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 selling.

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 Times.

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 Indices.

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 end.

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.