Whitney Tilson, the outspoken founder of hedge fund T2 Partners LLC,
is girding for a deeper mortgage market meltdown after being singed in
his first foray into the credit crisis' most toxic of securities -- subprime bonds.
Tilson and partner Glenn Tongue have halted their move into the U.S.
mortgage bond market, where an investment gone awry in one risky bond
in late 2008 led them to rein in risk.
Predictions of more fallout from the housing bubble are also
darkening their outlook in their usual playing field of stocks, which
have been rising from the ashes. New York-based T2 is selling bank
stocks, some of which recently doubled in value.
There will be a headwind of continued losses for the better part of
five years considering that banks are facing more losses on
residential and commercial real estate, Tilson told Reuters. Tilson
expects additional losses of more than $1 trillion.
The housing market will continue to be a driver of the credit
crunch, with the knock-on effects producing consumer loan defaults that
keep financial institution balance sheets under pressure, he said.
That view contrasts with hopes that U.S. housing could be on the
road to recovery, following signs that home sales are bottoming and
home building starts are rising.
The housing debacle led Tilson and Tongue to revamp a book already
in the works to highlight their stock strategies. Now published, More
Mortgage Meltdown (Wiley, $27.95) describes ways to profit through the
crisis, which they say is in about the fifth inning, using the analogy
of baseball's nine innings.
The housing slump, and complex machinations of loan loss mitigation,
have kept T2 from extending its reach into the mortgage bond market
that as recently as December, Tilson said promised enormous returns.
He's bidding on bonds, but below prices where the securities are
The $90 million fund bought a $3.8 million Long Beach Mortgage
subprime bond at 34 cents on the dollar, only to watch it fall to 28
cents as cash recovery from the underlying assets slowed, Tilson said.
Annualized returns on the bond may still be 31 percent, he wrote in
the book, which carries the subtitle, 6 Ways to Profit in These Bad
We were so sure we were going to make a fortune on this investment
and got blindsided, so it's made us even more cautious, he said. The
investment will be OK, he said.
T2's main fund gained 17 percent so far this year, nearly erasing
the 18.1 percent drop during 2008's carnage. In 2008, the S&P 500
Index declined 38 percent.
Tilson and Tongue say U.S. home-price drops could overshoot fair value of about 40 percent, to a decline of 50 percent.
As of February, home prices had fallen more than 30 percent since
their mid-2006 peak, according to S&P/Case-Shiller Home Price
In stocks, investors bludgeoned by the worst bear market since the
Great Depression have been clutching at signs in economic reports and
company earnings that signal the U.S. recession may be coming to an
Two-thirds of the 94 percent of S&P 500 companies that have
reported earnings through Monday have beat analysts expectations.
But to T2, the stock rally is nothing more than an opportunity to profit.
Tilson said T2 is booking profits in Wells Fargo & Co (WFC.N) and American Express Co (AXP.N),
shares that have more than doubled since March. The fund will continue
to hold the two financial companies, while betting against Bank of
America Corp (BAC.N), which is more exposed to a downturn, he said.
In housing, he is shorting homebuilders Centex Corp (CTX.N) and Pulte Homes Inc (PHM.N) because there is virtually no need for their product for years, he said.
Tilson said they really like their bets that will profit when stocks drop, especially MBIA Inc (MBI.N), the bond insurer he writes is so underreserved for losses that it will be seized and placed in runoff this year.