For celebrated bond fund manager Jeffrey Gundlach, the intensifying meltdown in the U.S. housing market has all the inevitability of a Sophoclean tragedy. The Chief Investment Officer of Santa Monica, Calif.-based TCW Group has been sounding warnings for more than a year that mortgage lenders had taken leave of their senses by spooning out mortgages without owner-equity cushions and with little or no verification of the borrowers’ ability to pay back the debt reports Barron’s.

By now, with mortgage defaults climbing and home sales falling, the plot line of this drama is becoming clear. But Gundlach says there are still several acts to come — and that the curtain may not come down until the close of this decade. He sees U.S. home prices dropping an average of 12% to 15% annually from the highs achieved last year and not reaching their eventual trough until late 2008, at the earliest. And they may not start recovering until 2010 or 2011, inflicting, in the meantime, real damage on the economy.

About the only bright spot: the mortgage market may offer some excellent investment opportunities in the year ahead, he says.

Gundlach was among the first to rail against the profusion of new types of home loans — interest-only mortgages, adjustable-rate mortgages with artificially low teaser interest rates in the early years of repayment, and so-called option ARMs, which allowed borrowers to make monthly payments that didn’t even cover interest costs — all of them designed, in Gundlach’s phrase, to “shoehorn” borrowers into homes often far beyond their financial means.

Gundlach thinks median U.S. home prices are unlikely to recover until the decade’s end.

Sure enough, all these dicey loans helped bring about what Gundlach now calls “the great margin call of 2007.” As home-price appreciation flamed out, subprime borrowers began to default in droves, especially on new mortgages, and mail back the keys to lenders. As a consequence, major subprime mortgage lenders like New Century began hitting the wall. Ultimately more than 100 subprime lenders were forced to close their doors as Spring turned into Summer.

That was followed in June by disclosure that two hedge funds managed by Bear Stearns were in deep trouble because of highly-leveraged subprime-debt bets that had gone bad. Soon a number of hedge funds, banks and other financial institutions from Asia and North America to Europe were reporting heavy losses on subprime debt investments. A number of hedge funds ended up being liquidated, and banking authorities in Germany and England were forced to arrange hasty bail-outs to save various banks.

The financial markets were further shocked in July and August when Moody’s and Standard & Poor’s and Fitch belatedly took over 5,000 negative ratings actions, decimating prices on all manner of residential mortgage-backed and home equity loan securities. “This was the biggest credit ratings catastrophe that our markets have ever seen,” Gundlach observed to Barron’s during a lengthy telephone interview.

Soon, the subprime contagion spread to other markets — from leveraged-buyout debt to asset-backed commercial paper, triggering a full-scale seizing up of global credit markets. Yields on risky debt paper soared. Buyers went on strike. The ascendancy of fear over greed forced central bankers to flood their financial systems with liquidity, and in the case of the Fed two weeks ago, to drop short-term interest rates.

Read it here: House of Cards Ready to Fall