An analyst who warned firm of subprime mess

NEW YORK - Throughout 2006, T. Rowe Price analyst Susan Troll watched in horror as one risky mortgage deal after another came to market. She became alarmed by a widening trend: mortgage lenders issuing home loans of poor quality - that is, subprime - that were then packaged and sold by Wall Street investment banks to investors worldwide.

Finally, in e-mails and meetings with her firm's money managers, Troll urged T. Rowe Price to sell its portfolio of subprime-mortgage securities.

"I just was amazed at how quickly these deals were getting done when you see constant deterioration in credit quality," she said. "It just didn't make sense."

Based on her warnings, the Baltimore investment firm sold some of its subprime assets in December 2006 and cleared its books of them by early February - well before the summer's credit crisis erased the market for these types of securities.

Troll's actions were hardly the norm. Plenty of analysts did not sound the alarm on the subprime mess. The ensuing turmoil in the financial system has wiped out billions of dollars of shareholder value in banks, investment firms, mortgage lenders, and bond-insurance companies.

So five years after high-profile Wall Street analysts were accused of pocketing millions for promoting the stock of shoddy companies, analysts are once again in the spotlight for their conduct. Should analysts have seen the meltdown coming? Why didn't they? Did conflict of interest play a role?

A key issue, experts note, is that the complex alphabet soup of debt securities, which have experienced explosive growth in recent years and which are at the heart of the credit crunch, are extremely hard to evaluate. That was the case, they say, even for some credit analysts whose job is to make calls on debt instruments - not to mention for stock analysts who typically look at a company's earnings relative to stock price, cash flow and other factors.

Some Wall Street credit analysts were publishing reports advising clients to short, or bet against, certain subprime securities a year ago. Stock analysts, however, generally continued to affirm their largely neutral "hold" ratings on financial companies well into 2007. Some of those companies' shares shed more than one-third of their value this year as the subprime crisis deepened and the value of those firms' portfolios fell.

"The fact of the matter is, most everybody in the industry, certainly analysts, never thought too deeply about these instruments," said Joseph Mason, an associate professor of finance at Drexel University. "In fact," he said, "they're very different from equities, and they're very different from even traditional debt instruments. . . . It's a world that was really ill-suited for traditional equity analysts and even traditional debt analysts."

Some Wall Street firms said they would increase coordination between equity and credit analysts in the future. "That is probably something in hindsight we would do more of going forward," said Greg Peters, who runs the fixed-income research group at Morgan Stanley. "In terms of what the fixed-income folks were thinking vs. what translated with the equity market, I would say there was not enough coordination between those two markets generally."

Richard X. Bove, a stock analyst at Punk Ziegel & Co. L.P., a New York investment bank, warned in an October 2006 report of "loan quality problems . . . that the banks have not prepared themselves to meet."

But he did not start downgrading the shares of banks and Wall Street brokerages that invested in those loans to "sell" until July, when some had already begun to fall.

Asked why he did not downgrade them sooner, Bove spoke of the pressure to always be right, the difficulty of going against the tide, and the need to hang on to clients, which include mutual funds and other money managers.

"You live or die based upon your stock picks," he said. "If you think everything's terrible, but everybody else thinks things are great and they keep buying the stocks, and you put a 'sell' too early, then people are just going to walk away from you. . . . I've got to get paid also, and if I start putting 'sells' on companies when the market momentum is forward, basically, people aren't going to pay me."