21 December 2009Dear ColleagueA year ago, I wrote my 2008 annual letter days after the failure of LehmanBrothers. At the time, the newspapers were full of bankers carrying cardboardboxes as they were sent home from their jobs.An apocalyptic future was beingforecast by respected commentators. Chaos reigned, and a total meltdown of the financial system seemed possible.Only 12 months on and today’s papers are again full of photos of bankers - butthis time they are going home with wheelbarrows of money as the bonus seasonkicks in.Not only has remuneration for those still employed in the bankingcommunity returned to the heady days of pre-crisis but, as I write, world equitymarkets are up something like 50% in the last six months.It might appear, against that background that we were all panickingunnecessarily. Unfortunately, my view is that it is more likely we are in the eye of the storm. For while we have pulled back from the brink, the fundamental causeof the crisis, primarily that the West is living beyond its means on borrowedmoney from the East, has yet to be addressed. Indeed, the steps taken over thelast 12 months, while providing a period of welcome and necessary calm, mayhave compounded the debt challenge which still has to be faced.Roger Bootle’s new book, “The Trouble with Markets”, is one of the best I haveread on the current situation and that is why we have chosen to send a specialedition to Terra Firma’s business colleagues. Unlike our choice last year, NiallFerguson’s “Ascent of Money” or indeed our choice of two years ago, JohnGalbraith’s “The Great Crash” which were both more historical in nature, Roger’shighly readable book reviews the causes of the current world economic crisis. Italso puts forward some creative ideas that he suggests both the West and Eastshould follow in order to move forward. I was particularly struck by his view thatfinancial markets are distributive by nature and provide little net benefit tosociety, rewarding those involved in markets out of proportion to the value of their work to society. That analysis seems particularly apt in view of the quick andremarkable return of the bonus culture to the banking world. Furthermore, in myview, such high pay levels attract many of the most talented individuals in societythus removing them from more entrepreneurial, creative or leadership roles in the“real” economy.For some time, a number of us have been arguing for a Glass-Steagall likeseparation of utility banking operations from high risk, high profit, investmentbankingactivities. So, now that there is a consensus that the largest financialoperations cannot be allowed to fail, it seems extraordinary to me that such aseparation is not supported by all. Contingent insurance, contingent liquidity andpre-agreed emergency plans for banks are all useful moves along the right pathbut do not touch the heart of our banking system. It cannot be right to continue

with a system which allows risk to be taken in the knowledge that, if things goright, bankers will take on average 60-80% of the profits generated throughcompensation and, if they go wrong, shareholders and ultimately theGovernment will pick up the costs. As the Bank of England’s December Financial Stability Report says, “If discretionary distributions had been 20% lower per year between 2000 and 2008, banks would have generated around £75billion of additional capital — more than provided by the public sector during thecrisis.” The cost of the crisis has been eyewatering, with the BBC calculatingthat the UK has spent over £30,000 per person trying to deal with the crisis, whilethe US has spent $10,000 a head. In total the IMF estimates that bailing out thebankshas cost the G20 countries $10 trillion. The separation of the activities of investment banks andthat of lending banks would allow more appropriateregulation and supervision and at the same time enableeach group to go aboutits respective business without posing undue riskand potential costs to society.Looking back, the last ten yearshave been a lost decade for investors duringwhich nearly all major markets finished lower than where they started. It is clear that we are going into the next decadein deeply unchartered waters –sufferingfrom the first financial meltdown in a truly global economy–thus predicting theeconomic outcome with confidence is a fool’s dream. However, one thing I doknow is that if we are to move forward and truly deal with the issues affecting our economic world today, we must be bold. We need to work to address thefundamental imbalances that exist. We must accept that the future world will bedifferent to that created by the financial boom which the rich in the West haveenjoyed over the last twenty or so years. We need to question the acceptedwisdom that a truly global market benefits all citizens in Western developednations. Indeed, I suspect we will, in time, see globalisation as the driver thatdelivered a massive transfer of economic power from the West to the East. Over the long term it will result in an ever growing class of permanent poor beingcreated in the West. I also suspect new graduates will find it increasingly difficultto get the jobs for which they are qualified. It is the young and the poor in theWestwho willpay the cost of global human resources competition.As is inevitable with any book, I do not agree with all of Roger’s views. For instance, heis particularly concerned about the dangers of deflation. However,my instincts, based on history, are conversely to worry about the perils of US andUK inflation in the longterm due to the massive amounts of money which havebeen injected into the system. Overall though, I think Roger’s book is excellentand I hope you enjoy it as much as I did.Against this background, over the course of 2009, we at Terra Firma have beendeeply focused on our current portfolio and have used our extensive operationalresources to drive performance despite these economic challenges. During theyear, this hard work has clearly yielded good operating performance in all our portfolio businesses, especially at EMI Music where the 2009 fiscal year EBITDAwas more than three times that of the previous year with top line growth comingthrough as well.Furthermore, 2010 should be even better.Regarding new investments, we have been cautious particularly with regard tothe UK. Nonetheless,we made two new investments for TFCP III. The first, inAustralia was Consolidated Pastoral Company, a major cattle farm businesswhich will benefit from growing long–term demand for protein. The other, in theUS,wasEverPower, a wind energy company which will benefit from long-termdemand for renewable power. I am excited by both of these deals and am