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“You cannot spend your way out of recession or borrow your way out of debt.” ‐ Daniel Hannan, Member of the European Parliament Dear Investors: There have been many significant global developments since our March letter. Governments around the world are running fiscal deficits at levels never before seen, while central banks have loosened monetary policy and are printing money at a record pace. While the US appears to have avoided a systemic implosion, the question becomes at what cost – now and in the future? In this letter, we address: • • • • • • • • The “good” news and bad news of the current economic situation; Areas of opportunity; The implications of global and US monetary policy; The current state of the US housing market and expectations for the future; The International Monetary Fund’s policy prescription for dealing with troubled economies; The boom and potential bust in China; The looming debt crisis in Japan; and How the fund is positioned to capitalize on these issues.
The purpose of this letter is not simply to communicate how the fund is positioned, but also – and possibly more importantly – to stimulate thought and discussion about the “big picture” implications of these issues. We believe that we are in the midst of a once‐in‐a‐lifetime (literally) economic shift that has affected or will affect everyone. While there are certainly hardships and challenges ahead, we also see opportunities.
The “Good” News?
The “good” news is the recession is officially over. Real GDP dropped only 4% peak‐to‐trough, S&P 500 revenues dropped only 18%, and home prices dropped only 31.3% nationwide. Broad‐based unemployment (including the underemployed) reached 17.0%, which translates into 17.4 million Americans out of work and another 9.2 million working part‐time jobs that are insufficient to pay their bills.1 After losing an average of 578,346 jobs every week since October 2008,2 the headline unemployment figure improved in July from 9.5% to 9.4%. Never mind that in August the Bureau of Labor Statistics (”BLS”) revised their prior estimates, and a portion of the “improvement” in July was achieved by adjusting the total size of the labor force (think increasing the denominator to reduce the percentage) and unemployment continued its upward trajectory to 9.7% in August and 9.8% in September. We are left wondering how broad based unemployment went from its most recent trough of 7.9% in December 2006 to 17.0% currently, while total retail sales declined only 3.6% over the same time period.3
Source: Mike Keefe, The Denver Post. Reprinted with permission.
Bernanke and crew have done a masterful job of pulling out all of the stops (and then some) to save the US and world banking system from collapse. Having gone from potential collapse to valuations well above the 10‐year averages, the S&P 500 now trades at 2x book value and 20x EPS and credit spreads relative to Treasuries are back to pre‐Lehman levels.
Where We are Bullish
There are great businesses which have too much leverage, which are being or will be recapitalized through consensual restructurings or Chapter 11 bankruptcies. These “capital transformation investments” usually involve buying senior debt and working with the company’s stakeholders and management to craft a plausible
According to the latest data available from the BLS, 15.142 million Americans are included in the labor force and are classified as “unemployed.” Another 2.219 million would like to work, but have not searched for a job in the last four weeks. An additional 9.179 million are classified as “part‐time for economic reasons,” meaning currently employed part‐ time as an alternative to not working at all. 2 Average Initial Jobless Claims since the first week of October, as published by the Department of Labor. 3 Source: Bloomberg.
© 2009 Hayman Advisors L.P.
This is one area where we are acutely focused and we believe presents the most asymmetric returns for being invested on the long side. and Japanese deflationists are concurrently engaging in what may be the largest. Everywhere you turn. One has to ask whether the US reached the critical tipping point? Beyond the quantitative measurements associated with government deficits and money creation. roughly 40% of what our government is spending has to be borrowed. communistic capitalists. money is flowing and many private equity players are prepared to invest in their existing portfolio companies after or in conjunction with a debt restructuring. Monetary Regimes and Inflation: History. here is where the really bad news begins. there exists a qualitative aspect to such a scenario that may be far more important. As the capital markets have recovered. .P. Peter Bernholz (Professor Emeritus of Economics in the Center for Economics and Business (WWZ) at the University of Basel. we will likely end up owning some amount of senior debt with attractive current pay characteristics and in certain circumstances end up holding equity in the company for little. Bernholz analyzes the 12 largest episodes of hyperinflations – all of which were caused by financing huge public budget deficits through money creation. if any. It is in these types of situations that we see great opportunity.766 trillion in FY 2010 with unified deficits of $1. real cost. In his most recent book. capital structure to return the entity to health and growth. governments are running enormous fiscal deficits financed by printing money.502 trillion. 3 © 2009 Hayman Advisors L. If the story could just finish here with such a happy ending – unfortunately. According to the current Office of Management and Budget (“OMB”) projections. Our investments are focused on asset‐heavy businesses where we can buy into the right portion of the capital structure in advance of the restructuring. respectively.580 trillion and $1. recent price action in metals. US federal expenditures are projected to be $3. To put it simply. On the back end. The qualitative perceptions of fiscal and monetary policies are impossible to control once confidence is lost. with 20 occurring after 1980. Never Before and Hopefully Never Again Western democracies. the dollar and commodities suggests that the market is already anticipating the future. In fact. global financial experiment in history.653 trillion in FY 2009 and $3. The chart below illustrates M1 growth of the world’s major currencies since 2007. Economic and Political Relationships.9% of expenditures in 2009 and 2010. M1 money supply is the most liquid measure of money outside of tangible currency. These projections imply that the US will run deficits equal to 43. The greatest risk of these policies is that the quantitative easing will persist until the value of the currency equals the actual cost of printing the currency (which is just slightly above zero). Switzerland) has spent his career examining the intertwined worlds of politics and economics with special attention given to money. respectively. There have been 28 episodes of hyperinflation of national economies in the 20th century. His conclusion: the tipping point for hyperinflation occurs when the government’s deficit exceed 40% of its expenditures.3% and 39.
with the exception of Japan. halfway through the game. and Hayman believes that the primary reason Japan’s money supply has not increased is that for the last decade Yen have fled the Japanese economy in search of higher‐yielding assets (widely known as the “Yen carry trade”). As a player in today’s real‐life Monopoly game. the major global currencies have experienced money supply growth between 15‐55% in less than three years. In a God‐like fashion (with a little ecclesiastical white‐out). To put this into perspective. the central banker decides to add two more banks of money to the game that are distributed to the participants as the central banker deems fit. The greatest concern is that. M1 Growth of Major World Currencies (December 2006 = 100%) 160% UK 150% 140% 130% 120% 110% 100% 90% Apr‐07 Apr‐08 Sep‐08 Sep‐07 Feb‐07 Feb‐08 Feb‐09 Apr‐09 Jun‐09 Jun‐08 Jun‐07 Jul‐07 Jul‐08 Dec‐08 Mar‐07 Mar‐08 Mar‐09 Dec‐06 Dec‐07 Oct‐07 Oct‐08 Jul‐09 Aug‐07 Aug‐08 Nov‐08 Nov‐07 May‐07 May‐08 May‐09 Aug‐09 Jan‐07 Jan‐08 Jan‐09 Japan US China Eurozone Source: Bloomberg. how are you positioned? Below is a more detailed assessment of what we are seeing domestically and internationally. and how we have positioned your capital so that you may emerge from the “game” a winner. 4 © 2009 Hayman Advisors L. imagine a game of Monopoly where the participants are playing with one bank of money. did the real value of anything change? Does the bartering for property increase or decrease prices? Did each unit of money become worth more or less? How does the central banker decide to allocate the extra money? Is it a fair process? Depending on how you were positioned prior to the additional “banks” of money being injected into the game and how you played the rest of the game. or a few players are about to go broke.P. the central banker decides that money is too tight and the velocity of the game is slowing down. you either feel fortunate (if you were about to go broke) or cheated (if you had played the game prudently). Under this scenario. . Then.
the monetary base consists of two key components: tangible currency and banking reserves. perhaps printing money is not such a terrible thing – it has driven rates down. we are concerned about the potential money supply growth that could occur quite rapidly as a result of the money printing that has already occurred. The $0. however.2 billion and $109. This means that for every dollar a bank receives in deposit. Fannie Mae. Why Hasn’t the Money Supply in the US Increased More Significantly? The Federal Reserve has engaged in roughly $1. Source: United States Federal Reserve. From a quantitative perspective. This is how the money supply accumulates to a multiple of the monetary base. Banking reserves represent the money that banks are required to hold against deposits. banks have been accumulating excess reserves. . banks typically hold only the minimum required reserves because any excess can be lent out at a profit. Excess reserves in the US banking system currently stand at $855 billion. seasonally adjusted M1 and M2 have only increased $73. rather it is the foundation on which the money supply is built. and so on.90. Even though they are not required by the Federal Reserve to hold these excess reserves. 5 © 2009 Hayman Advisors L.73 is lent out. one must understand the relationship between the monetary base and the money supply in a fractional reserve banking system. it can loan out $0.9 billion. Bloomberg. Freddie Mac or the Federal Home Loan Banks. Since September 2008.81 can be re‐lent. To understand the monetary impacts of quantitative easing. the reserve requirement is typically only 10%. Additionally. 4 5 Agency securities refer to those issued by Ginnie Mae.25%. banks are not lending because they are either capital constrained or concerned about additional losses deteriorating their existing capital. made mortgages more affordable and has not blown up the dollar money supply. The chart below shows the composition of the monetary base from 1959 to the present.90 then gets deposited elsewhere. Since the collapse of Lehman. this freshly printed money does not find its way into the money supply but instead stacks up at the banks. In short.4 however. As the Federal Reserve has engaged in quantitative easing. including Federal Reserve purchases of both Treasury and Agency securities.81 then gets re‐deposited into the system and another $0. This $0. The monetary base is not money supply.5 That being the case.P. the banking system has built up excess reserves to levels unprecedented in the post‐ World War II history of the US. the Federal Reserve has agreed to pay banks a small rate on their excess reserves of 0. Depending on the specific nature of the deposits. up from $2 billion just twelve months ago.2 trillion worth of quantitative easing (a nice way of saying “printing money”) this year. and $0. Under normal circumstances. respectively.
0 2.0 6. rather it would increase the money supply by some multiple of that. Notice the multiplier has collapsed from its (recent) historical norm of around 7x down to under 1x due to the banks holding excess reserves rather than lending and relending them into the economy as they typically do. shown as Checkable Deposits/Banking Reserves (January 1959 – August 2009) 14. The threat to the money supply occurs if banks decide they are comfortable with deploying those excess reserves or lending them out. Banking Reserve Multiplier.000 $800 $600 $400 $200 $0 Other / Adjustments Vault Cash (Not used for Reserves) Excess Reserves Required Reserves Currency 01/1959 08/1960 03/1962 10/1963 05/1965 01/1967 08/1968 03/1970 10/1971 05/1973 01/1975 08/1976 03/1978 10/1979 05/1981 01/1983 08/1984 03/1986 10/1987 05/1989 01/1991 08/1992 03/1994 10/1995 05/1997 01/1999 08/2000 03/2002 10/2003 05/2005 01/2007 08/2008 Source: United States Federal Reserve.400 $1.200 $1. The reserve multiplier shown represents the ratio of checkable deposits to banking reserves.0 4. If this were to happen.0 12. 6 © 2009 Hayman Advisors L. Historically this multiple is conservatively around 7x. it would not increase the money supply by $855 billion. Bloomberg.800 $1. Bloomberg.0 8.0 ‐ Required Reserve Multiplier 10‐yr MA Total Reserve Multiplier 10‐yr MA 01/1959 11/1960 09/1962 07/1964 05/1966 03/1968 01/1970 11/1971 09/1973 07/1975 05/1977 03/1979 01/1981 11/1982 09/1984 07/1986 05/1988 03/1990 01/1992 11/1993 09/1995 07/1997 05/1999 03/2001 01/2003 11/2004 09/2006 07/2008 Source: United States Federal Reserve. The chart below shows the banking reserve multiplier dating back to 1959.600 $1. . which implies a potential increase in the money supply of approximately $6 trillion. US Monetary Base (January 1959 – August 2009) (Dollars in Billions) $1.0 10.P.
which shows foreign official institutions’ purchases and sales of Treasury and Agency securities. to select the precise timing of when to withdraw the money from the system. Since the onset of the Agency purchase program. the multiplier could increase very quickly. In other words. Foreign Official Institutions’ 2009 Year‐to‐Date Purchase / (Sale) of Treasury and Agency Securities (Dollars in Billions) $60.000 $20. they should become more willing to lend. As they all rush to deploy the excess money they are sitting on.000 $30. This period typically lasts 12‐18 months. Year‐to‐Date Treasury Purchases / (Sales) January February March April May June July What if the “v‐shaped” recovery that appears to be priced into the markets takes hold? As banks’ confidence in the recovery strengthens. the Federal Reserve Agency purchase program is. funding a Treasury purchase program. in its forward‐looking nature. Consider for a moment what that would entail – the Federal Reserve selling its holdings of Treasuries and Agency securities into the market.000) $(30. .P. illustrates that as foreign institutions are selling Agency securities to the Federal Reserve.000) $(20. Imagine what will happen when the only buyer in the market place becomes a seller. We are today in the midst of what economists often refer to as the “Golden” period where everything feels good and the long‐term effects of deficit spending and money printing have not been realized. such that a recovery is sustained and inflation does not take hold? We believe the market. especially if China is no longer interested in buying any Agency securities. does not. they are using the proceeds to cover a substantial portion of their Treasury purchases. indirectly. These sales would put significant upward pressure on rates. We believe that neither the Federal Reserve nor the Treasury has the will power to force long rates higher in the midst of a fragile recovery. which could be very damaging to what will likely be a fragile recovery.000 $10. Interestingly.000 Year‐to‐Date Agency Purchases / (Sales) $50. the chart below. Therein lies the qualitative aspects of the perceived dangers of the actions by the Federal Reserve and other central banks that will cause a rush to hard assets even before the quantitative aspects of money printing take over. 7 © 2009 Hayman Advisors L.000) Source: Federal Reserve.000 $‐ $(10. Do you trust the Federal Reserve et al. the Federal Reserve has purchased more than 100% of the net issuance of both Agency debt and Agency MBS. The Federal Reserve has said repeatedly that it can withdraw this excess money from the system without a problem.000) $(40.000 $40.
Looking at housing data. Anyone? During the housing crunch that began in 2007. the two largest debtor nations in the world. not as I Do – The International Monetary Follies The International Monetary Fund (“IMF”) was founded almost 60 years ago by 45 member countries to provide a framework of international cooperation that would attempt to avoid a repeat of the economic policy mistakes during the 1930s. home buyers are able to purchase a house with no skin in the game.000 tax credit. It’s just a journal entry.6 It is no secret why FHA loans have increased wildly in popularity this year. Represents Adjusted Rate of Remuneration for the week of 9/21/09 – 9/27/09. it is proven time and time again that a low down payment is one of the greatest predictors of defaults. . The largest contributors to the IMF are the US and Japan with each country committing an additional USD$100 billion in 2009. 8 © 2009 Hayman Advisors L. A Little Hair of the Dog. Fannie and Freddie) essentially became the entire mortgage market. As one influential politician told us a few months ago. Source: IMF. Sound familiar? Once again. its key function is to provide stability to the international financial system through “rainy day” funds for fiscally irresponsible countries. voting rights and borrowing limits and represents a substantive ability to pay.5% down payment and the government is offering a tax credit of $8.24% per annum on their IMF commitments!7 6 7 Source: Inside Mortgage Finance.” At least they earn a whopping 0. The following advertisement from the FHA’s website is particularly interesting: Purchase or Refinance FHA HOME LOANS Do as I Say.000 to first time homebuyers. even though they have to borrow to contribute? No need to worry. and we all know how that movie ends. This time. Today the IMF membership includes 186 countries with each country assigned a quota linked to its relative size in the world economy.P. A member's quota resembles its financial and organizational relationship with the IMF. FHA loans only require a 3. These combined agencies wrote/guaranteed over 90% of the total loans made during the first half of 2009 with FHA loans becoming an increasingly larger share of the pie (FHA loans were 17.9% of total 2009 mortgage loans as of 6/30/09). a first time homebuyer could fund their entire down payment on a house costing $230. the government (via FHA. Wait a minute – the two most indebted nations in the world are the largest contributors to the IMF. It will be the US taxpayers that will ultimately pay the price. The US and Japan. it will not be Wall Street holding the bag. including its commitment obligations.000 or less. currently run large deficits and therefore are saddling their own citizens with additional debt to fund these commitments. With the $8. “It’s not real money. While the IMF advances a broad range of policy initiatives.
. the IMF simply chose to move the goalposts by increasing the borrowing limits to 600% of the borrowers’ quota. but the Chinese commitments are in the novel form of 5‐year bonds with a market rate of return (it makes you wonder what China’s definition of “market” will be). As a matter of fact. 9 © 2009 Hayman Advisors L. China created much fanfare by committing USD$50 billion to the IMF. in preparation for the upcoming G20 summit.P. As large economies and contributors. When it became obvious that the financial crisis would require numerous bailout loans in excess of the 200% limit. In September 2009. the IMF’s cumulative lending to any individual borrower was limited to 200% of the borrower’s quota at the IMF (Why set quotas when you can borrow multiples of them?). IMF Loan Commitments and Borrowings Shown as Percent of Borrower’s Quota (As of September 10. they were baffled to learn how the IMF has chosen to systemically exceed the quota ratio lending limits. They attempted to impose a facade of commercial discipline on the IMF by establishing lending limits based on the size of members’ quotas and covenants on each member loan. The IMF. 8 Source: IMF Public Information Notice no. the international banks) as demonstrated in the following table. 09/40.8 Still. For example. routinely ignores these guidelines.e. 2009) 1400% Total Commitments Under Stand‐by Agreements 1200% 1000% 800% 600% 400% 200% 0% Outstanding Borrowings from the IMF Undrawn Flexible Credit Line Borrowing Limit Until March 2009 Borrowing Limit Since March 2009 Quota Source: IMF. When we spoke with policy makers in the US that act as the conduit between Washington and the IMF. however. the IMF cannot restrain itself from ignoring even these higher limits to lend whatever is necessary to bailout creditors (i. Perhaps China recognizes that its citizens deserve compensation for their generosity and that the IMF’s business model needs an injection of market discipline. until March 2009. the US and Japan possess outsized influence at the IMF that enables them to steer its lending practices. Our policy makers are committing funds to bailouts without recognizing that the size of loan relative to the size of the economy makes repayment highly unlikely. with implicit permission from the US and Japan. it was reported by Caijing Magazine that Chinese Central Bank Governor Guo Qing Ping said on September 15 that the IMF should set specific goals and timetables to transfer voting rights from developed to developing nations.
3% 10 © 2009 Hayman Advisors L. 10 9 Latvia reports an 18% decline in GDP for the first quarter of 2009 Unemployment reaches 11. 2009. Latvia – A Case Study of an IMF Bailout While the IMF attempts to impose covenants on loans in the form of fiscal austerity measures and macroeconomic targets. 2008. the Latvian GDP has shrunk to an approximate run rate of $28 billion. Latvia has a population of approximately 2.5% March 2009 • • • Latvia’s new Prime Minister takes office IMF withholds 2nd installment of bailout plan as Latvia fails to implement necessary conditions to meet loan terms Unemployment reaches 10. $2.5 billion bailout (almost one third of its GDP. approximately 100% of initial budgeted 2009 revenue and nearly 130% of the updated 2009 budgeted revenue10). assumes unemployment rates to average 9% for 2009. “Latvian Parliament Passes Amendments to 2009 State Budget. they rarely enforce these conditions as evidenced by the case of Latvia. Source: “Latvian Saema Passed 2009 Budget in Final Reading.9 November 2008 • • Standard & Poor's cuts its ratings on Latvia to BBB‐ Latvia projects a 2009 budget deficit of less than 2% December 2008 • • • Latvia enters into a $10. So far in 2009. . and assumes that real GDP will shrink by 5% February 2009 • • Latvia's Prime Minister and cabinet resign Unemployment hits 9. Below is a chronology of the sheer ridiculousness of Latvia’s IMF‐led bailout.” The Baltic Course. and receives its first disbursement with the remainder to be made in nine installments subject to quarterly reviews The IMF credit agreement amounts to a whopping 1. June 16.200% of Latvia's IMF quota IMF bailout is predicated on Latvia maintaining a budget deficit of no more than 5%.P. Eurofound.2 million people and reported a GDP of approximately $34 billion for 2008. November 17.7% May 2009 • • All data pertaining to Latvia bailout chronology was sourced from the IMF and Bloomberg.4 billion of which was in the form of a standby credit agreement from the IMF.
“you cannot borrow your way out of debt. It is important to note here that $250. Recognizing the implications of his situation.000! In return for the bank’s additional risk. prepayments or increases in interest expense) and agree to a 13% budget deficit for 2009 Unemployment reaches 12. the bank lifts the restrictions. July 2009 • • • Latvia and the IMF renegotiate the bailout package and now preliminarily agree to a revised 10% budget deficit for 2009 (no apparent penalty was charged for this “renegotiation”) Latvia July new car sales drop 86.000 is his total income. As frequently stated.6% from July 2008 Unemployment reaches 11. and other developed countries that fund the IMF’s activities on non‐commercial terms are simply writing charity checks to fund creditor bailouts. The IMF preaches against 11 © 2009 Hayman Advisors L. His family’s expenses are spiraling out of control. and at the same time. for the third time.000 credit line from a bank and income of $285. he has certain expenses that he simply cannot cut. by the middle of 2010. If Latvia never repays its loan from the IMF.5 billion IOU. imagine Latvia is a person with a $10.000. Latvia is elated to learn that he has been granted credit in the amount of $240. and will be back to 2004 levels To put this into perspective. his family’s bills are coming in higher than expected. from September 2008 to September 2009. keeps the credit line the same and charges the same rate as before. Japan. it sets certain legally‐binding financial limitations to make sure Latvia is as prudent as can be with the new funds. .P. He is scared that the bank will call its loan back immediately. not disposable income. Fearing the worst. Now Latvia finds out that he is getting a pay cut and expects to only make $250. then the US.000.8% August 2009 • • • Latvia reports an 18. yet the IMF continues to fund a large loan to Latvia that will likely never be repaid. Latvia's gross domestic product (GDP) will have contracted by 25%. his credit score declines. He takes another pay cut and learns that his income will only be $200. Additionally. but to his pleasant surprise.3% September 2009 • • • Latvian Financial and Capital Markets Commission reports nearly 25% of all loans are delinquent with almost 14% overdue by more than 90 days According to Latvia’s State Employment Agency Director Baiba Pasevica. he applies for additional credit. compared with the highest point it reached in 2007. As is the case with any household. As the months pass. the unemployment level in Latvia has increased approximately 250% According to the chief economist at Swedbank (one of Latvia largest lenders). and he lets the bank know he cannot even come close to complying with the financial restrictions previously set by the bank.000 this year. with no additional covenants. the situation worsens for Latvia and his family. Would your bank be as accommodating as the IMF? Latvia failed to comply with virtually all of the material financial covenants and its prospects continue to worsen.7% decline in GDP for the second quarter of 2009 Latvia and the IMF renegotiate bailout package (again.” It is only a matter of time before Latvia recognizes this folly and the international coalition of lenders led by the IMF will be left with a $10.
” We believe the data set to watch is not their stock market.7trillion by the end of June 2009. and had grown to over RMB 73. We wonder what the encore in 2010 will have to be to sustain such “growth. which currently represents 40% of household expenditures. With this tsunami of money and credit creation. Source: Federal Deposit Insurance Corporation. China – Exploding Like a Fire‐Cracker? Despite the historic size of the fiscal stimulus injected into the US. The People’s Bank of China (PBoC) expanded Chinese M1 money supply by a staggering 28. 14 http://www. Total Chinese banking assets were approximately RMB 57. UK and Japanese economies.13 This increase represents almost 54% of Chinese GDP – equivalent to the US increasing total bank assets by USD$7. it is the cagey communists in China that take the cake with a massive USD$586 billion of fiscal stimulus (for an economy one third the size of the US) and an explosion in monetary policy. Evidence of this is clear from the 80% rebound in the Shanghai Stock Exchange Composite Index from its low in October 2008 (despite profits declining by almost 30%) as well as a rebound in property prices to previous inflated levels that leave the ratio of median price to median income in China at 7x that of the US (and we are well aware of how bad our US housing problem is). Food price inflation could be the tipping point for China. the Chinese government surpassed even the Federal Reserve and Bank of England in responding to the crisis with free money. 20% of the RMB 18 trillion went directly into the stock market. etc. and strong GDP growth is viewed as the essential tool to achieve it. . Many economic and political strategists have suggested that a growth rate of at least 8% is needed by China just to maintain stability as it seeks to modernize the western half of the nation still stuck in the Middle Ages. it is not surprising that China has been able to increase the level of fixed‐asset investment and boost industrial production and retail sales (which represent wholesale to retail sales rather than final sales to consumers) from the levels seen during the trough in economic growth late last year. The real economy has been unable to absorb all of the inflow.co. rather. where FDIC insured institutions have seen a decrease in total assets between September 2008 and today. As such. speculative real estate investments. not as I do” policy.html 12 © 2009 Hayman Advisors L. as they should have learned in the case of Argentina early in this decade.5 trillion at the end of June 2008.12 the Chinese banking system has grown at an extraordinary rate.e.7% year‐over‐year from September 2008 to September 2009. 13 Source: China Banking Regulatory Commission.P.). it is their cost of food. Unlike in the US. the Chinese government was also able to direct its banks to expand lending in order to keep the velocity of that money from falling like it has in the US. bond market or GDP. Aggressive loan growth of this type usually creates real non‐performing loan (“NPL”) problems. Maintaining stability and order is the absolute priority. the expanded lending has brought a temporary reprieve for troubled borrowers with non‐performing loans at 11 12 Source: Bloomberg. and the PBoC has suggested that up to 20% of the new credit has flowed into asset speculation14 (i. exactly this type of behavior to its troubled borrowers in an example of “do as I say.5 trillion in a single year. We believe the IMF should force restructurings and/or devaluations and then loan money to troubled nations.uk/finance/financetopics/financialcrisis/6011674/Credit‐tightening‐threatens‐Chinas‐giant‐ Ponzi‐scheme. But in this case.telegraph.11 On top of this core money supply increase.
which suggests that there is simply too much manufacturing and industrial capacity in China. 13 © 2009 Hayman Advisors L. 17 Source: Bloomberg. think increasing the denominator to reduce the percentage).77% of assets from 16. The key question with regard to China is whether this story is too good to be true.P. It feels eerily similar to credit markets in the United States in 2006‐2007. This situation is being exacerbated by the continued weakness in exports (down 23. in an environment where credit is unlimited and underwriting standards are all but non‐existent.4% year‐over‐year). one of the most compelling sets of data points to come out of China is the substantial drop in prices for goods and services (Purchasing Price Index (‐11. but also credit. Imports have recovered modestly from their lows at the beginning of the year and. it is pretty hard to default or be delinquent on a loan when it can be constantly refinanced or termed out to an even larger one.9%)) in an environment where not only money supply. and Producer Price Index (‐7. but recent official comments about curbing domestic cement and steel production may be a signal that the stock piling is slowing down. in terms of volume.6% in March of 200415 (again. Admittedly. To us. . asset prices are rising. but the prices for consumable goods and services are plunging. In China.1%). The domestic demand for raw materials may have driven a rebound in commodity prices. investment and “retail” sales are increasing at double‐digit percentage rates. Are the trillions of Renminbi of new lending being devoted to profit maximization and the investment in assets that genuinely generate income sufficient to service the debt? Or is China compounding the existing problem of overcapacity by building more and more real estate assets. factories and infrastructure when a huge inventory overhang already exists? We believe it is the latter.17 This downturn started after the financial collapse last September and has not responded to any of the fiscal and monetary stimulus so far. 15 16 Source: Bloomberg.4% year‐over‐year. Chinese banks falling to just 1. have exceeded last year’s levels. Wholesale Prices (‐7. The current situation is only sustainable as long as credit continues to expand at a dizzying pace. We have adapted an ancient proverb originally published by Erasmus around the year 1500 to describe this phenomenon: A rolling loan gathers no loss. Source: Bloomberg. the sixth month this year with a 20%+ decline16).
18 Source: Bloomberg. driven by the over expansion of credit into non‐economic investments and hidden by massive liquidity injections and yet more credit expansion. investment and particularly domestic savings. monetary. foreign direct investment (which has rebounded slightly but is still down 17. If the world’s most aggressive fiscal.P. and the resulting change in momentum will be a massive shock to the system. As such. 14 © 2009 Hayman Advisors L. Chinese YoY Change in Consumer. At some point the liquidity spigot must be turned off. at most.18 If this structure were to unravel. the potential to keep the balls in the air is greater than that of a more open system. All the while domestic capital is prevented from leaving the country and forced into the hands of the domestic banks where the credit machine can spin around and around. In our view. we believe that the Chinese monetary and banking systems could face substantial devaluation and default pressure.52% year‐over‐year) and trade surplus income (down 19. credit and investment expansion can. Wholesale and Purchaser Prices (June 2008 – August 2009) 20% Consumer Price Index 15% Purchasing Price Index of Raw Materials. Likewise the continued external demand for Chinese goods. deliver trend growth while increasing deflationary pressures. a continued decline in speculative inflows. We believe there is an NPL time bomb waiting to go off in the Chinese banking system. Fuels and Power Wholesale Price Index 10% Producer Price Index 5% 0% ‐5% ‐10% ‐15% Source: Bloomberg. it is crucial to identify the catalyst that will set fire to all this combustible credit. in an economy where the government exerts substantial control over credit allocation. ever larger for some time yet. we are skeptical of its sustainability.3%) could place pressure on this structure. . However. services and assets (as represented by the net inflow of foreign capital which is clearly apparent in the build‐up of foreign exchange reserves) allows the government to maintain the currency controls that prevent domestic capital from escaping the country in any meaningful way.
this model eventually becomes unsustainable. however. this could be the shock that instigates another round of frenzied risk aversion in global markets. First and foremost. Japan – Land of the Setting Sun Japan is one peculiar case where decades of chronic deficit spending and central government borrowing have not led to material currency devaluation and high (nominal) interest rates. if net new issuance of JGBs outstrips economic growth. while continuing to grow its central government’s debt burden at an accelerating pace. Along the way. We believe that Japan has reached its inflection point in 2009. Japan’s population is in secular decline. If the bright shining light of Chinese growth turns out to be the flaming destruction of a meteor crashing to earth.P. but without substantial social reform and re‐distribution of wealth. this ideal allowed the Japanese government to fund 95% of all of its bond sales by selling them directly to Japanese institutions and individuals. An anomaly of developed economic history. The best case scenario for China is that the current stimulus buys enough time for the developed world to return to 2006/2007 levels of demand for Chinese goods. there will not be the level of domestic demand and consumption required to allow the kind of growth seen in more developed economies. Along the way the Chinese will slowly attempt to rebalance their economy in favor of domestic demand. The ability to fund almost entirely by selling bonds to their own citizens allowed rates on Japanese Government Bonds (“JGBs”) to remain low as they did not have to compete for international capital. The National Institute of Population and Social Security Research (“IPSSR”) estimates that the Japanese population actually peaked in 2004 and is now on a long‐term negative trajectory. Japan experienced more than a decade of low (near zero “official”) interest rates and almost non‐ existent growth in both real and nominal terms. however. A review of Japanese demographic trends shows why this model may be closer to breaking than many may realize. The relative resilience of emerging markets (and China in particular) has been a source of optimism and bullish sentiment for equity and fixed‐income investors in the developed world. services and assets. Cultural forces spawned the generally accepted belief among Japanese citizens that it is their patriotic duty to lend their government money. Combined with an abnormally high savings rate (when compared to the rest of the developed world). We believe that the Chinese end‐game is to keep the stimulus flowing until there is either a danger sign of real CPI inflation or the rest of the world’s economies return to the pattern of growth and consumption that we have seen for the past six years. danger to this recovery narrative does exist. Please see the chart below: 15 © 2009 Hayman Advisors L. . lip service has been paid to the restructuring of the Chinese economy in order to increase domestic consumption.
000 Projected (IPSSR) 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042 2046 2050 Source: National Institute of Population and Social Security Research. Currently seniors make up 22. The impact of this trend is twofold: (i) the central government and ultimately Japanese workers will carry an accelerating social security burden which will require some combination of increased withholdings (effectively higher taxes) and further debt issuance.000 110. the chart below illustrates that Japan’s household savings rate as a percent of disposable 19 Source: OECD. Perhaps of even greater importance than the total population is the composition of the population. . Percentages represent 2009 estimates. a population under a common economy will reproduce at a rate that keeps the senior proportion roughly constant. and (ii) the positive savings rate that Japan has enjoyed for decades will turn negative.6% globally). Percent of Population Aged 65 or Older (1950 – 2050E) 40% 35% 30% 25% 20% 15% 10% 5% 0% Japan United States World 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042 2046 2050 Source: OECD. especially in a society whose public retirement program utilizes pay‐as‐you‐go funding.8% of Japan’s population (versus 12.19 The OECD estimates that the ratio will reach 29% by 2020 and will continue to grow thereafter.000 90. In fact.000 100. The following chart shows the percent of the population aged 65 or older projected out to 2050. Dotted lines denote 2009 – 2050 estimates. Japanese Total Population (1950 – 2050E) (In Thousands) 130.000 80. In an ideal world.P.000 Actual (Census) 120.9% in the US and 7. 16 © 2009 Hayman Advisors L. Solid lines denote historical actuals.
20 Granted. The best the central government could hope for from the current pool of savings is some reallocation toward a higher weighting of JGBs. Another key statement made by GPIF President Takahiro Kawase was that the fund should only need to sell JPY 4‐5 trillion because the additional shortfall will be made up from maturing government bonds.0 ¥45. Are you willing to lend the profligate Japanese government money for 10 years at 1. Annual Household Savings and Savings Rate (FY 1980 – 2007) (JPY in Trillions) ¥50. The demographic and savings trends suggest that this is not far off. In the course of our discussions with our investing peers as well as analysts across the major broker‐dealers. Japanese Ministry of Finance. 2009. FILP bonds represent 15% of total central government debt and 19% of total JGBs. For domestic household savings to continue to support net new JGB issuance. “World’s Biggest Pension Fund May Sell Japanese Bonds. June 15.21 While not considered “General” JGBs.” Bloomberg. is only JPY 4‐5 trillion – not enough to materially impact the markets. Interestingly.6% of its assets in a type of JGB called a FILP bond (“Fiscal Investment and Loan Program”).0 ¥25.0 ¥35.0 ¥15.0 ¥5.0 ¥30. however.3%? As prudent fiduciaries. income and pension payments has been on a general downtrend since 1981 (admittedly interspersed with upward movements in some years) and has now fallen to 2% from a peak of over 18%.22 GPIF owns 19% of all FILP bonds outstanding and for years had been a net purchaser. as all the savings to date are presumably already invested. we certainly are not. said in June that it may become a net seller of securities this fiscal year (ending March 2010) in order to pay benefits. the amount the GPIF is talking about selling. In the case of a borrower being a consistent net issuer of debt. creating a pool of JGB sellers – not buyers. 22 Source: Japanese Ministry of Finance. The problem is that all the current savings pool allows is the rolling of existing government debt. 21 Source: GPIF. we often hear the large pool of Japanese savings referenced as the reason Japan will be able to continue to sustain this model. Japan’s public pension fund and historically the biggest individual net buyer of JGBs. savings will actually become negative. 2009. there must be net new savings as well.0 ¥40. there is no distinction between the lender becoming a seller of debt and ceasing to roll near‐term maturities. . is of more importance than the nominal amount. As a greater percent of the population reaches retirement age. on a net basis. Currently GPIF holds 19. The trend.” Reuters. which would come at the detriment to other securities (corporate bonds and equities). 20 17 © 2009 Hayman Advisors L. What Source: “GPIF: may become net seller in 2009/10. July 8. the Government Pension Investment Fund (“GPIF”).0 ¥20.0 ¥10.0 ¥‐ Annual Net Savings (Left Axis) Savings Rate (Right Axis) Savings as % of GDP (Right Axis) 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: ESRI.P.
happens to demand for these bonds when the most substantive holder becomes a net seller? What happens as private funds and savers are faced with the same funding issues as GPIF? Just how big is the problem? As the chart below shows. how much of your own personal balance sheet are you willing to bet on rates remaining low indefinitely? Below is a comparison of JGB issuance to government interest expense. Hayman estimates. 18 © 2009 Hayman Advisors L.P. Debt/GDP Hayman Estimate Source: Japanese Ministry of Finance. Japan’s central government debt as a percent of GDP has increased from 99%. which is a dangerous number in and of itself. we expect this number to exceed 200% by the end of the current fiscal year. Bank of Japan. the government was able to issue an aggregate of JPY 365 trillion of General JGBs while annual interest expense declined from JPY 11. to a staggering 170% in the last ten years (as of the latest fiscal year ended March 2009).0 trillion to JPY 7.0 trillion between 1991 when government interest expense was at its peak through 2006 when it reached the trough. Rates declined enough to more than offset interest expense incurred as a result of new debt issuance. Any rational person (we’ll leave it to you to decide whether we at Hayman qualify) would expect the compounding impacts of issuing debt to service debt and fund budget shortfalls to lead to an exponential rise in interest expense which would only exacerbate the problem of needing to convince more buyers to lend the government money at less than 1. . As it becomes cheaper to borrow.5%. Through a combination of declining GDP and additional issuance. Japanese Central Government Debt / GDP (FY 1996 – 2009E) 220% 200% 180% 160% 140% 120% 100% 80% 60% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Total Central Govt. Through zero‐ interest‐rate‐policy instituted by the Bank of Japan (“BOJ”). In reality. simple financial alchemy and arithmetic allowed total debt to increase while interest expense paid by the Japanese government actually declined markedly.
Japanese Net General JGB Issuance and Interest Expense (FY 1983 – 2009E) (JPY in Trillions) ¥50. for which we have detailed data back to 1996.0 ¥20.0 ¥15. Hayman believes the piper must be paid in the near future.0 ¥8. in terms of government bond rates. Bloomberg.0 ¥‐ ¥13.0 ¥45.0 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Japanese Ministry of Finance. the Japanese government has been able to borrow like an American subprime homebuyer in Las Vegas.0 ¥5. As to be expected.0 ¥10.P. Bank of Japan. The next chart shows that.0 General JGB Issuance (Right Axis) Interest Expense (Left Axis) ¥12. this analysis considers only General JGBs and does not consider FILP bonds or other borrowings of the central government.0 ¥10.0 ¥9. July 1991 marked the beginning of a series of cuts in the BOJ discount rate toward 0. paints an uglier picture in terms of true debt issuance. Since debt has been so cheap. .0 ¥25.0 ¥7.1%. The inclusion of those debts.0 ¥35. BOJ Discount Rate and Central Government Bond Yields (March 1983 – June 2009) 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% BOJ Discount Rate Implied Sovereign Interest Rate Generic 5‐Yr Generic 10‐Yr 3/1983 3/1984 3/1985 3/1986 3/1987 3/1988 3/1989 3/1990 3/1991 3/1992 3/1993 3/1994 3/1995 3/1996 3/1997 3/1998 3/1999 3/2000 3/2001 3/2002 3/2003 3/2004 3/2005 3/2006 3/2007 3/2008 3/2009 Source: Japanese Ministry of Finance.0 ¥6. the nominal impact of zero‐interest‐rate‐policy appears to have run its course.0 ¥30. which was reached in September 2001. As an aside. JGB yields followed suit and continued declining even after the BOJ rate 19 © 2009 Hayman Advisors L. Japan continues to borrow at significantly below‐market rates and has set itself up to be dealt a potentially fatal blow with any slight uptick in rates. The key thing to note about the chart above is that interest expense has begun to explode again. Hayman estimates.0 ¥11.0 ¥40. Japan has milked zero‐interest‐rate‐policy for all it’s worth. As older debts have rolled to newer debts at the new lower rates.
18% of tax revenues are already used just to pay interest expense.24 What will happen to rates when the central government asks to borrow more money from its citizens. financing bills and other borrowings) matures within one year. You too might have a few too many drinks if you were responsible for Japan’s budget. There are no further good tools available to keep the government’s interest costs from growing. Hayman estimates. This means that a 1% increase in interest rates would massively increase the borrowing costs of JPY 223 trillion of government debt within the next twelve months. who are themselves becoming net sellers and net consumers? Ultimately Japan will have to compete for capital internationally. and judging by the new advertisements in Japanese taxi cabs encouraging citizens to continue purchasing government bonds. further increasing the need to issue more debt.3% 10‐year bond be attractive? We don’t think so. Even if the BOJ were to cut the discount rate to zero tomorrow (from a whopping 0. who appeared drunk at a G7 news conference last February. It is also worth pointing out that approximately 26% of Japan’s total central government debt (including all government bonds. 20 © 2009 Hayman Advisors L. . flattened. JGB yields effectively bottomed out in 2003 and have moved more‐or‐less sideways since then. “Government bonds are worth another look.P. Will a 1.10% today) the impact on government borrowing costs would be de minimis. it appears that the Japanese government shares our concerns. Considering the demographic challenge facing the country and the fact that the BOJ maxed out on rate cuts years ago. there is a frightening scenario unfolding whereby JGB issuance will continue to be significantly positive while domestic demand for the bonds turns secularly negative. the Ministry of Finance says in the advertisement.” The ad features a picture of former NHK anchor Junko Kubo. Japanese Advertisement for Japanese Government Bonds in Taxi Cabs According to Bloomberg. Source: Japanese Ministry of Finance. 37.23 We can sympathize with former Minister of Finance Shiochi Nakagawa. 23 24 Source: Japanese Ministry of Finance.
which spanned four quarters. which is the largest component at 58% currently.8%. representing 13. During the course of the recession. declined 20.4% of GDP and declined a staggering 36. Japan is an export economy. it is also important to focus on the state of the Japanese economy and the Yen. and Japan never got off its back. Seasonally Adjusted (December 1989 = 100%) 300% GDP Exports Imports Private Consumption Government Consumption Private Investment Public Investment 250% 200% 150% 100% 50% Dec‐89 Jun‐90 Dec‐90 Jun‐91 Dec‐91 Jun‐92 Dec‐92 Jun‐93 Dec‐93 Jun‐94 Dec‐94 Jun‐95 Dec‐95 Jun‐96 Dec‐96 Jun‐97 Dec‐97 Jun‐98 Dec‐98 Jun‐99 Dec‐99 Jun‐00 Dec‐00 Jun‐01 Dec‐01 Jun‐02 Dec‐02 Jun‐03 Dec‐03 Jun‐04 Dec‐04 Jun‐05 Dec‐05 Jun‐06 Dec‐06 Jun‐07 Dec‐07 Jun‐08 Dec‐08 Jun‐09 Source: Japanese Ministry of Finance. but it still does not explain an 8. 32. the peak‐to‐trough decline. declined 2. Private consumption. The persistent strengthening of the Yen recently and its reputation as a “safe haven” currency are puzzling. quarterly seasonally adjusted GDP declined 8.7% of GDP growth from December 1989 to the peak was due to growth in exports.8% peak‐to‐trough. wiped out 17 quarters of GDP growth.6%.1% of GDP. For those of you keeping score at home. Japanese exports become less competitive (i.4% of the total GDP decline. more expensive to foreign consumers). How do you think the country will do now with double‐digit output gaps and structural demographic issues coming to a head? Examining the major components of GDP reveals the primary drivers of the decline. Gross exports currently represent 12.4% over the peak‐to‐trough period (and declined further last quarter). To put it in perspective. Like it or not.e. Now we are getting somewhere.9% from its peak. and the second greatest growth engine (after government consumption) of the last twenty years shuts down. but also that any growth seen over the last twenty years has been driven almost exclusively by exports and government consumption. . Government consumption (not investment).P. In fact. Private non‐residential investment. who are experiencing their own financial challenges.2% peak‐to‐trough. As the Yen strengthens against the currencies of its major trading partners (the US being one). The chart below illustrates not only that the bulk of the GDP decline has been a result of export decline. While our discussion of Japan up to this point has focused on their sovereign debt burden and implications for interest rates.4% peak‐to‐trough (calendar first quarter 2008 to first quarter 2009) in real terms.4% decline in GDP. the second largest component at 18. As of the latest quarter. We have arguably just lived through the greatest Asian boom in history. Quarterly. 21 © 2009 Hayman Advisors L. the decline in gross exports comprised 72. or everything since the fourth quarter 2003. GDP is still off 7. Real GDP and its Primary Components. grew by 0.
26 All fiscal 2009 budget data sourced from the Japanese Ministry of Finance and adjusted to reflect comments in Finance Minister Yosano’s speech on April 27. Among his (admittedly noble) initiatives are increased child benefits. 25 22 © 2009 Hayman Advisors L.6 trillion. Mr. In the mean time. Source: “DPJ Policy Implementation Could Inflate Japan's Fiscal Deficits. Yukio Hatoyama. has outlined policies focusing on fiscal stimulus and domestic consumption with a disregard for the importance of exports.” Standard and Poor’s. Many of the DPJ’s initiatives are not scheduled to be implemented until the next fiscal year (beginning April 1. which the Ministry of Finance includes in their budget as revenue). We believe the net result of all of the above will be higher rates and a weaker Yen. down nearly 10% from two years ago (this does not include JGB or FILP debt issuance. 27 Source: Bank of Japan. Mr. . A persistently strong Yen will keep pressure on exports which will result in lower GDP and lower government tax revenues. The Japanese government can either allow rates to rise. which they probably know they cannot afford. the Bank of Japan (“BOJ”) has authorized itself to purchase JPY 21. or (most likely) some combination thereof. 2010) should concern investors who regard Japan as a “safe” destination for capital.25 Given the DPJ’s focus on the Japanese domestic consumer. This is true for trade‐balanced economies and net importers. 2009. the compounding impacts of issuing more debt will increase Japan’s interest expense burden (and consequently the deficit) even further. The flaw in Mr. Now that zero‐ interest‐rate policy has reached the extent of its potential benefits. 2009 regarding incremental stimulus spending. August 31. and an abolition of highway tolls. Hatoyama has made public statements in support of a strong Yen as it theoretically drives prices down and increases purchasing power. All else equal. or they can increase quantitative easing to attempt to keep rates low.6 trillion.0 trillion.6 trillion Yen per year of JGBs. Relative to the policies of the LDP.27 Japan is on full tilt with the government buying all classes of financial assets in an attempt to prop up their house of cards. a strong Yen will punish Japanese exporters which will create significant headwinds for income growth. Never mind the JPY 1 trillion of financial institution stocks that the BOJ is authorized to purchase through April 2010. Hatoyama’s logic is that in order to promote domestic consumption (without firing up the leverage machine). free public high school education. Hatoyama believes they can fund these programs without tax hikes and without increasing the fiscal deficit via budget reforms and efficiency improvements in deployment of public funds.P. which will lead to greater debt issuance. Compensating Measures Will Be Key. The DPJ leader. Revenues are expected to be JPY 51. The implied deficit is JPY 40. 2010). Soon the issuance of JGBs will be met with a lack of domestic demand. a weaker Yen.26 Interestingly. he has placed emphasis on distribution and welfare. The Democratic Party of Japan (“DPJ”) took power from the Liberal Democratic Party (“LDP”) in a landslide victory in the August 2009 general election. When we connect all of the proverbial dots. we expect either higher rates in Japan. He has yet to provide substantive details with respect to these plans. or the JPY 3 trillion of commercial paper and JPY 450 billion of corporate bonds authorized for purchase between October and December of this year. they will need income growth which requires growth in corporate gross profit and dividends. and rates will feel significant upward pressure. Japan’s fiscal 2009 budget (ending March 31. or 44% of government expenditures. Expenses including interest are expected to be JPY 91.
The debt financing position of sovereign governments has become very dependent on historically loose monetary policy. we are investing cautiously in credit. Capitalizing on Our Views To summarize our views. 23 © 2009 Hayman Advisors L. For example. but we believe that it could be sooner due to the size of both monetary and fiscal stimulus as well as the coordinated global nature of the actions.9% of Eurozone GDP. we will continue to selectively invest in corporate credits that meet our criteria. We are positioned for both outcomes. the central banks of the world have committed to funding the issuance of new sovereign debt directly through quantitative easing (in the US. primarily high‐yield bonds and bank loans. Based on our thesis of impending inflation and competition for sovereign capital as world governments run huge fiscal deficits (and sell debt to finance them). Additionally. Our underwriting standards take into consideration a range of macro variables including further home price depreciation. We believe that certain securities remain attractive due to many of the traditional mortgage‐backed buyers shying away from the market which will provide opportunity going forward. in the short term. we look at a broad array of pool‐specific traits and servicing techniques when determining value. We believe that in the event this monetary policy is actively tightened or indeed not actively loosened further.P. Additionally. The creditworthiness of many major economies in Western Europe. Asia and North America has been substantially affected by the rapid accumulation of new debt in the name of stimulus spending and bailouts. We target two types of situations – short duration performing credits that provide current income and distressed credits with solid asset coverage. Hayman has added corporate credit positions. maintained stress on consumer balance sheets and a prolonged downturn in the labor market. have relatively short weighted average lives and that provide attractive risk‐adjusted yields based on our assumptions. Unless a new dose of fiscal sobriety emerges around the world. and the borrowing needs of sovereign governments. Historically. central banks will have to choose at some point between the integrity of the money supply. This has allowed artificial demand for sovereign debt and low interest rates despite the massive amount of new supply. While we expect corporate defaults to remain elevated. We have also allocated a portion of the portfolio to precious metals and are seeking out unique opportunities in natural resources. We are not particularly bullish on the world macro environment or the US consumer for that matter. In the core Hayman portfolio. We believe global OECD rates will begin their ascent over the next 18‐24 months and that the best convexity for rates is in Japan. Many of our larger positions tend to have the same kind of asymmetrical risk/return characteristics that we strive to build into the portfolio. Hayman continues to believe that the transfer of private debt onto the public balance sheet in the form of deficit spending and government guarantees is unsustainable. we are invested in short duration credit and mortgages. however. UK and Japan) and indirectly through repurchase agreements with favorable terms (Eurozone and elsewhere). . banks from Ireland have absorbed approximately 15% of the European Central Bank’s outstanding liquidity injections. despite representing only 1. it has taken 18 months to two years to take hold. but we continue to invest slowly and defensively. we believe that global currency printing will inevitably lead to high levels of inflation – outright currency debasement. equal to approximately 25% of assets under management. The core strategy is to invest in mortgage‐backed securities that are very high in the capital structure. Hayman has built a mortgage position equal to approximately 50% of assets under management. the ability for sovereigns to fund themselves at the current rate of deficit spending is questionable.
This may not be reproduced. Respectfully.P. . solicitation or recommendation to sell or an offer to buy any securities. 24 © 2009 Hayman Advisors L. Such an offer may only be made to eligible investors by means of delivery of a confidential private placement memorandum or other similar materials that contain a description of material terms relating to such investment. J. distributed or used for any other purpose. Kyle Bass Managing Partner The information set forth herein is being furnished on a confidential basis to the recipient and does not constitute an offer. An investment in the Hayman Funds is speculative due to a variety of risks and considerations as detailed in the confidential private placement memorandum of the particular fund and this summary is qualified in its entirety by the more complete information contained therein and in the related subscription materials. investment products or investment advisory services. The information and opinions expressed herein are provided for informational purposes only. Reproduction and distribution of this summary may constitute a violation of federal or state securities laws.
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