How Vanguard Avoided The Subprime Mess

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All of the major Wall Street firms, save Goldman Sachs, have been taking a pounding this year after their investments in structured investment vehicles and the sub-prime market tanked amazingly. Goldman expects Citi to cut their dividend, bonuses at the top are being slashed, and overall the credit crisis is making a lot of people whisper the R word and discuss the erosion of the Fed’s power. Through all this, one thing I haven’t heard much of is how Vanguard was faring and whether or not they were taking any write-downs. I use Vanguard a lot (our taxable investing account, my SEP and my Rollover IRAs are all with Vanguard and in mutual funds) so I tried to dig a little to see whether I just wasn’t paying attention or if they escaped largely unscathed.

Luck would have it, they discussed it and it sounds like Vanguard’s Fixed Investment Group portfolio manager, Bob Auwaerte, did his homework. Instead of relying only on credit grading services, which graded many of those mortgage backed securities as AAA (highest), Vanguard dug deeper and analyzed the underlying factors (and then passed on the securities!):

  • What is the loan-to-value ratio? Vanguard purchases pools with lower loan-to-value ratios—meaning that there is more of a cushion between the size of the loan and the value of the house securing the mortgage.
  • How many loans are issued with documentation of the borrower’s financial data? If a high number of loans are not fully documented, Vanguard avoids that pool.
  • Where were the loans made? Many pools sold in recent years were based mainly on loans made in California and Florida, two markets where speculators fueled home price gains.
  • Is the home a primary or secondary residence, or purchased as an investment? Defaults tend to be lower on loans for primary residences.
  • Were the firms that originated the mortgage loans known for sloppy lending standards?
  • I was surprised to read this because I was under the impression that this sort of information wasn’t available for mortgage backed securities, because so many of places claimed to be blindsided by inaccurate grading and loose lending. In reality, the investment houses didn’t care – they saw a AAA, higher yields, and bought into it.

    I’m not saying that Vanguard will be able to dodge every crisis but I think they avoided this one pretty well because they did their homework, it says a lot about the culture and that my money is safer in their funds. Good job Vanguard.

    { 7 comments, please add your thoughts now! }

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    7 Responses to “How Vanguard Avoided The Subprime Mess”

    1. MoneyNing says:

      I wonder how much of the big companies losing so much money is the investment managers being lazy and how much of that is them just not knowing how to do what the guys at Vanguard and Goldman Sachs did.

    2. RacerX says:

      There is a great article about this in the latest Fortune magazine. My favorite part is that while his company has melting, the CEO of Lych was golfing on most days.

      Now, since he is outed, he will have to live off of his $116MM parachute! Now he can golf!

    3. jim says:

      MoneyNing: Vanguard sat out of investing in those securities, Goldman actually bet against them. It was a gutsy move that paid off tremendously but both firms had some smart folks working for them.

    4. Dave says:

      I think this type of information really exposes some laziness on the part of the banks and investment managers, since they blindly took the word of the bond ratings agencies, when a little common sense checking would have given warning that all was not well. If all it takes to be a money manager is looking at a few letters and picking the ones that say “AAA”, why are they paid so much?

      It also really makes the bond rating agencies look terrible. Yes, bundling mortgages together reduces the risk of individual defaults. But how can you give a high rating to a mortgage backed security when the whole pool is made up of stated income, 95% LTV loans to borrowers with poor credit in overheated markets? That seems like exactly the type of thing the “experts” are supposed to notice!

    5. MoneyNing says:

      Jim: I guess it means that other people were just ignorant and lazy. It’s a little disheartening to think that these people get paid so much money.

    6. Mrs. Micah says:

      This just deepens my crush on Vanguard. I was recently reading an interesting piece which showed how some companies affected by the sub-prime mess didn’t have to be…but they decided to go beyond what they’d been doing because the money was just too good. Pop.

    7. Richard says:

      Wait a minute? Vanguard is analyzing its investments before investing in it? Isn’t this called active investing, rather than passive investing? Isn’t Vanguard against active investing? Vanguard should be investing in bonds based on the market value of the bonds.

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