Vulture subprime buyers ramp up purchases

By Jennifer Ablan and Al Yoon - Analysis

NEW YORK (Reuters) - The allure of rotting mortgage bonds has grown so strong that Wall Street's vultures have begun picking over their carcasses -- a signal the credit crisis has entered a crucial stage in its vicious cycle.

In the past two months, these intrepid investors have begun betting billions of dollars on a hunch that mortgage security prices have fallen enough. It is a risk few have taken for a year or more as the credit crisis rooted in this very market wreaked havoc in financial markets around the world.

In early February, bid lists for bonds backed by middle-quality mortgages found no takers, even at what were then considered fire-sale prices, between 75 cents and 80 cents on the dollar. But the following month, though, Jeffrey Gundlach, chief investment officer at bond manager Trust Company of the West, began snapping up these same securities at 65 cents on the dollar during what he calls the "darkest moments for the markets.

"You had a massive, massive supply-demand imbalance that had developed into a death spiral," Gundlach said of the systemic liquidity squeeze in early March. "Those securities were really cheap against the fundamentals, so we went in big and started buying."

WATCH THE VULTURES

The behavior of Gundlach and those like him is important because this brand of investor -- patient, value scavengers willing to stomach some initial loss in exchange for huge windfalls when a market turns -- frequently signals that a market is forming a bottom when they are active.

In early March, banks and hedge funds stripped of access to credit had to sell mortgage securities to raise cash for margin calls. That helped send already panicky U.S. markets into a full-fledged credit freeze.

But the Federal Reserve stepped in and announced that it would lend up to $200 billion of U.S. Treasury securities to banks for 28-day periods in return for debt, including a range of mortgage-backed securities. That broke a month-long sell-off, sending the mortgage securities rallying strongly.