporations receiving money. Between the logistics of having individual issuers certify and issuers being reluctant to certify, the bond purchase portion of the program has been stalled.
So yes, the Fed made its first corporate facility purchases through ETFs as a result of all of this but also took two months to do so. If the main goal of the facility was to buy ETFs and they really wanted to get it done, they could get that up and running within a week max if not sooner.
> I think I'd still say that makes the ETFs more convenient? Certainly that's true under those rules; and to the extent those different rules exist for good reason (e.g., because with a diversified and liquid index, it's easier to avoid both the appearance of political favor and the actual thing), that seems fundamentally true too. So I don't see what that changes in my initial statement, though it's interesting that it happened "by accident" instead of by design.
I take issue with saying that they're making ETF purchases because they're more liquid and convenient for a few reasons. One of the main reasons is that only reason why they're buying them right now is because it's the only thing they're actually able to buy. Liquidity and convenience really mean nothing when you only have a single option.
As far as avoiding anything with politics, there was no consideration given for that when the facilities were announced and I doubt there is any now. They changed purchase eligibility retroactively to include fallen angels and the cutoff date magically included Ford while excluded several sizable issuers by a day or two. It's also very tough to hand out favors through bond purchases in a way that would materially affect funding costs for a specific issuer AND have it slip under the radar. While that doesn't escape the appearance of political favors, I would argue that by selecting Blackrock as the investment manager they really don't care about the appearance of politics. In fact, by selecting Blackrock, it shows that their primary goal was bonds rather than ETFs as you can easily find an investment manager to manage a few billion in ETFs; it's much harder to find one that can manage few hundred billion in bonds.
For example, is it just an inconsistency that issuers need to attest that they didn't receive money under the CARES act if their bonds are purchased directly, but not if they're purchased as part of an ETF? Or does that make sense, since it's politically acceptable to support a diversified index, but not to support a specific company that already received other government help? I like the latter choice because it's satisfying and logical, though I understand that the reality is hazier.
I do agree that buying ETFs is "cleaner" for all sorts of reasons. The certification process for bonds vs ETFs is slightly inconsistent but given that they're not going to participate in the create/redeem process, I don't have too much an issue with it. If they were buying ETFs, redeeming them, and then actively managing the bonds from there, then it would be a little more murky. Besides the fallen angel ETFs, none of the ETFs they've bought so far (and everything that qualifies as well) does not have any real issuer concentration that you could argue tremendously favors any particular issuer beyond reflecting the actual bond market.
To further expand on the overall topic, if all the Fed did was buy ETFs, there's a real risk that would not be enough. During any crisis, in order to be effective, central banks need to make big moves. To use a crude metaphor, individual bullets fired separately don't have nearly as much impact as a single bazooka round and sometimes you only have a chance for one shot. Bond markets aren't as efficient as equities and without secondary purchases, there could have been a real chance that you had ETFs more or less stabilized but several underlying issuer/sectors/whatever aggregate group continue to be dislocated. For another crude metaphor, sometimes the tail (ETFs) wags the dog on this stuff and vice versa. In order to have functioning markets, you need complete control over the entire animal which would be primary issuance, secondary bonds, and one of the more liquid proxies.
If the Fed buys individual bonds, then they have to decide the relative amounts that they're going to support each subgroup, which seems a lot more politically fraught to me. I understand the idea that if the Fed sees what they perceive as panic selling in a particular sector then they can intervene just there and get more effect per dollar spent, but that judgment seems a lot more controversial the narrower the group benefiting gets.
Liquidity and convenience in the markets means I can trade in size with tight bid/ask and possibly don’t need to deal with a scumbag dealer on the phone/chat. Operationally to me means there is something that prevents me from trading at all.
If no one wants to sell to the Fed, why do they need a certification? Also they're buying ETFs of bonds, are you saying this is materially different than buying the actual bonds?
If there is something preventing you from making trades it means you have lower liquidity.
I believe my original comment more or less correctly describes the operation of the program, and the reason for that operation. That operation wasn't actually the intent of the program, though, just the consequence of rules that didn't work like the drafters expected.
It seems like you think the Fed's failure is that they don't buy individual bonds. Why would the Fed prefer to buy individual bonds? The Fed buys individual bonds. It buys government debt and people hate them for it.
So it makes sense to me that they're buying ETFs. whatok pointed out that the Fed didn't originally set out to buy mostly (or exclusively) ETFs, but rather to buy mostly individual bonds--it's just that the individual-bonds program turned out to be too complicated to actually use, so they ended up buying all ETFs. I thought that was a good clarification, and an interesting lesson on the complexity of modern finance (that even the creators of the program failed to predict how it would actually work).
I'm not sure what to say to someone who hates the Fed for buying government debt, beyond that they've grossly misunderstood how a central bank works. I'd guess they also hate both the individual corporate bonds and the ETFs, so I'm not sure what your point is there?
I don't understand your first question. The certification process covers both primary and secondary purchases. The Fed's terms for primary purchases are pretty punitive and most issuers that qualify for it would easily be able to raise in syndicated markets. Markets are open right now so this does not present an issue.
The problem is the Fed is also unable to make secondary purchases unless issuers go through the certification process. The main purpose of the SMCCF is to buy secondary corporate bonds and they're unable to move on that because of the certification process.
Issuers would love to sell to the Fed but your understanding is only a small reason why none have certified yet. A lot has changed since these facilities were announced and there was extreme backlash against larger corporations taking advantage of PPP. There's a similar fear attached to this.
> Also they're buying ETFs of bonds, are you saying this is materially different than buying the actual bonds?
Yes, there absolutely is a material difference for the purposes of this facility and in actual trading. For the purposes of this facility, there are still many sectors/subsectors trading pretty wide to pre-covid levels. If you believe that these bond purchases facilitate the Fed's mandate of maximum employment, then targeting specific sectors that are having funding pressures would be one of accomplishing that.
> If there is something preventing you from making trades it means you have lower liquidity.
That's a really bizarre definition of liquidity for the context of this; especially when you're talking about the Fed. The discussion was on ETFs being more liquid than the underlying bonds. Something preventing me from trading does not mean that the thing being traded is illiquid. For example, there are many securities that require an ISDA to trade and offer way more liquidity than other similar options.
Of course... Everyone with poor debt quality would LOVE to sell to the Fed...
One of the big lessons of ETFs the past year has been whether the underlying "fake" liquidity of ETFs would cause problems for the underlying real poor liquidity of bonds. The Fed is buying ETFs because the price of the ETF goes into the underlying bonds. The Fed is buying bonds. They think it's close enough to buying the bonds.
It's really bizarre to me that you think a poor definition of liquidity is that you personally cannot sell bonds. I don't care if the market is bad or your phone is too broken to make your sell order. Complain to your boss that the market was fine but you couldn't make the trade. See what they say. You cannot trade. Your liquidity is bad.
Why would this be weird? A basket of securities is more diverse which spreads out your risk. Therefore, it makes sense that, in general, it would be more liquid.
Though I agree that long-term, smart investors will prefer to own a diversified product because of that lower risk. So it does make sense that whatever diversified product they choose becomes more liquid than its constituents, just for the small number of winners they coordinate on (thanks to better marketing, lower fees, better deals with market makers, etc.) and not all ETFs with comparable risk profile.
As far as primary issuance goes, the same issuer registration process is in play. There are pretty punitive funding fees vs where syndicated bond issuance is right now so there's little incentive for issuers to participate in it as well.
Primary corporate markets are very wide open and have been ever since they announced these facilities. Investment grade issuance is at over $1trn on the year and have been very concentrated in the last few months. The Fed has bought around $6bn in ETFs so far which is really nothing in the grand scheme of things. The main effect these facilities have had so far is restore market confidence.
in this case, its highly effective
Step 1: Fed conjurs D dollars into existence
Step 2: Fed trades D dollars for a stack of paper
Step 3: Fed trades paper stack for (1-r)D dollars
The net effect is the Fed giving away rD dollars. If the Federal government gives away any dollars, it is taxpayers footing the bill.
And this has more detail, from an earlier article [1]
Senator Pat Toomey of Pennsylvania asked Quarles to clarify if the taxpayers’ money ($454 billion handed over by the Treasury to the Fed, which will then be used as equity in Special Purpose Vehicles set up by the Fed and leveraged up to $4.54 trillion to make loans and purchases of toxic assets on Wall Street banks’ balance sheets), is in fact going to be used to absorb losses on what the Fed is taking off the balance sheets on Wall Street. Quarles responded as follows:
“The Treasury has the fiduciary responsibility, if you will, to the Congress for the use of the funds that are appropriated to it. So I wouldn’t want to speak for them as to how that equity should be handled. But it is true that in the construction of the 13(3) facilities [Fed’s emergency programs] that use Treasury equity, the Treasury equity is there to insure the Fed, which statutorily cannot take losses, has to be sure that it won’t, is there to insure that that cushion exists for the funding portion of the facility.”
Fed Chairman Jerome Powell has already admitted that the $454 billion is to be used to absorb losses that it anticipates it will take.
[1] https://wallstreetonparade.com/2020/05/wall-street-banks-pai...
Does this not imply exactly that, the taxpayers will be eating the losses?
The Fed is buying bonds at market prices and getting paid interest - the only way they'd lose money is if the bond market as a whole loses money / is overvalued, and specifically is overvalued by more than the interest rate.
Since 2008, we're desensitized to this level of intervention.
What will come of it? Who knows? But at least some recognize the risk in such uncharted territory.
“Socialising of this risk is fraught with moral hazard” - Daniel Loeb
“Today’s trading levels of stocks and bonds reflect ‘thumb on the scale’ valuations driven by persistent and massive government asset purchases and zero percent (or lower!) short-term policy rates, as well as an essentially unlimited tolerance for risk." - Paul Singer
And the other side of this is the fact that without any action, the economy will collapse further than it already has, and taxpayers certainly won't be in the black if that happens.
I didn't say they are eating losses, I said they are on the hook.
Give me $1000 from your bank account. Given my recent performance, I can generate some decent return.
What do you say?
> the economy will collapse further than it already has
With all due respect, this is my larger issue.
You're not necessarily wrong.
But we have no political imagination or will to think beyond what is forced down our throats. Either the Federal Reserve saves us all or we are doomed.
>But we have no political imagination or will to think beyond what is forced down our throats. Either the Federal Reserve saves us all or we are doomed.
I wouldn't view it as saving. The Fed's job is to stabilize prices and employment. If you think a different part of the government should be responsible for that, or if you think we shouldn't stabilize it at all (but then how much money should be printed? Should we abolish monetary policy completely?), then make that argument. But don't criticise the Fed for trying to do its job of ensuring price stability. When something happens that significantly decreases inflation, then the Fed responds by printing more money. It's not somehow "neutral" if the Fed were to ignore that and allow prices to drop.
> But don't criticise the Fed for trying to do its job of ensuring price stability.
By your own analysis, you're missing something here.
How's the Fed doing with that mandate?
You don't think there's room for criticism?
Critiques that they're doing too much fall completely flat, for me.
Unprecedented levels of Fed intervention hasn't prevented 41 million (and counting) new unemployment filings in just a few months.
This obsessive focus on propping up financial markets without more direct support for Main St is what I mean about lack of political imagination or will.
Congress passed extra unemployment insurance plus other payroll support. The Fed shouldn't duplicate that.
> Fed policy should be to enable full employment after the lockdowns are fully lifted, not now.
This is out of touch. The lockdowns are already lifting and as we will see, you don’t just bring back 41+ million jobs at the drop of a hat.
As long as prices (read: stock and bond markets) are stabilized, many of us don’t care.
Well as I already said above, the Fed isn't doing enough. They aren't stabilizing prices. If they were, the economic recovery would be much quicker.
Also, prices is not the same as stock and bonds. The Fed is perfectly fine with stock or bond drops, as long as they don't cause prices to drop. Stocks dropped over 20% in one day in 1987, but we avoided a recession because the Fed ensured prices remained stable.
The Fed has a dual mandate; employment promotion and inflation management. To the extent that the tools they have, which are limited, are insufficient to adequately promote employment while managing inflation, doing more for employment is what Congress and it's broader power of fiscal poki g setting is for.
Admittedly, Congress—most specifically the Senate—is asleep at the switch, but that's not the Fed’s fault.
It absolutely is the Fed's fault. We are still paying for the sins of the GFC and Fed policy has enabled Congressional dysfunction. Without extremely accommodative Fed policy for the past 10+ years, Congress would be forced to do their job.
But if Congress doesn't want to do it's job, even if the Fed were completely negligent, you have to conclude they would only do enough to relieve the pressure to roughly the point where things are now, if they were even competent enough to not screw that up.
If you want to blame someone other than Congress for Congress's nonfeasance (and “Congress” in the sense includes the President, who plays both a formal and informal role in legislation), maybe blame the people that choose and retain the nonfeasant officers, rather than the Fed for doing its job well enough in the face of the nonfeasance elsewhere that the wheels don't come completely off.
I for one would not like the entire country to descend into violence and madness. I'm willing to pile on debt to avoid anarchy.
The government is the lender of last resort because they can print new money to dilute old money. That's a high risk high reward lending scenario.
In some trivial sense, sure, but not really; by pouring tons of money into these funds, it is moving the market price. Real market prices are below the levels propped up by the Fed.
The logic here is armchair economics 101: supply and demand. The Fed is propping up demand.
You also need to distinguish between the expectations channel and the purchase channel. The Fed announcing it's going to pump money into the economy decreases expectations of a severe ongoing recession, which reduces the probability of default, which raises bond prices.
Translation: "You plebes just don't understand."
Typical Fed policy apologia.
If we are entering a new type of economy (which we have been since 2008), and the Fed is no longer worried about having an ever expanding balance sheet, then we are entering modern money theory territory, which is scary to me because we completely lack the oversight needed.
https://nathantankus.substack.com/
I'd start with the series "The Federal Reserve's Coronavirus Crisis Actions, Explained"
https://nathantankus.substack.com/p/the-federal-reserves-cor...
Come on HN. Surely there are better sources that share these opinions.
From the about page:
Ms. Martens worked on Wall Street for 21 years. The last decade of her career was spent as an outspoken critic of Wall Street’s corrupt practices, its private justice system and the repeal of the Glass-Steagall Act. (This YouTube video captures Ms. Martens testifying before the Federal Reserve on June 26, 1998 against the repeal of the Glass-Steagall Act.
If there was any credibility to that it might have mentioned what she did. Plenty of procedural/pm/pa jobs that don't require much holistic knowledge or qualification.
But I am guessing you are not arguing in good faith, as you seem unable to engage with the substance of the article but instead keep attacking the source.
But please do let me know if you have any issues with the contents of the article, I would be keen to hear them as you seem to be so interested in its authors. Otherwise I'll leave it at that and won't waste anymore energy on ad hominems.
[1]https://multinationalmonitor.org/mm2002/02april/april02inter...