t2 partners presentation on the mortgage crisis-4!3!09 3
TRANSCRIPT
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An Overview of the Housing/Credit Crisis
and Why There is More Pain to Come
T2 Accredited Fund, LP
Tilson Offshore Fund, Ltd.
T2 Qualified Fund, LP
April 3, 2009
T2 Partners Management L.P. is a Registered Investment Advisor
145 E. 57th Street
10th Floor
New York, NY 10022(212) 386-7160
www.T2PartnersLLC.com
This document is not a solicitation to invest in any investment product, nor is it intended to provide investment advice. It is intended for informationpurposes only and should be used by sophisticated investors who are knowledgeable of the risks involved. All data and comments herein are believed tobe correct, but there are no guarantees and readers should do their own work. Please refer to the relevant Confidential Private Placement Memorandum forfull details on investment roducts and strate ies of T2 Partners LLC.
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Prior to This Decade, Housing Had Been a Stable Investment,Increasing at Less Than of 1% Per Year After Inflation
Source: Robert J. Shiller, Irrational Exuberance, Princeton University Press 2000, Broadway Books 2001, 2nd edition,2005, also Subprime Solution, 2008, as updated by the author at http://www.econ.yale.edu/~shiller/data.htm
10 0
12 0
14 0
16 0
18 0
20 0
22 0
Rea l Home Price Index
(1890=100)
Trend Line
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And Then Housing Prices Exploded
Source: Robert J. Shiller, Irrational Exuberance, Princeton University Press 2000, Broadway Books 2001, 2nd edition,2005, also Subprime Solution, 2008, as updated by the author at http://www.econ.yale.edu/~shiller/data.htm
100
120
140
160
180
200
220
Re al Home P rice Index
(1890=100)
Trend Line
Housing Bubble
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From 2000-2006, the Borrowing Power of a TypicalHome Purchaser More Than Tripled
Source: Amherst Securities
Factors contributing to the ability to borrow more and more were:
1. Slowly rising income
2. Lenders being willing to allow much higher debt-to-income ratios
3. Falling interest rates
4. Interest-only mortgages (vs. full amortizing)
5. No money down
$0
$100,000
$200,000
$300,000
$400,000
Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
Pre-Tax Income
Borrowing Power
3.3x in January 2000
9.2x in January 2006
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Housing Became Unaffordable in Many Areas
0
10
20
30
40
50
60
70
80
Q1 1996 Q1 1997 Q1 1998 Q1 1999 Q1 2000 Q1 2001 Q1 2002 Q3 2004 Q3 2005 Q3 2006 Q3 2007
HousingOp
portunityIndex
Los Angeles, CA
Riverside, CA
San Diego, CA
Source: NAHB/Wells Fargo Housing Opportunity Index, which measures percentageof households that could afford the average home with a standard mortgage
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Americans Have Borrowed Heavily Against Their HomesSuch That the Percentage of Equity in Their Homes HasFallen Below 50% for the First Time on Record Since 1945
-6-
Source: Federal Reserve Flow of Fund Accounts of the United States
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
MortgageDe
bt(Bn)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Equityasa%
of
HomeValue
1945
Mortgage Debt: $18.6 billion
Equity: $97.5 billion
2008
Mortgage Debt: $10.5 trillion
Equity: $8.5 trillion
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There Was a Dramatic Decline in MortgageLending Standards from 2001 through 2006
Source: LoanPerformance, Paulson presentation; USA Today (www.usatoday.com/money/economy/housing/2008-12-12-homeprices_N.htm)
In 2005, 29% of
new mortgageswere interestonly or less,in the case ofOption ARMs vs. 1% in 2001
In 1989, theaverage downpayment for first-time homebuyers was
10%; by 2007, itwas 2%
The sale of newhomes costing$750,000 or
more quadrupledfrom 2002 to2006. Theconstruction ofinexpensivehomes costing$125,000 or lessfell by two-thirds
74
74
76
81
83
84
81
68
70
72
74
76
78
80
82
84
86
2001 2002 2003 2004 2005 2006 2007
CombinedLoantoValue(%)
1% 1%
3%
9%
14%
17%
8%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
2001 2002 2003 2004 2005 2006 2007
PercentofOriginations
33%
39%
45%
49%
56%
63%65%
0%
10%
20%
30%
40%
50%
60%
70%
2001 2002 2003 2004 2005 2006 2007
PercentofOriginations
0% 0%
1%
4%
8%
11%
5%
0%
2%
4%
6%
8%
10%
12%
2001 2002 2003 2004 2005 2006 2007
PercentofOriginations
Combined Loan to Value 100% Financing
Limited Documentation 100% Financing & Limited Doc
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The Decline in Lending Standards Led to aSurge in Subprime Mortgage Origination
Source: Reprinted with permission; Inside Mortgage Finance, published by Inside MortgageFinance Publications, Inc. Copyright 2009.
10%9%
9%
10%9%
10%10%
7%7%
8%
18%
20%20%
8%
$0
$100
$200
$300
$400
$500
$600
$700
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Originations
(Bn)
0%
5%
10%
15%
20%
25%
% ofTotal
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$0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 $5.0
CDO/ CLO
Other Consumer
Construction & Development
Option ARM
Auto
Credit Card
Home Equity
Jumbo Prime
High-Yield / Leveraged Loans
Subprime
Commercial & Industrial
Other Corporate
Alt-A
Commercial Real Estate
Prime Mortgage
Amount Outstanding (Trillion)
But Subprime Mortgages Are Only aTiny Part of the Mortgage Problem
Sources: Federal Reserve Flow of Funds Accounts of the United States, IMF Global Financial Stability Report October 2008, Goldman SachsGlobal Economics Paper No. 177, FDIC Quarterly Banking Profile, OFHEO, S&P Leverage Commentary & Data, T2 Partners estimates
C G
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Among the Many Causes of The GreatMortgage Bubble, Two Stand Out
The companies making crazy loans didnt care very much if thehomeowner ended up defaulting for two reasons:1. Either they didnt plan to hold the loan, but instead intended to pass it along
to Wall Street, which would bundle, slice-and-dice it and sell it (along withany subsequent losses) to investors around the world;
2. Or, if they did plan to hold the loan, they assumed home prices would keeprising, such that homeowners could either refinance before loans reset or, ifthe homeowner defaulted, the losses (i.e., severity) would be minimal.
There were many other reasons, of course a bubble of thismagnitude requires what Charlie Munger calls Lollapalooza Effects The entire system real estate agents, appraisers, mortgage lenders,
banks, Wall St. firms and ratings agencies became corrupted by the vastamounts of quick money to be made Regulators and politicians were blinded by free market ideology or the
dream that all Americans should own their homes, causing them to fallasleep at the switch, not want to take the punch bowl away and/or getbought off by the industries they were supposed to be overseeing
Debt became increasingly available and acceptable in our culture Millions of Americans became greedy speculators and/or took on too much
debt Greenspan kept interest rates too low for too long Institutional investors stretched for yield, didnt ask many questions and
took on too much leverage In general, everyone was suffering from irrational exuberance
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As Long As Home Prices Rise Rapidly, Even Subprime MortgagesPerform Well But If Home Prices Fall, Look Out Below!
Source: T2 Partners estimates
0%
10%
20%
30%
40%
50%
60%
20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40%Home Price Appreciation
CumulativeLoss(%)
S
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Wall Streets Demand for Loan Product Was aMajor Driver of the Decline in Lending Standards
As discussed later in this presentation, the Asset-Backed Securities (ABSs) and
Collateralized Debt Obligation (CDO) businesses were enormously profitable forWall Street firms Structured finance was a big driver of the surge in profitability of financial firms and
their employees:
To produce ABSs and CDOs, Wall Street needed a lot of loan product
Mortgages were a quick, easy, big source
It is easy to generate higher and higher volumes of mortgage loans: simply lendat higher loan-to-value ratios, with ultra-low teaser rates, to uncreditworthyborrowers, and dont bother to verify their income and assets (thereby invitingfraud)
Theres only one problem: DONT EXPECT TO BE REPAID!
Source: Moodys Economy.com
5%
6%
7%
8%
9%
10%
11%
1975 1980 1985 1990 1995 2000 2005
PercentofUSTotal
Financial Services Profits as a % of U.S. Total Financial Services Wages as a % of U.S. Total
0%
10%
20%
30%
40%
50%
1975 1980 1985 1990 1995 2000 2005
PercentofUSTotal
Th W S f T i M t
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There Was a Surge of Toxic MortgagesOver the Past 10 Years
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Origi
nations(Bn)
Conforming, FHA/VA
Jumbo
Alt-A
Subprime
Seconds
Source: Reprinted with permission, Inside Mortgage Finance, published by Inside Mortgage Finance Publications, Inc. Copyright 2009
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Private Label Mortgages (Those Securitized by Wall St.) Are 15%of All Mortgages, But Are 51% of Seriously Delinquent Mortgages
Number of Mortgages (million)
Approximately two-thirds of homes have mortgages and of these, 56% are owned orguaranteed by the two government-sponsored enterprises (GSEs), Fannie & Freddie
Source: Freddie Mac, Q4 08
Number of Seriously
Delinquent Mortgages (000)
Total: 55.0 million Total: 3.5 million
Freddie Mac13
Ginne Mae/FH A6
Private Label8
Fannie Ma e18
Banks & Thrifts8
15%
Private Label
1734
Banks & Thrifts397
Freddie Mac232
Fannie Mae444
Ginne Mae /FHA378
51%
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Nearly 8% of Mortgages on 1- to 4-Family Homes WereDelinquent or in Foreclosure as of the End of 2008
Source: National Delinquency Survey, Mortgage Bankers Association. Note: Delinquencies (60+ days) are seasonally adjusted
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Q41979
Q41980
Q41981
Q41982
Q41983
Q41984
Q41985
Q41986
Q41987
Q41988
Q41989
Q41990
Q41991
Q41992
Q41993
Q41994
Q41995
Q41996
Q41997
Q41998
Q41999
Q420
00
Q420
01
Q420
02
Q420
03
Q420
04
Q420
05
Q420
06
Q420
07
Q420
08
Percen
tageofHomeLoans
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All Types of Loans, Led by Subprime, Are Seeing a Surgein Delinquencies
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Q11999
Q31999
Q120
00
Q320
00
Q120
01
Q320
01
Q120
02
Q320
02
Q120
03
Q320
03
Q120
04
Q320
04
Q120
05
Q320
05
Q120
06
Q320
06
Q120
07
Q320
07
Q120
08
Q320
08
Per
centNoncurrent
Alt AOption ARM
Jumbo
Subprime
Prime
Home Equity Lines of Credit
Source: Amherst Securities, LoanPerformance; National Delinquency Survey, Mortgage Bankers Association;FDIC Quarterly Banking Profile; T2 Partners estimates. Note: Prime is seasonally adjusted.
S l f E i i H A F lli d F l
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Sales of Existing Homes Are Falling and ForeclosuresAre Rising, Leading to a Surge in Inventories
Source: NATIONAL ASSOCIATION OF REALTORS Existing Home Sales data series
Months SupplyExisting Home Sales
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Millions
4.7 million units as of
the end of February 2009
3
4
5
6
7
8
9
10
11
12
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Months
3.8 million units, equal to 9.7
months as of the end of February
24% f H Wi h M O M Th h
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24% of Homeowners With a Mortgage Owe More Than theHome Is Worth, Making Them Far More Likely to Default
There Has Been a Dramatic Rise inHomeowners Who Are Under Water
In Bubble Markets, Far MoreHomeowners Are Under Water
Source: Zillow.com Q4 08 Real Estate Market Report; Moody's Economy.com, First American CoreLogic, T2 Partners estimates;
Among people who bought homes in the past five years, 30%+ are under water
4%
6%
16%
20%
24%
0%
5%
10%
15%
20%
25%
Dec-06 Dec-07 Sep-08 Dec-08 Mar-09
PercentUnderwater
Price Index Is % of Last 5 Yrsat Lowest Price Drop Purchasers Who
Metro Area Level Since Since Peak Are Under Water
New York 2004-Q3 -15.2% 23.0%Los Angeles 2003-Q4 -32.0% 56.4%Boston 2002-Q2 -21.8% 27.8%Washington 2004-Q1 -24.8% 50.3%Miami 2004-Q1 -36.6% 65.1%San Francisco 2003-Q3 -27.8% 51.2%
Atlanta 2004-Q4 -10.4% 23.2%San Diego 2002-Q4 -34.4% 63.9%
Phoenix 2004-Q3 -37.7% 36.4%Las Vegas 2003-Q4 -41.8% 61.4%
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Certain Types of Loans are Severely Under Water
Source: Amherst Securities, LoanPerformance, Standard & Poors
73%
50%
45%
25%
0%
10%
20%
30%
40%
50%
60%
70%
80%
Prime Alt A Subprime Option ARM
Percen
tUnderwater
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Foreclosure Filings Have Increased Dramatically
Note: Foreclosure filings are defined as default notices, auction sale notices and bank repossessions
Sources: RealtyTrac.com U.S. Foreclosure Market Report
Foreclosures in February rose 30% year-over-year and 6% sequentially
Starting to flatten due to a number of states and banks plus Fannie and Freddieimplementing foreclosure moratoria
RealtyTrac estimates that over 1.5 million bank-owned properties are on the market,representing around a third of all properties for sale in the U.S.
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
Jun-
05
Aug-
05
Oct-0
5
Dec-0
5
Feb-
06
Apr-0
6
Jun-
06
Aug-
06
Oct-0
6
Dec-06
Feb-
07
Apr-0
7
Jun-
07
Aug-
07
Oct-0
7
Dec-0
7
Feb-
08
Apr-0
8
Jun-
08
Aug-
08
Oct-0
8
Dec-08
Feb-
09
NumberofForeclosu
res
In Bubble Markets Prices Are Way Down Driven By a
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$0
$100
$200
$300
$400
$500
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
MedianHo
mePrice(000s)
0%
10%
20%
30%
40%
50%
60%
70%
Foreclos
ureResale%
In Bubble Markets, Prices Are Way Down Driven By aSurge in the Number of Homes Sold Out of Foreclosure
Source: MDA Dataquick. Note: Includes new construction
California
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Home Prices Are in an Unprecedented Freefall
Source: Standard & Poors, OFHEO Purchase-Only Index, NATIONAL ASSOCIATION OF REALTORS Existing Home Sales data series
100
120
140
160
180
200
220
Q12000
Q22000
Q32000
Q42000
Q12001
Q22001
Q32001
Q42001
Q12002
Q22002
Q32002
Q42002
Q12003
Q22003
Q32003
Q42003
Q12004
Q22004
Q32004
Q42004
Q12005
Q22005
Q32005
Q42005
Q12006
Q22006
Q32006
Q42006
Q12007
Q22007
Q32007
Q42007
Q12008
Q22008
Q32008
Q42008
S&P/Case-Shiller U.S. National Home Price Index
S&P/Case-Shiller 20-City Composite
OFHEO Purchase-Only Index
NAR Median Sales Price of Existing Homes
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Home Prices Need to Fall Another 13% to Reach Trend Line
Sources: Robert J. Shiller, Irrational Exuberance, 2nd. Edition, Princeton University Press,2005, Broadway Books 2006,also Subprime Solution, 2008, as updated by author at http://www.econ.yale.edu/~shiller/data.htm
100
120
140
160
180
200
220
1950
1954
1958
1962
196
6
197
0
197
4
197
8
1982
1986
1990
1994
1998
2002
2006
RealHomePriceIndex(1890=100)
-13% to
Trend
Trend Line
-32% fromPeak
The Housing Affordability Index Shows
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14
16
18
20
22
24
26
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
MortgagePay
mentonMedianPriced
Homeas%o
fFamilyIn
come
The Housing Affordability Index ShowsHouses Are Now Affordable
Source: NATIONAL ASSOCIATION OF REALTORS Housing Affordability Index
Before concluding that houses are cheap, however, there are three big caveats: first, low rates are only
available to those who qualify for conforming mortgages, which doesnt help millions of homeowners orpotential homeowners who have spotty credit histories or are underwater on their current mortgages.Second, with low enough interest rates, almost anything looks affordable; if rates rise, houses wont lookso reasonably priced based on these metrics. Finally, in light of the severe economic downturn, averageincome may fall for quite some time.
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Mortgage Rates Have Fallen Recently
Source: HSH Associates, Yahoo! Finance.com
2
3
4
5
6
7
8
Feb-04
May-0
4
Aug-04
Nov-04
Feb-05
May-0
5
Aug-05
Nov-05
Feb-06
May-0
6
Aug-06
Nov-06
Feb-07
May-0
7
Aug-07
Nov-07
Feb-08
May-0
8
Aug-08
Nov-08
Feb-09
Rate(%)
Jumbo 30 Yr FRMJumbo 5/1 Hybrid ARM
Conforming 30 Yr FRM
Conforming 5/1 Hybrid ARM
10-Year Treasury
The Home Price-to-Rent Ratio Has
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The Home Price-to-Rent Ratio HasReturned to Normal Levels
Source: NATIONAL ASSOCIATION OF REALTORS Existing Home Sales data series, U.S. Census Bureau, T2 Partners estimates
15
17
19
21
23
25
27
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
MedianHomePric
etoMedianGrossRent
A Study of Bubbles Shows That All of Them
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Commodities
Currencies
Note: For S&P charts, trend is 2% real price appreciation per year. Source: GMO. Data through 10//10/08.
* Detrended Real Price is the price index divided by CPI+2%, since the long-term trend increase in the price of the S&P 500 has been on the order of 2% real.
StocksS&P 500
1920-1932
0.3
0.8
1.3
1.8
2.3
20 21 22 23 24 25 26 27 28 29 30 31
DetrendedRealPrice
Trend Line
S&P 500
1946-1984
0.0
0.5
1.0
1.5
2.0
2.5
4 6 5 0 5 4 5 8 6 2 6 6 7 0 7 4 7 8 8 2
DetrendedRealPrice
Trend Line
Japan vs. EAFE ex-Japan
1981-1999
0.0
0.5
1.0
1.5
2.0
2.5
3.0
8 1 83 8 5 8 7 89 9 1 9 3 95 9 7 9 9
RelativeReturn
Trend Line
S&P 500
1992-October 2008
0.8
1.2
1.6
2.0
2.4
92 94 9 6 98 00 02 0 4 0 6 08
Detrended
RealPrice
Trend Line
U.S. Dollar
1979-1992
0.8
1.0
1.2
1.4
1.6
1.8
2.0
79 81 83 85 87 89 91
CumulativeReturn
U.K. Pound
1979-1985
0.8
0.9
1.0
1.1
1.2
1.3
1.4
79 80 81 82 83 84
CumulativeReturn
Japanese Yen
1983-1990
0.8
0.9
1.0
1.1
1.2
1.3
1.4
83 84 85 86 87 88 89 90
CumulativeReturn
Japanese Yen
1992-1998
0.8
0.9
1.0
1.1
1.2
1.3
1.4
92 93 94 95 96 97
CumulativeReturn
Gold
1970-1999
0
40 0
80 0
1200
1600
2000
70 74 78 82 86 90 94 98
RealPrice
Crude Oil
1962-1999
0
20
40
60
80
6 2 6 6 7 0 7 4 7 8 8 2 8 6 9 0 9 4 9 8
RealPrice
Nickel
1979-1999
0
50
100
150
200
250
79 81 83 85 87 89 91 93 95 97
RealPrice
Cocoa
1970-1999
0
10 0
20 0
30 0
40 0
50 0
60 0
70 74 78 82 86 90 94 98
RealPrice
*
A Study of Bubbles Shows That All of ThemEventually Return to Trend Line
The Biggest Danger is That Home Prices Overshoot on the
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The Biggest Danger is That Home Prices Overshoot on theDownside, Which Often Happens When Bubbles Burst
Source: GMO
0.00
0.25
0.50
0.75
1.00
1.25
1.50
1.75
2.00
2.25
2.50
1927 1930 1933 1936 1939 1942 1945 1948 1951 1954
DetrendedRealS&P500StockPriceIndex
-59%
Overrun: 59%
Fair Value to Bottom: 1.5 Years
Fair Value to Fair Value: 23 Years
0.00
0.25
0.50
0.75
1.00
1.25
1.50
1.75
2.00
2.25
1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1976 1978 1980 1982 1984 1986
DetrendedRealS&P500Stoc
kPriceIndex
-45%
Overrun: 45%
Fair Value to Bottom: 7 Years
Fair Value to Fair Value: 12 Years
S&P 500 1927-1954
S&P 500 1955-1986
Home Prices Have Already Crashed Through the Trend
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Home Prices Have Already Crashed Through the TrendLine in California And There Is No Sign of Stabilization
Source: Reprinted with permission of the California Association of REALTORS . All rightsreserved. www.rebsonline.com, T2 Partners estimates.
$0
$100
$200
$300
$400
$500
$600
Jan-79
Jan-81
Jan-83
Jan-85
Jan-87
Jan-89
Jan-91
Jan-93
Jan-95
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Median
Price($000s)
Median Sales Price
4% Trend
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Outlook for Housing Prices
We think housing prices will reach fair value/trend line down 40% from the peak
based on the S&P/Case-Shiller national (not 20-city) index, which implies a 10-15%further decline from where prices where as of the end of 2008. Its almost certain thatprices will reach these levels
The key question is whether housing prices will go crashing through the trend line andfall well below fair value? Unfortunately, this is very likely. In the long-term, housingprices will likely settle around fair value, but in the short-term prices will be driven both
by psychology as well as supply and demand. The trends in both are veryunfavorable Regarding the former, national home prices have declined for 30 consecutive months since
their peak in July 2006 through January 2009 and theres no end in sight, so this makesbuyers reluctant even when the price appears cheap and sellers desperate.
Regarding the latter, there is a huge mismatch between supply and demand, due largely tothe tsunami of foreclosures. In January 2009, distressed sales accounted for 45% of allexisting home sales nationwide and more than 60% in California. In addition, the shadowinventory of foreclosed homes already likely exceeds one year and there will be millions moreforeclosures over the next few years, creating a large overhang of excess supply that willlikely cause prices to overshoot on the downside, as they are already doing in California.
Therefore, we expect housing prices to decline in the 45-50% range, bottomingin mid-2010
We are also quite certain that wherever prices bottom, there will be no quick rebound Theres too much inventory to work off quickly, especially in light of the millions of
foreclosures over the next few years. While foreclosure sales are booming in many areas, regular sales by homeowners have
plunged, in part because people usually cant sell when theyre under water on theirmortgage and in part due to human psychology: people naturally anchor on the price they
paid or what something was worth in the past and are reluctant to sell below this level. Wesuspect that there are millions of homeowners like this who will emerge as sellers at the firstsign of a rebound in home prices.
Finally, we dont think the economy is likely to provide a tailwind, as we expect it to contractthe rest of 2009, stagnate in 2010, and only then grow tepidly for some time thereafter.
There Have Been 5 Million Jobs Lost So Far in This
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There Have Been 5 Million Jobs Lost So Far in ThisRecession, More Than 3 Million in the Past Five Months
Source: Bureau of Labor Statistics
-1000
-800
-600
-400
-200
0
200
400
600
Jan-90
Jan-91
Jan-9
2
Jan-9
3
Jan-9
4
Jan-95
Jan-9
6
Jan-9
7
Jan-9
8
Jan-99
Jan-00
Jan-0
1
Jan-0
2
Jan-03
Jan-04
Jan-0
5
Jan-0
6
Jan-07
Jan-08
Jan-0
9
ChangeinNonfarm
PayrollEmployment
(000s)
There have been job
losses every monthsince December 2007
The Unemployment Rate Jumped to 8 5% in March
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3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
Jan-70
Jan-73
Jan-76
Jan-79
Jan-82
Jan-85
Jan-88
Jan-91
Jan-94
Jan-97
Jan-00
Jan-03
Jan-06
Jan-09
Unemplo
ymentRate
The Unemployment Rate Jumped to 8.5% in March,the Highest Level Since 1983
Source: Bureau of Labor Statistics
If part-time and discouraged workers are factored in, the unemployment
rate would have been 15.6% in March. In addition, the average workweek in dropped to 33.2 hours, a new record low.
The Decline from Peak Employment Now
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The Decline from Peak Employment NowExceeds the Past Five Recessions
Source: Bureau of Labor Statistics
-4.0%
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0 6 12 18 24 30 36 42 48Months after pre-recession peak
1980 2001-051990-931974-76
2007-
1981-83
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Consumer Confidence is at an All-Time Low
0
20
40
60
80
100
120
140
160
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
ConsumerC
onfidenceIndex
Near all-time low
Note: 1985=100
Source: The Conference Board (www.pollingreport.com/consumer.htm)
Banks are Tightening Consumer Credit and
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Banks are Tightening Consumer Credit andNew Household Borrowing Has Plunged
Source: Federal Reserve
Household Borrowing 1990-2008(Seasonally-Adjusted Annual Rate)
$0
$200
$400
$600
$800
$1,000
$1,200
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
($ billions)
Percent of US Banks Tightening Consumer Credit
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
Jan-00
Sep-00
May
-01Ja
n-02Se
p-02M
ay-03
Jan-04
Sep-04
May
-05Ja
n-06Se
p-06M
ay-07
Jan-08
Sep-08
Credit Cards Other Consumer Loans
The Credit Bubble Led to a Bubble in
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Sources: Federal Reserve, BEA, as of Q2 2007, GMO presentation
Low Debt Era Rising Debt Era
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05
FinancialP
rofitsasPercen
tofGDP
100%
150%
200%
250%
300%
350%
TotalDebtasPercen
tofGDP
Dec-
Total Debt
Financial Profits
The Credit Bubble Led to a Bubble inFinancial Profits (& Share of GDP)
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The Outlook Is Grim
Defaulting subprime and Alt-A loans drove the first stage of themortgage crisis
The next leg down of the mortgage crisis will be driven by
defaulting Alt-A, Option ARM, jumbo prime and prime loans aswell as home equity lines of credit (HELOCs) and second liens(closed-end seconds)
Losses outside of the mortgage sector will also continue to rise
due to commercial real estate, leveraged loans, junk bonds, etc.
The Wave of Resets from Subprime Loans
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$0
$5
$10
$15
$20
$25
$30
$35
Jan-
06
Apr-0
6
Jul-0
6
Oct-0
6
Jan-
07
Apr-0
7
Jul-0
7
Oct-
07
Jan-
08
Apr-0
8
Jul-0
8
Oct-0
8
Jan-
09
Apr-0
9
Jul-0
9
Oct-0
9
Jan-
10
Apr-1
0
Jul-1
0
Oct-1
0
LoanswithPaymentShock(Bn)
Sources: LoanPerformance, Deutsche Bank; slide from Pershing Square presentation, How to Save the Bond Insurers, 11/28/07.
pIs Mostly Behind Us
We are
here
But a Wave of Alt A Resets Is Ahead of Us
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$0
$1
$2
$3
$4
$5
$6
$7
$8
$9
$10
Jan-
10
Jul-1
0
Jan-
11
Jul-1
1
Jan-
12
Jul-1
2
Jan-
13
Jul-1
3
Jan-
14
Jul-1
4
Jan-
15
Jul-1
5
Months to 1st reset
Amount(Bn)
$0
$50
$100
$150
$200
$250
$300
EstimatedCu
mulativeResetAmou
nt(Bn)
Sources: Credit Suisse, LoanPerformance
But a Wave of Alt-A Resets Is Ahead of Us
We are
here
There Are $2.5 Trillion of Alt-A Loans Outstanding
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$0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 $5.0
CDO/ CLO
Other Consumer
Construction & Development
Option ARM
Auto
Credit Card
Home Equity
Jumbo Prime
High-Yield / Leveraged Loans
Subprime
Commercial & Industrial
Other Corporate
Alt-A
Commercial Real Estate
Prime Mortgage
Amount Outstanding (Trillion)
$ gWhen One Includes Those Held by the GSEs
Sources: Federal Reserve Flow of Funds Accounts of the United States, IMF Global Financial Stability Report October 2008, Goldman SachsGlobal Economics Paper No. 177, FDIC Quarterly Banking Profile, OFHEO, S&P Leverage Commentary & Data, T2 Partners estimates
D li i f S iti d Alt A M t A S i
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Delinquencies of Securitized Alt-A Mortgages Are Soaring
0%
5%
10%
15%
20%
25%
Jan-99
May-99
Sep-9
9
Jan-
00
May-0
0
Sep-
00
Jan-
01
May-
01
Sep-
01
Jan-
02
May-0
2
Sep-
02
Jan-
03
May-0
3
Sep-
03
Jan-
04
May-0
4
Sep-0
4
Jan-
05
May-0
5
Sep-
05
Jan-
06
May-
06
Sep-
06
Jan-
07
May-0
7
Sep-
07
Jan-
08
May-0
8
Sep-
08
Jan-
09
PercentN
oncurrent(60+days)
Sources: Amherst Securities, LoanPerformance
Alt-A Delinquencies By Vintage Show the Collapse
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q y g pin Lending Standards in 2006 and 2007
0%
5%
10%
15%
20%
25%
30%
0 5 10 15 20 25 30 35 40 45 50 55 60
Months of Seasoning
PercentN
oncurrent(60+days)
2007 2006
2005
2004
2003
Sources: Amherst Securities, LoanPerformance
O
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An Option ARM is an adjustable rate mortgage typically made to a primeborrower Sold under various names such as Pick-A-Pay
Banks typically relied on the appraised value of the home and the borrowershigh FICO score, so 83% of Option ARMs written in 2004-2007 were low- or no-
doc (liars loans) Each month, the borrower can choose to pay: 1) the fully amortizing interest andprincipal; 2) full interest; or 3) an ultra-low teaser interest-only rate (typically 2-3%), in which case the unpaid interest is added to the balance of the mortgage(meaning it is negatively amortizing) Approximately 80% of Option ARMs are negatively amortizing
Lenders, however, booked earnings as if the borrowers were making full interestpayments
A typical Option ARM is a 30- or 40-year mortgage that resets (recasts) afterfive years, when it becomes fully amortizing If an Option ARM negatively amortizes to 110-125% of the original balance (depending
on the terms of the loan), this triggers a reset even if five years have not elapsed Upon reset, the average monthly payment jump 63% from $1,672 to $2,725
($32,700 annually)
My sense is that many option ARM borrowers are in a worse position thansubprime borrowers, says Kevin Stein, associate director of the California
Reinvestment Coalition, which combats predatory lending. They wind up owingmore and the resets are more significant.
A Primer on Option ARMs
About $750 Billion of Option ARMs Were Written
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Source: Reprinted with permission, 2008 Mortgage Market Statistical Annual, published by InsideMortgage Finance Publications, Inc. Copyright 2008. T2 Partners estimates
About $750 Billion of Option ARMs Were Written
5%
9%
1%
8%
5%
$0
$50
$100
$150
$200
$250
$300
2004 2005 2006 2007 2008
Originations(Bn)
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
PercentofTotal
Options ARMs Were a Bubble State Phenomenon
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Options ARMs Were a Bubble State Phenomenon
Source: Amherst Securities, LoanPerformance
CA, 58%
FL, 10%
NV, 3%
AZ, 3%
HI, 1%
Other, 25%
Beginning in March 2005, High-FICO-Score Borrowers Opted for an
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g g , g pAbove-Market-Rate Option ARM in Exchange for the Low Teaser Rate
Source: Amherst Securities, Bloomberg Finance L.P.
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
8.5
Jan-
02
Apr-0
2
Jul-0
2
Oct-0
2
Jan-
03
Apr-0
3
Jul-0
3
Oct-0
3
Jan-
04
Apr-0
4
Jul-0
4
Oct-0
4
Jan-
05
Apr-0
5
Jul-0
5
Oct-0
5
Jan-
06
Apr-0
6
Jul-0
6
Oct-0
6
Jan-
07
Apr-0
7
Jul-0
7
Oct-0
7
Jan-
08
InterestRate(%)
Fannie Mae 30 Year FRM IndexOption ARM Index
Option ARM borrowers during this period(when nearly all option ARMS were written)were saying they couldnt afford a fully-
amortizing mortgage otherwise theywould have taken one
Delinquencies of Securitized Option ARMs Are Soaring
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Delinquencies of Securitized Option ARMs Are Soaring
Sources: Amherst Securities, LoanPerformance
0%
5%
10%
15%
20%
25%
30%
35%
Jan-99
May-99
Sep-9
9
Jan-
00
May-0
0
Sep-
00
Jan-
01
May-
01
Sep-
01
Jan-
02
May-0
2
Sep-
02
Jan-
03
May-0
3
Sep-
03
Jan-
04
May-0
4
Sep-0
4
Jan-
05
May-0
5
Sep-
05
Jan-
06
May-
06
Sep-
06
Jan-
07
May-0
7
Sep-
07
Jan-
08
May-0
8
Sep-
08
Jan-
09
PercentN
oncurrent(60+days)
Option ARM Delinquencies By Vintage Show the
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Collapse in Lending Standards in 2005-2007
Sources: Amherst Securities, LoanPerformance
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
0 5 10 15 20 25 30 35 40 45 50 55 60
Months of Seasoning
PercentNoncurrent(60+days) 2007
2006
2005
2004
2003
Delinquencies of Securitized Jumbo Prime
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-49-
Mortgages Are Soaring
Sources: Amherst Securities, LoanPerformance
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
Jan-99
May-99
Sep-9
9
Jan-
00
May-0
0
Sep-
00
Jan-
01
May-
01
Sep-
01
Jan-
02
May-0
2
Sep-
02
Jan-
03
May-0
3
Sep-
03
Jan-
04
May-0
4
Sep-0
4
Jan-
05
May-0
5
Sep-
05
Jan-
06
May-
06
Sep-
06
Jan-
07
May-0
7
Sep-
07
Jan-
08
May-0
8
Sep-
08
Jan-
09
Percent
Noncurrent(60+days)
Delinquencies of Prime Mortgages Are Soaring
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Delinquencies of Prime Mortgages Are Soaring
Sources: Mortgage Bankers Association National Delinquency Survey
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
Q1
1999
Q31
999
Q12
000
Q3
2000
Q1
2001
Q32
001
Q12
002
Q32
002
Q12
003
Q32
003
Q12
004
Q32
004
Q12
005
Q32
005
Q12
006
Q32
006
Q12
007
Q32
007
Q12
008
Q32
008
PercentN
oncurrent(60+days)
HELOCs and Home Equity Loans Soared
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in Popularity During the Bubble
Home Equity & Junior Lien Loans ($ in billions)
$-
$100
$200
$300
$400
$500
$600
$700
$800
$900
$1,000
Mar-0
0
Jun-
00
Sep-
00
Dec-00
Mar-0
1
Jun-
01
Sep-
01
Dec-01
Mar-0
2
Jun-
02
Sep-
02
Dec-02
Mar-0
3
Jun-
03
Sep-
03
Dec-03
Mar-0
4
Jun-
04
Sep-
04
Dec-04
Mar-0
5
Jun-
05
Sep-
05
Dec-05
Mar-0
6
Jun-
06
Sep-
06
Dec-06
Mar-0
7
Jun-
07
Sep-
07
Dec-07
Mar-0
8
Jun-
08
Sep-
08
Home Equity Loans Junior Lien Mortgages
Note: Does not include approximately $200 billion of securitized HELOCs and junior liens
Source: FDIC Quarterly Banking Profile
Many Borrowers Used HELOCs to Buy New Cars
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As home prices have declined and other funding sources have driedup, millions of consumers have maxed out on home equity debt.
In hot markets like California and Florida, a significant percentage of allconsumers tapped into the value of their homes to help finance theirnew cars, according to CNW Marketing Research.
Clearly this dynamic does not bode well for HELOC recovery rates ornew car sales.
Source: New York Times 5/27/2008
Many Borrowers Used HELOCs to Buy New Cars
Delinquencies of HELOCs and CESs Are Soaring
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Delinquencies of HELOCs and CESs Are Soaring
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
Q12
004
Q22
004
Q32
004
Q42
004
Q1
2005
Q22
005
Q32
005
Q42
005
Q12
006
Q22
006
Q32
006
Q42
006
Q12
007
Q22
007
Q32
007
Q42
007
Q12
008
Q22
008
Q32
008
Q42
008
PercentNoncurrent(90+days)
Closed-End Junior LienMortgages
Home Equity Lines of Credit
Source: FDIC Quarterly Banking Profile
Pools of HELOCs and CESs Can SufferS
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0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59
Months Since Close
MonthlyLossR
ate(3maverage)
Ambac Projection April 2008 Actual
Astronomical Losses Due to 100%+ Severities
Source: Ambac Q1 08 presentation, Amherst Securities; funds managed by T2 Partners are short Ambac
On one second lien deal, Ambac expected losses of 10-12% when it guaranteed the senior
tranche. A year ago, Ambac admitted that the pool would likely lose 81.8% of its value andbased on the pools performance since then, this will almost certainly prove to be conservative.
From Ambac slide, 4/08:
This is a second lien deal that closed in April 2007 Loss to date 9.9% Projected loss: 81.8% Projected collateral loss as a % of current collateral: 86%
A reasonable estimate of projected collateral loss for theabove transaction might have been 10-12%, with thetransaction having an A+ rating at inception and beingstructured to withstand 28-30% collateral loss
The Timing Indicates That We Are Still in the MiddleI i f th B ti f th G t M t B bbl
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Innings of the Bursting of the Great Mortgage Bubble Mortgage lending standards became progressively worse starting in 2000, but really
went off a cliff beginning in early 2005 The worst loans were subprime ones, which generally had two-year teaser rates and
are now defaulting at unprecedented rates Such loans made in Q1 2005 started to default in high numbers upon reset in Q1
2007, which not surprisingly was the beginning of the current crises The crisis has continued to worsen as even lower quality subprime loans made over
the remainder of 2005 reset over the course of 2007, triggering more and moredefaults It takes an average of 15 months from the date of the first missed payment by a
homeowner to a liquidation (generally a sale via auction) of the home Thus, the Q1 2005 subprime loans that defaulted in Q1 2007 led to foreclosures and
auctions in early 2008
Given that lending standards got much worse in late 2005 through 2006 and into thefirst half of 2007, and the many other types of loans that are now with longer resetdates that are now starting to default at catastrophic rates, there are soberingimplications for expected defaults, foreclosures and auctions in 2009 and beyond,which promise to drive home prices down further
In summary, today we are only in the middle innings of an enormouswave of defaults, foreclosures and auctions that is hitting the UnitedStates. We predicted in early 2008 that it would get so bad that it wouldrequire large-scale federal government intervention which has
occurred, and were likely not finished yet.
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A Breakdown of Our Financial Sector Loss Estimates
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A Breakdown of Our Financial Sector Loss Estimates
Sources: T2 Partners estimates
$0 $100 $200 $300 $400 $500 $600 $700 $800
CDO/ CLO
Other Consumer
Construction & Development
Option ARM
Auto
Credit Card
Home Equity
Jumbo Prime
High-Yield / Leveraged Loans
Subprime
Commercial & Industrial
Other Corporate
Alt-A
Commercial Real Estate
Prime Mortgage
Amount (Bn)
Total Estimated
Financial Sector
Losses = $3.8 trillion
Institutions Have Been Able to Raise Capital to Mostly KeepU With W it d B t Thi Will Lik l N t C ti
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Up With Writedowns, But This Will Likely Not Continue
Sources: Bloomberg Finance L.P.
$0
$250
$500
$750
$1,000
$1,250
$1,500
Prior Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009
Amo
unt(Bn)
Losses & WritedownsCapital Raised
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To Learn More
More Mortgage Meltdown Will Be Available in Mid-May
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-61-
More Mortgage Meltdown Will Be Available in Mid-May
The Next Value Investing Congress is May 5-6 in Pasadena
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The Next Value Investing Congress is May 5 6 in Pasadena
Value Investor Insight and SuperInvestor Insight
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Value Investor Insight and SuperInvestor Insight