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How Vanguard Avoided The Subprime Mess

Posted By Jim On 12/27/2007 @ 1:08 pm In Investing | 7 Comments

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 [3], 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 [4] 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.


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    [2] Email: mailto:?subject=http://www.bargaineering.com/articles/how-vanguard-avoided-the-subprime-mess.html

    [3] Citi to cut their dividend: http://www.marketwatch.com/news/story/citigroup-seen-cutting-dividend-40/story.aspx?guid=%7b0043DB9C-4002-4E94-A6E2-FBC36B1E5B98%7d&print=true&dist=printTop

    [4] discussed it: https://personal.vanguard.com/us/VanguardViews?FW_Event=vviewsnewsletters&chunk=/freshness/News_and_Views/news_ITVautumn2007_ALL_subprime_ALL.html&Season2=Autumn&Year2=2007

    Thank you for reading!