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Why one big investor likes Geithner's toxic loan plan

March 27, 2009 |  7:30 am

When the government talks about a "public-private partnership" to save the banking system from rotting mortgage assets, the private half of that includes people like Jeffrey Gundlach.

As chief investment officer of money management titan TCW Group (Trust Co. of the West) in L.A., Gundlach already has had plenty of experience buying so-called distressed mortgage securities over the last year.

And the good news for Treasury Secretary Timothy F. Geithner is that Gundlach is interested in buying more of the bad stuff -- not out of altruism, but because he thinks mortgage assets are cheap.

Or at least, they were cheap a week ago, when Gundlach was paying as little as 38 cents on the dollar for some mortgage-backed bonds, he says. Even assuming that 20% to 30% of the loans backing the bonds are delinquent, Gundlach says, at those depressed prices he’s earning annualized yields of 28% or so on the securities, thanks to the homeowners who are still making their payments.

Gundlach The pricing issue, however, has been the sticking point for many banks that would like to unload mortgage assets, but not at 38 cents on the dollar. The banks want more. The public-private partnership program is supposed to narrow the gap between where cash-needy banks will sell and opportunistic investors will buy.

Gundlach said the program should work. "To me, it looks like a pretty good deal," he said. Ditto for many of his big-money clients, including some sovereign wealth funds, Gundlach said. "They’ve been calling us," asking about joining in, he said.

The government will put up its own capital alongside investors. Uncle Sam also will provide financing to leverage the purchases.

That combination of government capital and loans won’t persuade Gundlach to pay the 80 cents on the dollar that banks might want, he says. But for some mortgage securities, "Even at 58 cents or 60 cents, it’s a good proposition now," he says.

If Gundlach overpays for mortgage securities under Geithner’s plan, TCW will lose. But the bulk of the losses would be borne by the government -- a risk that Geithner said was unavoidable if private investors were to be lured in to participate on a large scale.

The Treasury specifically is trying to recruit the biggest private U.S. investors in mortgage securities to partner with it, to bring critical mass to the plan. The short list of those investors includes TCW, which manages about $70 billion in mortgage assets.

If the banks haven’t been selling mortgage securities at depressed prices, who has? Gundlach points to Asian investors who, he says, have been spooked by the Obama administration’s plan to encourage mortgage-loan servicers to modify loans for struggling homeowners.

That was the last straw for some Asian institutions that own U.S. mortgage bonds, Gundlach said. "They’ve been selling, selling, selling," he said. "Some of them said, ‘We think [the bonds] are going to zero.’ "

They may have a case of seller’s remorse at the moment.

-- Tom Petruno

Photo: Jeffrey Gundlach. Credit: Annie Wells / Los Angeles Times

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