Eaton Vance manager: Markets poised for upset

Tue Dec 12, 2006 12:51 PM ET

NEW YORK (Reuters) - Financial markets are vulnerable to a significant correction in the next 12 months that might be triggered by an event in the derivatives markets, a well-known municipal bond manager said on Tuesday.

"I will be very surprised if we don't get an accident in the next months," Thomas Metzold, who invests roughly $4.5 billion in the Eaton Vance National Municipals Fund, told the Reuters Investment Outlook Summit in New York.

"Whether it is in the credit default swap market or a leveraged buyout scenario, there is going to be a major default and all this liquidity that is out there can dry up pretty quickly," Metzold said.

Looking back to 1998 when hedge fund Long Term Capital Management collapsed, Metzold said the biggest problem was that LTCM had so much exposure to counterparties that none of them knew how much the others had. "And it all came tumbling," he said.

Even though lenders have become stricter since the LTCM debacle, Metzold said trillions of dollars of counterparty risk still exist "that no one really has their hands around."

In the swaps market, positions are often traded so frequently that the party that is ultimately responsible for the underlying risk is not always immediately known.

Although the fixed-income market may look "perfect on the surface," Metzold worried that "underneath it is boiling." Metzold, who has been investing in fixed-income securities for more than two decades, said he has a more bearish outlook than many of his competitors as he worries in particular that the dollar will continue to fall, foreign buyers will lose their taste for U.S. fixed-income securities, and eventually the situation will become a "snowball rolling down hill."

One of the biggest problems may be that investors no longer worry about risk, Metzold said. "I can't believe I haven't seen an editorial cartoon that shows a tombstone with the name 'risk,' rest in peace, because risk is dead," Metzold said.

"People don't believe they can lose money anymore," he added.