BlackRock chief calls the Treasury bubble

Blackrock CEO Larry Fink says that investors' rush to Treasuries has the makings of a bubble.

The Tinkerbell economy

More Videos

More from Fortune

Will Mmmhops be a hit? NBA confirms L.A. Clippers sale to ex-Microsoft CEO Steve Ballmer FBI and SEC probe into Carl Icahn and golfer Phil Mickelson

FORTUNE 500 Current Issue Subscribe to Fortune

(Fortune) -- For a firm that's gaining a reputation for cleaning up after financial disasters, BlackRock remains remarkably optimistic.

CEO Larry Fink said Wednesday that he believes investors are getting ready to return to riskier parts of the markets, such as the market for bank loans and the deeply distressed mortgage securities area. The comments come even as BlackRock's own first-quarter earnings show just the opposite has been happening at an unprecedented pace.

The first quarter saw $35 billion flow into BlackRock's (BLK) cash management accounts, as fearful investors fled stocks and bonds for the safety of government debt. Outflows in fixed income and equities were $3.2 billion, BlackRock said. "For the first time, we are seeing some very strong flows going from fixed income into cash," Fink said on Wednesday's conference call with investors.

But Fink indicated on Wednesday's call that the firm is trying to persuade investors that the so-called fear trade - swapping out of corporate and asset-backed securities for Treasuries - has been overdone. Saying the move into Treasuries has the makings of a "bubble," Fink said he believes the low returns available today on risk-free Treasury securities - the 10-year Treasury note recently yielded 3.61%, down from 5% before the credit crunch hit the markets last summer - will eventually force money managers back into less popular parts of the fixed-income markets.

"We're seeing more and more institutions looking at riskier areas of fixed income," Fink said in response to a question on Wednesday's call. "We believe we're at the beginning of the capitulation stage ... and there's quite a bit of equity out there to invest in these products."

If anyone has a view into the market for distressed fixed-income assets, it's Fink. He noted on the call that BlackRock has been "heavily in the news with some substantial assignments" in the distressed asset area. Indeed, BlackRock gained headlines last month when it was tapped by the Federal Reserve Bank of New York to manage the $30 billion in assets the Fed took on in backstopping JPMorgan Chase's (JPM, Fortune 500) $1 billion rescue of Bear Stearns (BSC, Fortune 500). Previously, the firm was brought in last last year to temporarily manage a troubled Florida state money fund.

BlackRock says its first quarter told two distinct stories - the strength of its core asset management business, which showed an 18% year-over-year rise in assets under management, and the pain of stressed financial markets as expressed by a 12-cent-a-share nonoperating loss. The firm's first-quarter adjusted profit was $1.90 a share, which is up from $1.59 a year ago but a dime short of the Wall Street analyst consensus estimate. Shares fell 1% in midafternoon trading.

But another story emerges in the firm's breakdown of deals in its pipeline of new business. BlackRock said more than half of new deals are in its asset management advisory business, which Fink said involves "working with clients in terms of long-term distributions and dispositions." One aspect of that is helping financial firms work off the leverage that investors have become so averse to in recent months. While Fink concedes that "we have not hit the bottom yet" in the markets, "we do believe there will be a turnaround" - perhaps later this year.

But before the market finds its footing, Fink said on Wednesday's first-quarter earnings conference call, the government must first shore up the housing market. He said even steep discounts aren't likely to draw investors back into mortgage-related products until they see a "more stable economic environment," featuring better consumer confidence. Consumer confidence dropped sharply for the second straight month in March and sits at a five-year low.

The key to changing the environment, Fink added, rests in stopping the free fall of house prices. "We need to find a solution for the low income housing market," Fink said. "We need to create a new FHA housing program."

Rep. Barney Frank introduced a plan earlier this year to clear the Federal Housing Administration to insure some $300 billion in mortgages. The Congressional Budget Office estimates the plan could save several hundred thousand homeowners from foreclosure, the Washington Post reports. The White House has endorsed a limited version of the plan, though some in Congress oppose the idea altogether because they believe it amounts to a bailout of those who recklessly bought homes beyond their means.

In any case, Fink believes an FHA plan, together with the aggressive rate-cutting on the part of the Federal Reserve, would help put the economy back on the right track. "We're beginning the healing process in a lot of areas," he said, contending that a rebound in consumer confidence would lead to a bounce in credit measures and a rise in the stock market.

In that sentiment, Fink simply echoed the statements made recently by Bob Doll, BlackRock's stock investment chief. Yesterday, Doll published a note citing 10 reasons to like U.S. stocks. The list started with pessimistic sentiment before moving on to the cheap dollar and improving technical factors.

It seems that Fink largely agrees, though even if the markets continue to show fear, BlackRock has its cleanup business to fall back on. "We believe this business is going to be extremely robust for the coming months, quarters and years," Fink said Wednesday.