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TCW bear warns investors to flee counterparty risk
NEW YORK, Sept 17 (Reuters) - Investors should flee from bond funds that have exposure to investment banks through credit-default swaps and other derivatives, Jeffrey Gundlach, manager of the TCW Total Return Bond Fund, said on Wednesday.
The financial turmoil that has led to a bankruptcy filing by Lehman Brothers Holdings Inc LEH.P, the government bailout of insurer American International Group Inc (AIG.N) and the Bank of America Corp (BAC.N) purchase of Merrill Lynch & Co MER.N has created unacceptable risks to bond funds holding contracts with such firms, he said on a conference call.
"I would highly recommend investors query their fund families today about the amount of counterparty risk," said Gundlach, who is also chief investment officer at Los Angeles-based TCW, which manages $160 billion in assets. "If there is any appreciable amount, get out immediately."
Corporate default rates are on the rise and may be hastened by the credit crunch that has pushed borrowing costs sharply higher for firms that thrive on the debt, he said.
Debt of New York-based investment bank Morgan Stanley (MS.N) is now trading at more than 1,000 basis points above Treasury yields, a level at which no financial company can survive, he said.
Morgan Stanley will likely be forced to align itself with a bank, similar to Merrill Lynch's agreement to be purchased by Bank of America earlier this week, Gundlach added.
In the housing market, which is at the epicenter of financial system problems, home prices are headed sharply lower despite efforts by the government to prop up mortgage finance giants Fannie Mae and Freddie Mac, he said, while the prime mortgage market is already experiencing foreclosure rates in the realm of the Great Depression.
He noted it took eight years for the housing market to reach a bottom during the Depression, and then did not rise for another eight years.
"Loans being originated are massively underwater the day they are made," Gundlach said, speaking of market prices for pools of prime loans. "There is no end in sight." (Reporting by Al Yoon; editing by Gary Crosse)
