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

June 2, 2009
T2 Partners Management L.P. Is A
Registered Investment Advisor
145 E. 57th Street 10th Floor
New York, NY 10022
(212) 386-7160
Info@T2PartnersLLC.com
www.T2PartnersLLC.com
For more information…

3
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and Is the #1 Selling Investing Book in the Country

4
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October 19-20 in New York City
Register at www.valueinvestingcongress.com

5
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SuperInvestor Insight

6
 For the Second Half of the 20th Century,
Housing Was a Stable Investment

300
Shiller
Lawler
275
Real Home Price Index (1890=100)

250

225

200

175
Trend Line
150

125

100
0

8
5

9
19

19

19

19

19

19

19

19

19

19

19

19

19
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; Lawler Economic & Housing Consulting
7
…And Then Housing Prices Exploded

300
Shiller
Lawler
275
Real Home Price Index (1890=100)

250

225

200
Housing
Bubble
175
Trend Line
150

125

100
86

94

02
62

70

78

98

06
66

74

82

90
50

58
5

20
19

19

19

20
19

19
19

19

19

19
19

19
19

19

SOURCES: Robert J. Shiller, Irrational Exuberance: Second Edition, as updated by the author; Lawler Economic & Housing Consulting.
8
 From 2000-2006, the Borrowing Power of a
Typical Home Purchaser Nearly Tripled

$400,000
Pre-Tax Income
Borrowing Power

$300,000

$200,000

9.2x in January 2006

$100,000

3.3x in January 2000

$0
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

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
Source: Amherst Securities 9
Housing Became Unaffordable in Many
Areas

80
Riverside, CA
70 Los Angeles, CA
San Diego, CA

60
Housing Opportunity Index

50

40

30

20

10

07
05

06
96

97

98

99

00

02

04
0

20

20

20
19

20

20
19

19

19

20

20
1

3
1

1
Q

Q
SOURCES: NAHB/Wells Fargo Housing Opportunity Index, which measures percentage of households that could afford the average home with a standard
mortgage 10
Americans Have Borrowed Heavily Against Their Homes Such
That the Percentage of Equity in Their Homes Has Fallen
Below 50% for the First Time on Record Since 1945

$12,000 90%

80%
$10,000
70%

Equity as a % of Home Value

$8,000 60%
Mortgage Debt (Bn)

1945 50%
$6,000 Mortgage Debt: $18.6 billion
Equity: $97.5 billion
2008 40%
Mortgage Debt: $10.5 trillion
Equity: $8.5 trillion
$4,000 30%

20%
$2,000
10%

$0 0%
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

SOURCE: Federal Reserve Flow of Fund Accounts of the United States

11
There Was a Dramatic Decline in Mortgage
Lending Standards from 2001 through 2006
Combined Loan to Value 100% Financing
86 18%

84
17%
• In 2005, 29% of
84
83
16%
new mortgages
82
81 81
14%
14%
were interest only
80 12% — or less, in the
Combined Loan to Value (%)

Percent of Originations
78 10%
9%
case of Option
76
76
8%
8%
ARMs — vs. 1%
74
74
74 6%
in 2001
72 4%
3% • In 1989, the
70 2%
1%
average down
1%
68
2001 2002 2003 2004 2005 2006 2007
0% payment for first-
2001 2002 2003 2004 2005 2006 2007

time home buyers

Limited Documentation 100% Financing & Limited Doc was 10%; by
70% 12%
2007, it was 2%
65%
63% 11%

60%
• The sale of new
10%
56%
homes costing
49%
50%
45% 8% 8%
$750,000 or more
quadrupled from
Percent of Originations
Percent of Originations

40% 39%

33% 6%
5%
2002 to 2006.
30%
4% The construction
4%
20% of inexpensive
2%
1%
homes costing
10%

0%
$125,000 or less
0%
0%
2001 2002 2003 2004 2005 2006 2007
0%
2001 2002 2003 2004 2005 2006 2007
fell by two-thirds
SOURCES: Amherst Securities, LoanPerformance; USA Today (www.usatoday.com/money/economy/housing/2008-12-12-homeprices_N.htm) 12
Among the Many Causes of The Great
Mortgage Bubble, Two Stand Out

• The companies making crazy loans didn’t care very much if the
homeowner ended up defaulting for two reasons:
1. Either they didn’t 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 with
any subsequent losses) to investors around the world;
2. Or, if they did plan to hold the loan, they assumed home prices would keep
rising, such that homeowners could either refinance before loans reset or, if
the homeowner defaulted, the losses (i.e., severity) would be minimal.
• There were many other reasons, of course – a bubble of this
magnitude 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 vast
amounts 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 fall
asleep at the switch, not want to take the punch bowl away and/or get
bought 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, didn’t ask many questions and
took on too much leverage
– In general, everyone was suffering from irrational exuberance
13
 As Long As Home Prices Rise Rapidly,
Even Subprime Mortgages Perform Well –
But If Home Prices Fall, Look Out Below!
Cumulative Five-Year Loss Estimates for a Bubble-Era Pool of Subprime Mortgages
60%

50%

40%
Cumulative Loss (%)

30%

20%

10%

0%
20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40%
Home Price Appreciation

Source: T2 Partners estimates

14
Deregulation of the Financial Sector Led to a
Surge of Leverage, Profits and Compensation
Ratio of Financial Services Wages to Nonfarm Private-Sector Wages, 1910-2006

• Among the most profitable areas for Wall Street firms was producing Asset-Backed Securities
(ABSs) and Collateralized Debt Obligations (CDOs)
• 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 lend at higher
loan-to-value ratios, with ultra-low teaser rates, to uncreditworthy borrowers, and don’t bother
to verify their income and assets (thereby inviting fraud)
• There’s only one problem: DON’T EXPECT TO BE REPAID!
Source: Ariell Reshef, University of Virginia; Thomas Philippon, NYU; Wall St. Journal, 5/14/09 15
 Over the Past 30 Years, We Have Become a
Nation Gorged in Debt – To The Benefit of
Financial Services Firms

3.0% 350%
Low Debt Era Rising Debt Era
Financial Profits as Percent of GDP

2.5%

Total Debt as Percent of GDP

300%

2.0%
250%

1.5%
Total Debt

Financial Profits 200%

1.0%

150%
0.5%

0.0% 100%
Dec- 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05

Sources: Federal Reserve, BEA, as of Q2 2007, GMO presentation

16
There Was a Surge of Toxic Mortgages
Over the Past 10 Years

$4,000
Conforming, FHA/VA
Jumbo
$3,500 Alt-A
Subprime
Seconds
$3,000

$2,500
Originations (Bn)

$2,000

$1,500

$1,000

$500

$0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

SOURCE: Inside Mortgage Finance, published by Inside Mortgage Finance Publications, Inc. Copyright 2009.
17
Private Label Mortgages (Those Securitized by
Wall St.) Are 15% of All Mortgages, But Are 51%
of Seriously Delinquent Mortgages

Approximately two-thirds of homes have mortgages and of these, 56% are owned or
guaranteed by the two government-sponsored enterprises (GSEs), Fannie & Freddie
Number of Seriously
Number of Mortgages (million) Delinquent Mortgages (000)

Banks & Thrifts

Banks & Thrifts 397 Fannie Mae
8
444

Fannie Mae
Freddie Mac
18
232
Private Label
15% 8
Ginne Mae/FHA
378

Ginne Mae/FHA
6
Private Label
Freddie Mac 1734
13
51%

SOURCE: Freddie Mac, Q4 2008.

18
 Percentage of Home Loans
Q
4
Q 19

0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
4 7
Q 19 9
4 80
Q 19
4 8
Q 19 1
4 82
Q 19
4 8
Q 19 3
4 84
Q 19
4 8
Q 19 5
4 86
Q 19
4 87
Q 19
4 88
Q 19
4 89
Q 1 99
4 0
Q 19
4 91
Q 19
4 92
Q 19
4 93
Q 19
4 9
Q 19 4
4 95
Q 19
4 9
Q 19 6
4 97
Q 19
4 9
Q 19 8
4 99
Q 20
4 0
Q 20 0
4 01
Q 20
4 0
Over 9% of Mortgages on 1-to-4-Family Homes

Q 20 2
4 03
Were Delinquent or in Foreclosure as of Q1 2009

Q 20
4 0
Q 20 4
4 05
SOURCE: National Delinquency Survey, Mortgage Bankers Association. Note: Delinquencies (60+ days) are seasonally adjusted.

Q 20
4 06
Q 2 00
4 7
20
08
19
All Types of Loans, Led by Subprime, Are
Seeing a Surge in Delinquencies

45%
Alt A
Option ARM
40%
Jumbo
Subprime
35% Prime
Home Equity Lines of Credit
30%
Percent Noncurrent

25%

20%

15%

10%

5%

0%
Q 00

Q 01

Q 01
Q 99

Q 99

Q 00

Q 02

Q 03

Q 03

Q 04

Q 04

Q 05

Q 06

Q 06

Q 07

Q 08
08
Q 07
Q 02

Q 05
20

20

20

20

20

20
20
20

20

20
19

19

20

20
20

20

20

20

20

20
3

1
1

3
1

3
1

1
Q

SOURCES: Amherst Securities, LoanPerformance; National Delinquency Survey, Mortgage Bankers Association; FDIC Quarterly Banking Profile;
T2 Partners estimates. Note: Prime is seasonally adjusted. 20
 The Decline in Lending Standards Led to a
Surge in Subprime Mortgage Origination

$700 25%

$600
20%
20% 20%

18% % of
$500
T ota l
Origina tions
(Bn)

15%
$400

$300
10% 10% 10%
10% 10%
9% 9%
9%
8%
$200 7% 8%
7%

5%

$100

$0 0%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: Reprinted with permission; Inside Mortgage Finance, published by Inside Mortgage
Finance Publications, Inc. Copyright 2009.
21
 The Wave of Resets from Subprime
Loans Is Mostly Behind Us

$35

$30 We are
here
$25
Loans with Payment Shock (Bn)

$20

$15

$10

$5

$0
07

0
6

08

09
7

0
6

0
6

09

10
06

9
-0

-0

-1
-0

l-0

l-0

l-1
l-0

r-0

-0

-0

-1
-0

l-0

n-
n-

n-

r-

n-
n-

ct
pr

pr
pr

ct

ct

ct
ct

Ju

Ju

Ju
Ju

Ju
Ap

Ap
Ja

Ja

Ja

Ja
Ja

O
O

A
A

Sources: LoanPerformance, Deutsche Bank; slide from Pershing Square presentation, How to Save the Bond Insurers, 11/28/07. 22
Numerous Areas of the Mortgage Market Will
Suffer Significant Losses Going Forward

Prime Mortgage

Commercial Real Estate

Alt-A

Other Corporate

Commercial & Industrial

Subprime

High-Yield / Leveraged Loans

Jumbo Prime

Home Equity

Credit Card

Auto

Option ARM

Construction & Development

Other Consumer

CDO/ CLO

$0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 $5.0
Amount Outstanding (Trillions)

SOURCES: Federal Reserve Flow of Funds Accounts of the United States, IMF Global Financial Stability Report October 2008, Goldman Sachs Global
Economics Paper No. 177, FDIC Quarterly Banking Profile, OFHEO, S&P Leverage Commentary & Data, T2 Partners estimates. 23
Two Waves of Losses Are Behind Us…
But Three Are Looming

Losses Mostly Behind Us

• Wave #1: Borrowers committing (or the victim of) fraud & speculators, who
defaulted quickly. Timing: beginning in late 2006 (as soon as home prices
started to fall) into 2008. Mostly behind us.
• Wave #2: Borrowers who defaulted when their mortgages reset due to
payment shock. Timing: early 2007 (as two-year teaser subprime loans
written in early 2005 started to reset) to the present. Now tapering off as
low interest rates mitigate payment shock.
Losses Mostly Ahead of Us
• Wave #3: Prime loans (most of which are owned or guaranteed by the
GSEs) defaulting due to job loss and home price declines (i.e., underwater
homeowners). Timing: started to surge in early 2008 to the present.
• Wave #4: Jumbo prime, second lien and HELOCs (most of which are on
banks’ books) defaulting due to job loss and home price declines/
underwater homeowners. Timing: started to surge in early 2008 to the
present.
• Wave #5: Losses among loans outside of the housing sector, the largest of
which will be in the $3.5 trillion area of commercial real estate. Timing:
started to surge in early 2008 to the present.

24
Recent Signs of Stabilization Are Likely
the Mother of All Head Fakes

• Rather than representing a true bottom, recent signs of stabilization

are likely due to two short-term factors:
1. Home sales and prices are seasonally strong in April, May and June
due to tax refunds and the spring selling season
2. A temporary reduction in the inventory of foreclosed homes
– Shortly after Obama was elected, his administration promised a new, more
robust plan to stem the wave of foreclosures so the GSEs and many other
lenders imposed a foreclosure moratorium
– Early this year, the Obama administration unveiled its plan, the Homeowner
Affordability and Stabilization Plan, which is a step in the right direction –
but even if it is hugely successful, we estimate that it might only save 20%
of homeowners who would otherwise lose their homes
– The GSEs and other lenders are now quickly moving to save the
homeowners who can be saved – and foreclose on those who can’t
– This is necessary to work our way through the aftermath of the bubble, but
will lead to a surge of housing inventory later this year, which will further
pressure home prices

25
There Is a Surge of Notices of Default and
Foreclosures Among the GSEs

Prime Notices of Default

Subprime Notices of Default

Subprime Foreclosures
Prime Foreclosures

SOURCE: The Field Check Group.

26
Future Losses Will Be Driven By Three
Primary Factors

1. The Economy
• Especially unemployment
2. Interest rates
• Ultra-low rates have helped mitigate some of the damage
• But if the recent spike in rates continues, it could lead to an even greater surge
in defaults and losses
3. Behavior of homeowners who are underwater
• Roughly one-fourth of homeowners with mortgages are currently underwater,
some deeply so
• For many, it is economically rational for them to walk – so called “jingle mail” –
but how many will do so?
• There is little historical precedent – we are in uncharted waters
• As home prices continue to fall and homeowners become more and more
underwater, they are obviously more likely to default, thereby creating a vicious
cycle, but what exactly will the relationship be? Have millions of foreclosures led
to a diminution of the stigma of losing one’s home?
• Our best guess is that there will be rough symmetry: for homeowners 5%
underwater, an additional 5% will default due to being underwater; 10%
underwater will lead to 10% more defaults, and so forth…

27
 24% of Homeowners With a Mortgage Owe
More Than the Home Is Worth, Making
Them Much More Likely to Default
Among people who bought homes in the past five years, 30%+ are underwater*
In Bubble Markets, Far More
Homeowners Are Underwater
Price Index Is % of Last 5 Yrs
at Lowest Price Drop Purchasers Who
Metro Area Level Since Since Peak Are Under Water* There Has Been a Dramatic Rise in
New York 2004-Q3 -15.2% 23.0% Homeowners Who Are Underwater
Los Angeles 2003-Q4 -32.0% 56.4%
Boston 2002-Q2 -21.8% 27.8%
25%
24%
Washington 2004-Q1 -24.8% 50.3%
Miami 2004-Q1 -36.6% 65.1%
San Francisco 2003-Q3 -27.8% 51.2%
20%
Atlanta 2004-Q4 -10.4% 23.2%
20%
San Diego 2002-Q4 -34.4% 63.9%
Phoenix 2004-Q3 -37.7% 36.4%
16%
Las Vegas 2003-Q4 -41.8% 61.4%
Percent Underwater

15%

* The actual figures are likely even worse,

as this data doesn’t capture people who
bought since 2003 and subsequently did a 10%

cash-out refi or after-the-fact second

mortgage. 50% of all subprime and Alt-A 6%

loans in existence when the collapse 5%

4%

happened were cash-out refis that carried a

higher loan balance than the original
0%
purchase loan amount. Dec-06 Dec-07 Sep-08 Dec-08 Mar-09

Source: Zillow.com Q4 08 Real Estate Market Report; Moody's Economy.com, First American CoreLogic, T2 Partners estimates 28
Certain Types of Loans Are Severely
Underwater

80%

73%
70%

60%

50%
Percent Underwater

50%
45%

40%

30%
25%

20%

10%

0%
Prime Alt A Subprime Option ARM

SOURCES: Amherst Securities, LoanPerformance, Standard & Poor’s.

29
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 5-10% further decline from where
prices where as of the end of Q1 2009. It’s almost certain that prices will reach these levels
• The key question is whether housing prices will go crashing through the trend line and fall well
below fair value. Unfortunately, this is very likely. In the long-term, housing prices 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 very unfavorable
– Regarding the former, national home prices have declined for 33 consecutive months since their peak in July
2006 through April 2009 and there’s no end in sight, so this makes buyers reluctant – even when the price
appears cheap – and sellers desperate.
– Regarding the latter, there is a huge mismatch between supply and demand, due largely to the tsunami of
foreclosures. In March 2009, distressed sales accounted for just over 50% of all existing home sales
nationwide – and more than 57% in California. In addition, the “shadow” inventory of foreclosed homes
already likely exceeds one year and there will be millions more foreclosures over the next few years,
creating a large overhang of excess supply that will likely cause prices to overshoot on the downside, as
they are already doing in California.
• Therefore, we expect housing prices to decline 45-50% from the peak, bottoming in mid-2010
• We are also quite certain that wherever prices bottom, there will be no quick rebound
• There’s 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 can’t sell when they’re underwater on their mortgage 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. We suspect that there are millions of
homeowners like this who will emerge as sellers at the first sign of a rebound in home prices
• Finally, we don’t think the economy is likely to provide a tailwind, as we expect it to contract the
rest of 2009, stagnate in 2010, and only then grow tepidly for some time thereafter

30
 Percent Noncurrent (60+ days)
Q
1

0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
19
Q 99
3
19
Q 99
1
Are Soaring

20
Q 00
3
20
Q 00
1
20
Q 01
3
20
Q 01
1
20
Q 02
3
20
Q 02
1
20
Q 03

SOURCE: Mortgage Bankers Association National Delinquency Survey.

3
20
Q 03
1
20
Q 04
3
20
Q 04
1
20
Q 05
3
Delinquencies of Prime Mortgages

20
Q 05
1
20
Q 06
3
20
Q 06
1
20
Q 07
3
20
Q 07
1
20
Q 08
3
20
08
31
15 States With the Highest Prime
Mortgage Foreclosure Rates

SOURCE: New York Times, 5/24/09.

32
Delinquencies of Prime and Alt-A
Mortgages Are Soaring

SOURCE: New York Times, 5/24/09.

33
There Are $2.4 Trillion of Alt-A Mortgages
and Their Resets Are Mostly Ahead of Us

$300
$10
We are $9
here

$250
Estimated Cumulative Reset Amount (Bn)
$8

$7

$200
$6
Amount (Bn)

$150
$5

$4

$100
$3

$2

$50
$1

$0
$0
4
0

15
10

12

13

5
3
1

14
11

l-1
l-1

l- 1

l-1

l-1

l-1
n-
n-

n-
n-

n-
n-

Ju
Ju

Ju

Ju

Ju

Ju
Ja

Ja
Ja

Ja

Ja

Ja

SOURCES: Credit Suisse, LoanPerformance.

34
NOTE: This chart only shows resets for a small fraction of Alt-A loans, but is representative of all of them.
 Percent Noncurrent (60+ days)
Ja
n-

0%
5%
10%
15%
20%
25%
99
Ju
l-9
Ja 9
n-
0
Ju 0
l-0
Ja 0
n-
01
Ju

SOURCES: Amherst Securities, LoanPerformance.

l-0
Ja 1
n-
0
Ju 2
l-0
Mortgages Are Soaring

Ja 2
n-
03
Ju
l-0
Ja 3
n-
0
Ju 4
l-0
Ja 4
n-
05
Ju
l-0
Delinquencies of Securitized Alt-A

Ja 5
n-
0
Ju 6
l-0
Ja 6
n-
07
Ju
l-0
Ja 7
n-
0
Ju 8
l-0
Ja 8
n-
09
35
Alt-A Delinquencies By Vintage Show the
Collapse in Lending Standards in 2006 and 2007

30%

2007 2006
25%
Percent Noncurrent (60+ days)

20%

15%
2005

10%
2004

5%
2003

0%
0 5 10 15 20 25 30 35 40 45 50 55 60
Months of Seasoning

SOURCES: Amherst Securities, LoanPerformance.

36
 Percent Noncurrent (60+ days)
Ja
n-

0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
99
Ju
l-9
Ja 9
n-
0
Ju 0
l-0
Ja 0
n-
01
Ju

SOURCES: Amherst Securities, LoanPerformance.

l-0
Ja 1
n-
02
Ju
l-0
Mortgages Are Soaring

Ja 2
n-
03
Ju
l-0
Ja 3
n-
04
Ju
l-0
Ja 4
n-
05
Ju
l-0
Ja 5
n-
06
Ju
l-0
Ja 6
n-
07
Ju
l-0
Delinquencies of Securitized Jumbo Prime

Ja 7
n-
08
Ju
l-0
Ja 8
n-
09
37
HELOCs and Home Equity Loans Soared
in Popularity During the Bubble

$1,000
Closed-End Junior Lien Mortgages
$900
Home Equity Lines of Credit

$800

$700

$600
Amount (Bn)

$500

$400

$300

$200

$100

$0
03

05

06

07

08
00

02
01

0
20

20

20
20

20

20

20
20

20

1
1

1
1

Q
Q

Note: Does not include approximately $200 billion of securitized HELOCs and junior liens. SOURCE: FDIC Quarterly Banking Profile.
38
Many Borrowers Used HELOCs to Buy
New Cars

• As home prices have declined and other funding sources have dried up,
millions of consumers have maxed out on home equity debt.
• In hot markets like California and Florida, a significant percentage of all
consumers tapped into the value of their homes to help finance their new
cars, according to CNW Marketing Research.

• Clearly this dynamic does not bode well for HELOC recovery rates or new
car sales.
SOURCE: New York Times 5/27/2008.
39
Delinquencies of HELOCs and CESs
Are Soaring

4.5%
Closed-End Junior Lien Mortgages
Home Equity Lines of Credit
4.0%

3.5%
Percent Noncurrent (90+ days)

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%
4

Q 04

Q 05

Q 05

Q 06

Q 07

Q 07

Q 08

Q 08
04

Q 004

Q 005

Q 05

Q 06

Q 006

Q 006

Q 07

Q 007

Q 008

Q 008

09
0
20

20

20

20

20

20

20

20

20

20

20

20

20
20
2

2
3

1
1

1
Q

SOURCE: FDIC Quarterly Banking Profile.

40
 A Primer on Option ARMs

• An Option ARM is an adjustable rate mortgage typically made to a prime borrower

• Sold under various names such as “Pick-A-Pay”
• Banks typically relied on the appraised value of the home and the borrower’s high
FICO score, so 83% of Option ARMs written in 2004-2007 were low- or no-doc (liar’s
loans)
• Each month, the borrower can choose to pay: 1) the fully amortizing interest and
principal; 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 interest
payments
• A typical Option ARM is a 30- or 40-year mortgage that resets (“recasts”) after five
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 can jump significantly, though the payment
shock is currently mitigated by ultra-low interest rates
• ‘My sense is that many option ARM borrowers are in a worse position than subprime
borrowers,’ says Kevin Stein, associate director of the California Reinvestment
Coalition, which combats predatory lending. ‘They wind up owing more and the resets
are more significant.’ 41
About $750 Billion of Option ARMs Were
Written, Nearly All at the Peak of the Bubble

$300 9%
9%
8%
$250 8%
7%

$200 6%
Originations (Bn)

Percent of Total
5% 5%
$150 5%
4%

$100 3%

2%
$50
1% 1%

$0 0%
2004 2005 2006 2007 2008

SOURCES: 2008 Mortgage Market Statistical Annual, published by Inside Mortgage Finance Publications, Inc. Copyright 2008. T2 Partners estimates.
42
Options ARMs Were a Bubble State
Phenomenon

Other
25%

Arizona
3%
California
Nevada 58%
3%

Florida
10%

SOURCES: Amherst Securities, LoanPerformance.

43
Beginning in March 2005, High-FICO-Score
Borrowers Opted for an Above-Market-Rate
Option ARM in Exchange for the Low Teaser Rate

8.5
Fannie Mae 30 Year FRM Index
Option ARM Index
8.0

Nearly all option ARM borrowers during

7.5
this period (when nearly all option
ARMS were written) can’t afford a fully-
7.0
amortizing mortgage – otherwise they
would have taken one
Interest Rate (%)

6.5

6.0

5.5

5.0

4.5

4.0 6

07

08
2

03

04

6
2

7
4
05

06

6
02

7
4

5
-0
-0

-0

-0

-0

-0
l-0
l-0

l-0

l-0

l-0
-0

-0

-0

-0
-0

r-0

l-0

n-
n-
n-

n-
n-

n-

n-
pr

pr
ct

pr

pr
pr

ct

ct
ct

ct

ct
Ju
Ju

Ju

Ju
Ju

Ju
Ap

Ja
Ja

Ja

Ja
Ja

Ja

Ja
O

O
O

O
A

A
A

SOURCE: Amherst Securities, BloombergFinance, L.P.

44
 Percent Noncurrent (60+ days)
Ja
n-

0%
5%
10%
15%
20%
25%
30%
35%
99
Ju
l-9
Ja 9
Are Soaring

n-
0
Ju 0
l-0
Ja 0
n-
01
Ju
l-0
Ja 1
n-
02
Ju
l-0
Ja 2
n-
03

SOURCES: Amherst Securities, LoanPerformance, T2 Partners estimates.

Ju
l-0
Ja 3
n-
04
Ju
l-0
Ja 4
n-
05
Ju
l-0
Ja 5
n-
06
Ju
l-0
Ja 6
n-
07
Ju
l-0
Delinquencies of Securitized Option ARMs

Ja 7
n-
08
Ju
l-0
Ja 8
n-
09
45
Option ARM Delinquencies By Vintage Show the
Collapse in Lending Standards in 2005-2007

45%

2006
40%

35%

2007
Percent Noncurrent (60+ days)

30%
2005
25%

20%

2004
15%

10% 2003

5%

0%
0 5 10 15 20 25 30 35 40 45 50 55 60
Months of Seasoning

SOURCE: Amherst Securities, LoanPerformance.

46
Existing Homes Sales Are Falling and Foreclosures
Are Rising, Leading to a Surge in Inventories

Existing Home Sales

7.5

7.0

6.5

6.0
Millions

5.5
Months Supply
12

11
5.0

4.7 million units as of the 10

4.0 million units, equal to 10.2
4.5
end of April 2009 months as of the end of April 2009
9

4.0
8
Months
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

3
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

SOURCE: NATIONAL ASSOCIATION OF REALTORS® Existing Home Sales data series.

47
Foreclosure Filings Have Increased
Dramatically

• Foreclosures in April rose 32% year-over-year, but only 1% sequentially

• April was the highest monthly total since RealtyTrac began issuing its report in January 2005
despite a decrease in bank repossessions (REOs)
• 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.

400,000

350,000

300,000
Number of Foreclosures

250,000

200,000

150,000

100,000

50,000

0
Ap 06

A p 08
Ju 0 6

D -06

Ju 0 8

De 08
O 05

F e 06

O 07
Au -05

Au 06

Au -08
Ap 07

Ap 09
De 05

Ju 0 7

D 07

9
Fe 05

O 06

Fe 07

O 08

Fe 08
A u 07

r- 0
b-

b-
r-

-
g-

g-
n-

b-

b-
-

r-

r-

-
c-

g-

g-

c-
n-

ct
ec
n

n
ct

ct

ct
ec
Ju

Note: Foreclosure filings are defined as default notices, auction sale notices and bank repossessions. SOURCE: RealtyTrac.com U.S.
Foreclosure Market Report. 48
Home Prices Are in an Unprecedented
Freefall

220
S&P/Case-Shiller U.S. National Home Price Index
S&P/Case-Shiller 20-City Composite
OFHEO Purchase-Only Index
200
NAR Median Sales Price of Existing Homes

180

160

140

120

100
Q 00

Q 01

Q 01

Q 02

Q 04

Q 05

Q 05

Q 06

Q 08
09
0

Q 02

Q 03

Q 03

Q 04

Q 06

Q 07

Q 07

Q 08
0
20

20

20

20

20

20

20

20

20

20

20

20

20

20

20

20
20

20

20
1

3
3

1
Q

SOURCES: Standard & Poor’s, OFHEO Purchase-Only Index, NATIONAL ASSOCIATION OF REALTORS® Existing Home Sales data series.
49
Home Prices Need to Fall Another 5-10%
to Reach Trend Line

300
Shiller
Lawler
275
Real Home Price Index (1890=100)

250

225

200
Housing
Bubble
175
Trend Line
150

125

100
62

70

78

86

94

02
50

58

66

74

82

90

98

06
5
19

19

19

19

19

19

19

19

19

19

19

19

20

20
19

SOURCES: Robert J. Shiller, Irrational Exuberance: Second Edition, as updated by the author; Lawler Economic & Housing Consulting.
50
A Study of Bubbles Shows That All of
Them Eventually Return to Trend Line

S&P 500 Japan vs. EAFE ex-Japan S&P 500

S&P 500 Stocks 1981-1999
1920-1932 1946-1984 1992-October 2008
2.3 2.5 3.0 2.4

Detrended Real Price

Detrended Real Price

Detrended Real Price

2.0 2.5

Relative Return
1.8 2.0
2.0
1.5
1.3 1.5 1.6
Tre nd Line 1.0
Tre nd Line 1.0
0.8 0.5 1.2
0.5 Tre nd Line Trend Line
0.3 0.0 0.0 0.8
20 21 22 23 24 25 26 27 28 29 30 31 46 50 54 58 62 66 70 74 78 82 81 83 85 87 89 91 93 95 97 99 92 94 96 98 00 02 04 06 08

U.S. Dollar U.K. Pound Currencies Japanese Yen Japanese Yen

1979-1992 1979-1985 1983-1990 1992-1998
2.0 1.4 1.4 1.4

Cumulative Return
Cumulative Return
Cumulative Return

Cumulative Return
1.8 1.3 1.3 1.3
1.6 1.2 1.2 1.2
1.4 1.1 1.1 1.1
1.2 1.0 1.0 1.0
1.0 0.9 0.9 0.9
0.8 0.8 0.8 0.8
79 81 83 85 87 89 91 79 80 81 82 83 84 83 84 85 86 87 88 89 90 92 93 94 95 96 97

Gold Crude Oil Commodities Nickel Cocoa

1970-1999 1962-1999 1979-1999 1970-1999
2000 250
80 600
1600 200 500
60
Real Price
Real Price

Real Price
400
Real Price

1200 150
40 300
800 100
200
400 20 50 100
0 0 0 0
70 74 78 82 86 90 94 98 62 66 70 74 78 82 86 90 94 98 79 81 83 85 87 89 91 93 95 97 70 74 78 82 86 90 94 98

SOURCE: GMO LLC. 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.
51
The Biggest Danger is That Home Prices
Overshoot on the Downside, Which Often
Happens When Bubbles Burst

S&P 500 1927-1954

2.50
Overrun: 59%
2.25 Fair Value to Bottom: 1.5 Years
Fair Value to Fair Value: 23 Years
Detrended Real S&P 500 Stock Price Index

2.00

1.75

1.50

1.25

1.00
S&P 500 1955-1986
2.25
0.75
Overrun: 45%
2.00 Fair Value to Bottom: 7 Years
0.50
Fair Value to Fair Value: 12 Years

Detrended Real S&P 500 Stock Price Index

0.25 -59% 1.75

0.00 1.50
1927 1930 1933 1936 1939 1942 1945 1948 1951 1954
1.25

1.00

0.75

0.50
-45%
0.25

0.00
1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1976 1978 1980 1982 1984 1986

SOURCE: GMO LLC, T2 Partners calculations.

52
In Bubble Markets, Prices Are Way Down,
Driven By a Surge in the Number of Homes Sold
Out of Foreclosure

$500
California 70%

60%
$400

50%
Median Home Price (000s)

Foreclosure Resale %
$300
40%

30%
$200

20%

$100
10%

$0 0%
7
6

09
6

9
07

8
6

8
6

8
r-0

r-0
0

r-0

r-0
-0

-0
l-0

l-0

l-0
-0

-0
n-

n-

n-
n
ct

ct
ct
Ju

Ju
Ju
Ap

Ap

Ap

Ap
Ja

Ja

Ja
Ja
O

SOURCE: MDA Dataquick. Note: Includes new construction

53
Home Prices Have Crashed Through the Trend
Line in California, But Stabilized in March

$600
Median Sales Price
4% Trend
$500
Median Price ($000s)

$400

$300

$200

$100

$0

1
3

93

05

07
5

03

09
79

85

91

97

0
8

-9
-8

-8

n-

n-
n-

n-
n-
n-

n-

n-

n-

n-

n-

n-
n-

n
n

Ja
Ja

Ja
Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja
Ja
Ja
Ja

Ja

SOURCE: California Association of REALTORS ® . All rights reserved. www.rebsonline.com, T2 Partners estimates.
54
The Housing Affordability Index Shows
Houses Are Now Affordable

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 doesn’t help millions of homeowners or potential 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 won’t look so reasonably priced based on these metrics. Finally, in light of
the severe economic downturn, average income may fall for quite some time.

26

24
Mortgage Payment on Median Priced
Home as % of Family Income

22

20

18

16

14
89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09
19

19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

20

20

20

20

20
SOURCE: NATIONAL ASSOCIATION OF REALTORS® Housing Affordability Index 55
Mortgage Rates Have Fallen Recently

10
Jumbo 30 Yr FRM
Jumbo 5/1 Hybrid ARM
9
Conforming 30 Yr FRM
Conforming 5/1 Hybrid ARM
8
10-Year Treasury

7
Rate (%)

2
N 5

Fe 5

N 8
N 4

Fe 4

N 6

Fe 6

N 7
Au 5

Au 6
Au 4

Fe 7

Fe 8
M 4

Au 07

Au 8

9
M 06

M 09
M 05

M 07

M 8
0
-0

0
-0

0
0
-0

-0

-0
-0
-0

-0

-0
0

-0
g-

g-

g-

g-
g-
b-

-
b-

b-
b-
b-

b-
ov

ov
ov

ay
ay

ay
ay

ov

ov
ay

ay
Fe

SOURCES: HSH ASSOCIATES, Freddie Mac PMMS, Yahoo! Finance. 56

The Home Price-to-Rent Ratio Has Returned
to Normal Levels

27

25
Median Home Price to Median Gross Rent

23

21

19

17

15
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

SOURCE NATIONAL ASSOCIATION OF REALTORS® Existing Home Sales data series, U.S. Census Bureau, T2 Partners estimates
57
Are We Seeing the Beginnings of a
Bottom in Hard-Hit Markets?

SOURCE: NY Times, 5/4/09.

58
Home Prices in Sacramento More Than Tripled
in Six Years – And Have Now Fallen 47%

SOURCE: Zillow.com.
59
The Vast Majority of Sacramento Homeowners Who
Purchased During the Bubble Years Are Now Underwater

SOURCE: Zillow.com.
60
In Sacramento Country, Home Sales Have
Rebounded – But Are Still Outweighed by Defaults

Monthly Notices-of-Default in Sacramento

SOURCES: MDA Dataquick; The Field Check Group -- data provided by ForeclosureRadar.com.
Note: Includes new construction. 61
Home Prices Are Stabilizing in Sacramento Country,
In Part Due to More Higher End Homes Being Sold Off

Sacramento House Prices at the Sacramento Mix of Houses at

Time of Foreclosure/REO the Time of Foreclosure/REO

SOURCE: The Field Check Group -- data provided by ForeclosureRadar.com.

62
Comments From Mark Hanson (1)
The Field Check Group, May 5, 2009

California housing – at the low end – is 'bottoming' mostly because: a) median prices
are down 55% from their peak over the past two years, thereby making the low end
affordable; b) foreclosures have temporarily been cut by 66% through moratoriums
reducing supply; and c) demand is picking up going into the busy season.
But the moratoriums are ending and the number of foreclosures in the pipeline is
massive – they will start showing themselves as REO over the near to mid-term. The
Obama plan held the foreclosure wave back, creating a huge backlog and now the
servicers are testing hundreds of thousands of defaults against the new loss mitigation
initiatives. We presently see the Notice of Defaults at record highs and Notice of Trustee
Sales back up to nine-month highs – there is no reason for a loan to go to the Notice of
Trustee Sale stage if indeed it wasn't a foreclosure. However, the new 'batch' are not only
from the low end but a wide mix all the way up to several million dollars in present value.
Because the majority of buyers are in ultra low and low-mid prices ranges, the supply-
demand imbalance from foreclosures and organic supply will crush the mid-to-upper
priced properties in 2009. We already have early seasonal hard data proving this. As the
mid-to-upper end go through their respective implosions this year and the volume of
sales in these bands increase as prices tumble, the mix shift will raise median and
average house prices creating the ultimate in false bottoms. We also have data proving
this phenomenon.

63
Comments From Mark Hanson (2)
The Field Check Group, May 5, 2009

After a year or so the real pain will occur when the mid to upper bands are down 40% from where
they are now, and the price compression has made the low to low-mid bands much less attractive – the
very same bands that are so hot right now. Rents are tumbling and those that bought these properties
for investment will be at risk of default (investors have been buying all the way down). Investors have
just started to get taken to the woodshed from all of the supply and this will get much worse. Mid-to-
upper end rental supply is also flooding on the market making it much better to rent a beautiful million
dollar house than putting $300,000 down and buying.
After investors are punished -- and with move-up buyers gone for years – it will leave first-time
homeowners to fix the housing market on their own. Good luck and good night. Five years from now
when things look to be stabilizing, all of these terrible kick-the-can-down-the-road modifications that
leave borrowers in 5-year-teaser, ultra-high-leverage, 150% LTV, balloon loans will start adjusting
upward and it will be Mortgage Implosion 2.0. These loan mods will turn millions of homeowners into
over-levered, underwater, renters and ensure housing is a dead asset class for years to come.
Due to a confluence of events including a national foreclosure moratorium and near-zero sales in the
mid to upper end during the off season, the broader housing data show signs of stabilization. Taken in
context, it is a blip. There are no silver linings or green shoots in housing whatsoever other than by these
first-time homeowners – former renters – who now find it cheaper to own than rent. This is a very good
thing, but it only applies to a small segment of the population and will not be able to support the market.
In addition, the first-time buyers who come out of the rental market put continuous pressure on rents.
Our data shows that the mid-to-upper end housing market is on the precipice of the exact cliff that the
market fell off of in 2007, led by new loan defaults. What happens to the economy when you hit the mid-
to-upper end earners the same way the low-to-mid end was hit with the subprime implosion? We will find
out soon enough. When we look back on housing at the end of 2009, anyone that made positive
housing predictions this year will not believe how far off they were.
64
There Have Been 5.7 Million Jobs Lost So Far in
This Recession, More Than 3 Million in the Past
Five Months

600

400
Change in Nonfarm Payroll Employment (000s)

200

-200

-400

-600 There have been job

losses every month
-800
since December 2007
-1000
90

Ja 2

Ja 4

Ja 6

Ja 8

Ja 0

Ja 2

Ja 4

Ja 6

Ja 8
Ja 1

Ja 3

Ja 5

Ja 7

Ja 5
Ja 9

Ja 1

Ja 3

Ja 7

09
9

0
n-

n-

n-

n-

n-

n-

n-

n-

n-

n-
n-

n-

n-

n-

n-

n-

n-

n-

n-

n-
Ja

Ja

SOURCE: Bureau of Labor Statistics.

65
The Unemployment Rate Jumped to 8.9%
in April, the Highest Level Since 1983

If part-time and discouraged workers are factored in, the unemployment

rate 12%
would have been 15.8% in April. In addition, the average work week
in April was 33.2 hours, a record low.
11%

10%

9%
Unemployment Rate

8%

7%

6%

5%

4%

3%

03

06

09
91

94
79
73

76

00
97
82

85

88
70

n-

n-

n-
n-

n-
n-

n-

n-

n-

n-

n-
n-

n-
n-

Ja

Ja

Ja

Ja

Ja
Ja

Ja

Ja

Ja

Ja
Ja

Ja

Ja

Ja

SOURCE: Bureau of Labor Statistics. 66

The Decline from Peak Employment Now
Exceeds the Past Five Recessions

0.0%
1980 1981 - 83 1990 - 93
1974 - 76 2001 - 05
-0.5%

-1.0%

-1.5%

-2.0%

-2.5%

-3.0%

-3.5%

-4.0%
2007-
-4.5%
0 6 12 18 24 30 36 42 48
Months after pre-recession peak

SOURCE: Bureau of Labor Statistics

67
Consumer Confidence Rebounded in April
and May

160

140

120
Consumer Confidence Index

100

80

60

40

20

0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Note: 1985=100. SOURCE: The Conference Board (www.pollingreport.com/consumer.htm)

68
Banks are Tightening Consumer Credit and
New Household Borrowing Has Plunged

Percent of US Banks Tightening Consumer Credit

70%

60%

50%

40%

30%

20%

10%

0% Household Borrowing 1990-2008

(Seasonally-Adjusted Annual Rate)
-10%
$1,200
-20%
($ billions)
02

06
00

04

08
1

7
00

04

08
02

06
-0
-0

-0

-0

p-
n-

n-

n-

n-

n-
p-

p-

p-

p-
ay

ay

ay

ay
Ja

Ja

Ja

Ja
Se

Se

Se

Se

Se
Ja

$1,000
Credit Cards Other Consumer Loans

$800

$600

$400

$200

$0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

SOURCE: Federal Reserve Board.

69
Pools of HELOCs and CESs Can Suffer
Astronomical Losses Due to 100%+ Severities

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 – and
based on the pool’s performance since then, this will almost certainly prove to be conservative.

3.0%
Ambac Projection April 2008
Actual

2.5% From Ambac slide, April 2008:

• Second lien deal that closed in April 2007
Monthly Loss Rate (3m average)

• Loss to date 9.9%; projected loss: 81.8%

2.0% • Projected collateral loss as a % of current
collateral: 86%
• A reasonable estimate of projected collateral
1.5% loss for the above transaction might have
been 10-12%, with the transaction having an
A+ rating at inception and being structured to
withstand 28-30% collateral loss
1.0%

0.5%

0.0%
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

SOURCES: Ambac Q1 08 presentation, Amherst Securities; funds managed by T2 Partners are short Ambac. 70
The Timing Indicates That We Are Still in the
Middle Innings of the Bursting of the Great
Housing 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 more defaults
• 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 the first half of
2007, and the many other types of loans that are now with longer reset dates that are now starting
to default at catastrophic rates, there are sobering implications 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 enormous

wave of defaults, foreclosures and auctions that is hitting the United
States. We predicted in early 2008 that it would get so bad that it would
require large-scale federal government intervention – which has
occurred, and we’re not finished yet.

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Total Losses Are Now Estimated at $2.1-$3.8
Trillion – And Only a Fraction of This Has Been
Realized To Date

$4,000
$3,778 Corporate
$3,552
$3,500 Consumer

Commercial
$3,000 Real Estate
$2,632 Residential
Mortgages
$2,500
Amount (Bn)

$2,083
$2,000
$1,473
$1,500 $1,214
GSEs
$1,000 Insurers

$500 Banks/
Brokers

$0
Goldman Roubini Jan T2 Partners IMF Apr 2009 Writedowns to Capital Raised
Sachs Jan 2009 Mar 2009 Date
2009

SOURCES: Goldman Sachs, International Monetary Fund, RGE Monitor, Bloomberg Finance L.P., T2 Partners estimates.
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A Breakdown of Our Financial Sector
Loss Estimates

Amount (Bn)
$0 $100 $200 $300 $400 $500 $600 $700 $800

CDO/ CLO

Other Consumer
Total Estimated
Construction & Development Financial Sector
Option ARM Losses = $3.8 trillion
Auto
Credit Card

Home Equity

Jumbo Prime

High-Yield / Leveraged Loans

Subprime

Commercial & Industrial

Other Corporate

Alt-A

Commercial Real Estate

Prime Mortgage

SOURCE: T2 Partners estimates.

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Institutions Have Been Able to Raise Capital to
Mostly Keep Up With Writedowns, But This Will
Likely Not Continue

$1,500
Losses & Writedowns
Capital Raised

$1,250

$1,000
Amount (Bn)

$750

$500

$250

$0
Prior Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009

SOURCE: Bloomberg Finance L.P.

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Where We Are Finding Opportunities

• Blue-chips. The stocks of some of the greatest businesses, with strong balance sheets and dominant
competitive positions, are trading at their cheapest levels in years – due primarily to the overall market
decline and weak economic conditions rather than any company-specific issues. In this category, we’d
put Coca-Cola, McDonald’s, Wal-Mart, Altria, ExxonMobil, Johnson & Johnson, and Microsoft.
• Out of favor blue-chips. For somewhat more adventurous investors looking to buy great companies in the
most out-of-favor sectors such as financials and retailers, we own Berkshire Hathaway, Wells Fargo,
American Express and Target. All are great businesses, but their stocks have suffered mightily thanks to
the economic downturn. We think they’re good bets to rebound when things stabilize.
• Balance sheet plays. For investors who are comfortable with lower-quality businesses but want downside
protection, there are many companies trading near or even below net cash on the balance sheet.
Examples in our portfolio include digital media equipment company EchoStar Corp. and clothing retailer
dELiA*s. Berkshire is the best of both worlds: a premier company but also a balance sheet play.
• Turnarounds. There are countless companies that have gotten clobbered by the economic downturn and
are reporting dismal results – with stock prices to match. Investors in those that survive and return to
anything close to former levels of profitability will be well rewarded – but picking these stocks isn’t easy.
Among our holdings in this category are Wendy’s restaurants, Winn-Dixie supermarkets, Huntsman, a
specialty chemical maker, Crosstex, a pipeline company, and Resource America, a specialty finance
company.
• Special situations. This is somewhat of a catch-all category that, for us, includes Contango Oil & Gas, a
stock that’s declined due to an aborted attempt to sell the company and the sharp drop in the price of
natural gas.
• Mispriced options. Every once in a while we take a tiny position in a highly speculative situation – often
where the stock price is below $1 – in which there’s a real chance that the outcome is zero, but also a
decent chance, in our opinion, of making many multiples of our money. On an expected value basis,
therefore, a small portfolio of such investments is attractive. Our holdings include General Growth
Properties, TravelCenters of America, Ambassadors International, Borders Group and PhotoChannel
Networks.
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