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Thursday, September 18, 2008

The worst is yet to come

Jeffrey Gundlach, chief investment officer at Los Angeles-based mutual-fund company TCW Group Inc., told clients on a conference call late Wednesday that the crisis in credit and housing may not abate for several years and is actually getting worse.


Gundlach based his assessment on a belief that housing prices still face several more years of decline, a protracted slump, he said, not seen since the Great Depression. Moreover, Gundlach said it's possible that home prices could be sluggish until 2022.

"If it's like the Depression experience -- and it sure is shaping up that way -- it could take several years. Maybe we won't see a bottom in home prices until 2014," he said.
Write-offs could top $1 trillion
As a forecaster, Gundlach didn't just climb aboard the gloom-and-doom wagon. He was early to spot the cracks that subprime loans were making in the financial system, and among the first to warn that an era of easy money would come to a bad end.
"The subprime market is a total unmitigated disaster and it's going to get worse," Gundlach told money managers and financial advisers at an investment conference in June 2007. See full story.
And Gundlach has put his shareholders' money where his mouth is, shunning derivatives and counterparty risk in his bond fund portfolio.
That defensive posture should offer protection in the continuing credit storm that Gundlach foresees. In this bleak scenario, an unprecedented -- and growing -- number of home foreclosures, along with mortgage loans that are under water as soon as they're originated and a glaring lack of buyers for even modestly risky assets keeps the financial system under enormous stress.
Expect loan default rates to rise, Gundlach said, not just in the subprime market, but among the top-drawer prime borrowers as well. The prime default rate could approach 10% from a current 2% before the carnage is over, he said.
"The current environment is maybe a little worse that what was experienced in the Depression in terms of the housing market," Gundlach said.
More troubles ahead
Accordingly, financial institutions may suffer write-offs that could surpass $1 trillion before conditions improve, he said. As of late August, credit losses and writedowns at the world's 100-largest banks and brokerages topped $506 billion, he noted.
Among the casualties, Gundlach said, is Citigroup. The company's balance sheet problems could be on a scale similar to that of insurer American International Group, which the U.S. bailed out this week.
"I would give a very meaningful probability to the biggest, next AIG-size debacle being Citigroup," the strategist said.
"I would definitely not be a buyer of Citigroup stock," Gundlach said.

Other financial giants also won't escape the crisis unscathed, Gundlach said. "I don't see how Wachovia can make it as a stand alone," he said. He expressed the same sentiment about Morgan Stanley.
Indeed, late Wednesday the New York Times reported that Morgan Stanley was exploring a merger with Wachovia or another bank. See full story.
Europe's financial giants are in similar or even worse shape than their U.S. counterparts, Gundlach said, with "substantial exposures to assets which U.S. banks are now getting taken to the woodshed over. I would rate all European banks as not a buy."
The breakdown will take a further toll on U.S. stocks, Gundlach added. The S&P 500 will tumble below 800, he said, about 35% below its 1156 close on Wednesday.
Said Gundlach: "None of us have ever seen this, and it's no market for old men, but risk aversion is the order of the day." End of Story


Jonathan Burton is an assistant personal finance editor for MarketWatch, based in San Francisco.

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