Baltimore-based investment firm T. Rowe Price was able to save itself from financial difficulties related to large volumes of properties in foreclosed homes auctions because one of its credit analysts made a correct analysis of the housing market and the subprime lending boom in 2004.
Before the subprime market caused the collapse of the housing sector and the frenzy of foreclosed homes auctions in 2007, T. Rowe has already cut down its investments related to subprime lending.
It was Susan Troll, one of the firm’s credit analysts, who warned colleagues and the company about the danger of investing in mortgage securities backed by subprime loans in 2004. She did not know yet at that time that subprime loans would put a lot of homes into foreclosed homes auctions just a few years after.
Troll related that she felt her first doubts about the ultimate consequences of the boom in subprime lending and the soaring home prices when she attended a conference held by the biggest subprime mortgage servicers in California.
During the meetings, Troll and the other investors were given opportunities to observe service calls between mortgage servicers and borrowers. Troll was able to realize that borrowers were confused about the structure of their home loans and why interest rates would reset to higher rates after a couple of years.
When somebody remarked that the loans were not really mortgages but bridge loans, something clicked with Troll.
Troll realized that lenders were offering adjustable-rate home loans that have low fixed rates during the first 2 or 3 years and that would reset to much higher rates after the low-rate period.
What was stunning was that lenders told borrowers that they can refinance to lower rates after 2 or 3 years if they make their monthly payments on time and thereby improve their credit records. The borrowers got only the first concept – that they can refinance to lower rates. They never thought they would see their homes go to foreclosed homes auctions.
Troll explained that one of the errors of Wall Street, ratings agencies and other financial firms was that they did not have a model for home price declines. They were all forecasting home price increases.
By 2006, T. Rowe stopped buying subprime mortgage securities. When 2007 came and record numbers of homes were being sold through foreclosed homes auctions, T. Rowe has already cut down its exposure to the subprime sector.
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