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A D VI S 0 R S. L. P.
October 2, 2009
"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. how the fund is positioned, but also - and possibly more of these issues. We
The purpose of this letter is not simply to communicate importantly everyone. believe that we are in the midst of a once-in-a-lifetime
- to stimulate thought and discussion about the "big picture" implications
(literally) economic shift that has affected or will affect
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, dropped only 18%, and home prices dropped only 31.3% nationwide. the underemployed) million working part-time jobs that are insufficient S&P 500 revenues (including
reached 17.0%, which translates into 17.4 million Americans out of work and another 9.2 to pay their bills.' After losing an average of 578,346 jobs figure improved in July from 9.5% to 9.4%. Never and a portion (think of the the size of the labor force increasing
every week since October 2008,2 the headline unemployment "improvement" denominator in July was achieved by adjusting
mind that in August the Bureau of Labor Statistics ("BLS") revised their prior estimates, the total to reduce the percentage) and unemployment We are left wondering continued
its upward trajectory
to 9.7% in August
and 9.8% in September. time period."
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
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. back to pre-Lehman levels. 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
Where We are Bullish
There are great businesses which have too much leverage, which are being or will be recapitalized consensual restructurings or Chapter 11 bankruptcies. These "capital transformation investments" involve buying senior debt and working with the company's stakeholders
to craft a plausible
to the latest data available from the BLS, 15.142 million Americans are included in the labor force and are Another 2.219 million would like to work, but have not searched for a job in the last four for economic reasons," meaning currently of Labor. employed part9.179 million are classified as "part-time
classified as "unemployed." weeks. An additional
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 3 Source: Bloomberg.
© 2009 Hayman Advisors L.P.
of which were caused by financing tipping point for hyperinflation Bernholz analyzes the 12 largest episodes of hyperinflations deficit exceed 40% of its expenditures. here is where the really bad news Never Before and Hopefully Never Again Western democracies. we will likely end up owning some amount of senior end up holding equity pay characteristics company for little. experiment and Japanese deflationists in history. Monetary money creation. M1 growth of the world's major currencies since 2007. begins.766 trillion in FY 2010 with unified deficits of $1. debt with attractive On the back end. governments enormous fiscal deficits financed by printing money. The qualitative the future. Switzerland) 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 of national economies in the 20th century. if any. Peter Bernholz (Professor Emeritus of Economics in the Center for Economics and Business (WWZ) has spent his career examining the intertwined In his most recent book. slightly above zero). money is Our flowing and many private equity players are prepared to invest in their existing portfolio with a debt restructuring.3% and 39. expenditures measurements respectively. recent price action in metals. One has to ask whether the US reached the critical tipping point? such a scenario that may be far more important. History.all the His conclusion: after 1980. 3 © 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. Economic and Political Relationships. projections. US federal expenditures huge public budget deficits through occurs when the government's According to the current Office of Management $1. businesses where we can buy into the right portion and in certain circumstances structure in advance of the restructuring. impossible to control once confidence suggests that the market is already anticipating is lost.653 trillion in FY 2009 and $3. are focused on asset-heavy current It is in these types of situations companies after or in of the capital in the that we see great opportunity. In fact. with 20 occurring worlds of politics and Regimes and Inflation: . Everywhere are concurrently engaging in what are running may be the largest. roughly 40% of what our government deficits and money creation. As the capital markets have recovered. real cost. economics with special attention given to money. associated with government has to be borrowed. If the story could just finish here with such a happy ending . communistic capitalists. These projections and Budget ("0MB") are projected to be $3. the dollar and commodities M1 money supply is the most liquid measure of money outside of tangible currency. respectively.capital structure conjunction investments to return the entity to health and growth.unfortunately.580 trillion and imply that the US will run deficits equal to 43. The chart below illustrates perceptions there exists a qualitative of fiscal and monetary is spending aspect to policies are Beyond the quantitative in 2009 and 2010.502 trillion. There have been 28 episodes of hyperinflation at the University of Basel.9% of To put it simply. global financial you turn. .
co co co co co co co co co co co mmmm mmm a. r-.!!l u. as the central banker deems fit.<: ra OJ ra :J :J OJ ra ra :J ~ :J OJ OJ 0 . r-..-------------------------------------------------------------------~ -UK -Eurozone 90% U) m co a a a 9 9 1:. r-. r-.. halfway through the game.Ml Growth of Major World Currencies (December 2006 = 100%) 160% . with the exception of Japan. Then. the major global currencies have experienced money supply growth between 15-55% in less than three years. r-. and how we have Below is a more detailed assessment of what we are seeing domestically positioned your capital so that you may emerge from the "game" a winner. ~ 9 a 9 ~ 9 a ~ 9 9 9 1:. ::?! <C ::?! ~ Cl <C <Il a z Cl .:J ~ :J OJ U 0 OJ <: OJ ra >. "banks" of money being injected into the game (if you were about to go broke) or cheated (if and how you played the rest of the game. a. ::?! <C ::?! ~ <C r-. did the real value of Is it a fair process? to the participants anything change? Does the bartering for property increase or decrease prices? Did each unit of money become more or less? How does the central banker decide to allocate the extra money? prior to the additional Depending on how you were positioned you had played the game prudently). the central banker decides that money is too tight and the velocity of or a few players are about to go broke. . imagine a game of Monopoly where the participants are playing with one bank of (with a little To put this into perspective. In a God-like fashion ecclesiastical white-out). 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").<: ~ t>O C. r-. the central banker decides to add two more banks of money to the game that are Under this scenario. The greatest concern is that. how are you positioned? and internationally. U > u <: OJ ra >. ~ 9 a 9 ~ 9 u <: t>O C. 4 © 2009 Hayman Advisors L. r-. money. Source: Bloomberg. t>O <: >u >. r-.. the game is slowing distributed worth down.P. you either feel fortunate As a player in today's real-life Monopoly game. a. ~ 9 a 9 ~ 9 a ~ 9 9 9 1:. r-. r-.!!l u. ::?! <C ::?! ~ <C <Il a z Cl .!!l u. r-.
it has driven rates down. . rather it is the foundation two key components: requirement $0. Source: United States Federal Reserve. made perspective. we seasonally adjusted M1 and M2 have only increased $73. Since the collapse of Lehman. This means that for every dollar a bank receives in deposit.2 billion and $109. Additionally. money") this year. Freddie Mac or the Federal Home Loan Banks. The monetary In short. money supply growth that could occur quite rapidly as a result of the money To understand the monetary impacts of quantitative monetary base and the money supply in a fractional tangible supply. perhaps printing mortgages more affordable are concerned about the potential printing that has already occurred. into the system and another multiple of the monetary base. currency and banking reserves.81 then gets re-deposited to a is typically only 10%.90.Why Hasn't the Money Supply in the US Increased More Significantly? The Federal Reserve has engaged in roughly $1. this freshly printed money does not find its way into the money supply but instead stacks up at the banks. This is how the money supply accumulates This $0. agreed to pay banks a small rate on their excess reserves of 0. From a quantitative That being the case. one must understand the relationship reserve banking system.' and has not blown up the dollar money supply.25%. up from $2 billion just twelve months ago. Even though they are not required by the Federal Reserve to hold these excess reserves.81 can be re-Ient. Under normal circumstances. be lent out at a profit. the reserve The $0. including worth of quantitative easing (a nice way of saying Federal Reserve purchases of both Treasury and Agency securitles:" money is not such a terrible thing .P.9 billion. The chart below shows the composition of the monetary base from 1959 to the 4 5 Agency securities refer to those issued by Ginnie Mae. Depending on the specific nature of the deposits. respectively. banks are not lending because they are either capital constrained concerned about additional losses deteriorating their existing capital. however.73 is lent out. banks have been accumulating As the Federal Reserve has engaged in quantitative easing. Since September present. 2008. and $0. easing. the banking system has built up excess reserves to levels unprecedented in the postor the Federal Reserve has World War II history of the US.2 trillion "printing however. 5 © 2009 Hayman Advisors L. Banking reserves represent banks are required to hold against deposits. Excess reserves in the US banking system currently stand at $855 billion. it can loan out $0. and so on. Bloomberg. banks typically hold only the minimum required reserves because any excess can excess reserves. Fannie Mae.90 then gets deposited elsewhere. the monetary between the base is not money base consists of the money that on which the money supply is built.
...-i .....-i ..................-...-i ..-i en r-..-i .-~~ en LI'I en ....--.-i .........-i C'Il +--..-.............-.......... en .......... 00 m 0 Lon ....-i en r-.......... r-.... ...... The threat to the money supply occurs if banks decide they are comfortable with deploying those excess reserves or lending them out.................. co co co en en en en . ......... 0 ..-i 0 0 r-.. .--..... .-i .. 0 ...........-i LI'I C'Il en r-.... .-i . C'Il . co m 000'-<0000'-<0000'-<0000'-<0000'-<0000'-<000 0 Lon .. . en en ..... 14....... .-i N '<t r-........-< C'Il LI'I Ul co en ................-i Ul co en 0 .. LI'I 0 .. • Other / Adjustments • Vault Cash (Not used for Reserves) -----------------------+1 • Excess Reserves • Required Reserves • Currency NNNNNN 0 0 0 N C'Il 00 00 0 LI'I 0 0 Lon 0 0 .-i 0 0 Source: United States Federal Reserve. ...........0 -- 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 shown as Checkable Deposits/Banking Reserves (January 1959 ........-< C'Il '<t co r-... .. en .......-.... 0 ..... ........ Banking Reserve Multiplier.................-i . is conservatively The chart below increase in the money supply of approximately dating back to 1959... r-......... 00 m 0 Lon .....--.............. Bloomberg..... r-........... .0 10.P........0 4.....-i ......-i 0 ........-i en en en ......0 12.......... r-..--..... ....... r-..............0 8....................-....-i ...... ..........-i NNNNN . ..... If this were to happen..... en ..... co co co co co co en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en .......000 $800 $600 $400 $200 $0 en 0 N C'Il LI'I r-. around 7x...... .............................-i C'Il en 0 0 .......-i en 0 ...... LI'I 0 ...200 $1...-i ....-. ..August 2009) (Dollars in Billions) $1..-.......-.........-i . en LI'I Ul Ul Ul Ul Ul Ul r-.............-i C'Il '<t Ul co en 0 0 0 0 0 en 0 0 0 0 0 .......-. 0 0 0 ..-i 0 ..0 2................... r-......... r-..-i .--......... .....-i r-.... .-< N '<t LI'I r-....-i .......... en en en en ............ co 0 .......0 6..-... Historically this multiple $6 trillion..-i 0 r-...-i N '<t Ul co 0 0 Ul Ul Ul Ul Ul r-..-i 0 0 en .... r-.... r-.. .. r-........... en ..... .-i . which implies a potential shows the banking reserve multiplier shown represents the ratio of checkable deposits to banking reserves..August 2009) Required Reserve Multiplier ------ 10-yr MA Total Reserve Multiplier ----- 10-yr MA ...-i LI'I r-.... en r-........-...... 00 m 0 Lon ..-.. Bloomberg.--...... 00 m co Source: United States Federal Reserve.400 $1.....-. .-.. ..-i ...600 $1..................800 $1...-i . .-i . . co 0 0 ..-i .. 6 © 2009 Hayman Advisors L..... .US Monetary Base (January 1959 .......-i ..... co 0 N C'Il co en en en en en en en . LI'I 0 C'Il en en 0 LI'I ...-. it would not increase the money supply by $855 billion............-.. The reserve multiplier Notice the multiplier rather it would increase the money supply by some multiple of that.....-.-...--.. co m 0 Lon ..-i ... into the economy as they typically do..
Federal Reserve has purchased more than 100% of the net issuance of both Agency debt and Agency MBS. In other words. they should become more willing to lend. As they all rush to deploy the excess money they are sitting on.000 $40. What if the "v-shaped" recovery that appears to be priced into the markets takes hold? As banks' confidence in could increase very quickly.the Federal Reserve selling its holdings of Treasuries These sales would put significant upward pressure on rates. especially if China is no longer interested institutions' in buying any Agency securities. in its forward-looking Therein lies the qualitative neither the Federal Reserve nor the Treasury has the will power to force long rates higher in the midst of a fragile recovery.000) _. the be very damaging to what will likely be a fragile recovery. funding a Foreign Official Institutions' (Dollars in Billions) $60. which could Since the onset of the Agency purchase program. Treasury purchase program. the Federal Reserve Agency purchase program is.__---------------------------Source: Federal Reserve. Do you trust the Federal Reserve et al.000 $20. the multiplier inflation the precise timing of when to withdraw the money from the system.P. which shows foreign official illustrates that as foreign institutions are portion of purchases and sales of Treasury and Agency securities. Imagine what will happen when the only buyer in the market place becomes a seller. does not. to select nature. and Agency securities into the market. .000 $10.000 • Year-to-Date $- $(40. We are today in the midst of what economists often refer to as the "Golden" realized. the chart below. indirectly. selling Agency securities to the Federal Reserve. We believe that the recovery strengthens. Interestingly. This period typically lasts 12-18 months. have not been 7 © 2009 Hayman Advisors L. aspects of the perceived dangers of the actions by the Federal aspects of period Reserve and other central banks that will cause a rush to hard assets even before the quantitative where everything feels good and the long-term effects of deficit spending and money printing money printing take over.000 $30. such that a recovery is sustained and does not take hold? We believe the market. they are using the proceeds to cover a substantial their Treasury purchases.000 • Year-to-Date 2009 Vear-to-Date Purchase I (Sale) of Treasury and Agency Securities Agency Purchases/ Treasury Purchases/ (Sales) (Sales) $50.The Federal Reserve has said repeatedly problem. that it can withdraw this excess money from the system without a Consider for a moment what that would entail .
not as I Do . even though they have to politician told us a few months ago. The largest contributors therefore includes 186 countries with each country assigned a quota linked to its relative size with the IMF. Purchase or Refinance FHA HOME LOANS Do as I Say. Once again. ability to obligations. the two largest debtor nations in the world.the to the IMF. will not be Wall Street holding the bag.A Little Hair of the Dog. and we all know how that movie ends. nations in the world are the largest contributors As one influential run large deficits and Wait a minute .9% of total 2009 mortgage loans as of 6/30/09). it is proven time and time again that a low down payment is one of the greatest predictors of defaults. currently are saddling their own citizens with additional No need to worry.000 tax credit. the government the entire mortgage market.000 or less. debt to fund these commitments. With the $8.000 to first time homebuyers. Fannie and Freddie) essentially became over 90% of the total loans made agencies wrote/guaranteed during the first half of 2009 with FHA loans becoming an increasingly larger share of the pie (FHA loans were 17.The International Monetary Follies The International a framework stability during the 1930s.6 It is no secret why FHA loans have increased wildly in is offering a tax credit of could fund their entire popularity this year. Anyone? During the housing crunch that began in 2007.24% per annum on their IMF commitments!" 6 7 Source: Inside Mortgage Finance. Source: IMF. Represents Adjusted Rate of Remuneration 8 © 2009 Hayman Advisors L. voting rights and borrowing limits and represents a substantive A member's quota resembles its financial and organizational to the IMF are the US and Japan with each country committing an additional USD$100 billion in 2009. "It's not real It's just a journal entry. The US and Japan. to the international Today the IMF membership in the world economy. FHA loans only require a 3. for the week of 9/21/09 . two most indebted borrow to contribute? money.5% down payment and the government $8. These combined (via FHA. Monetary Fund ("IMF") was founded almost 60 years ago by 45 member countries to provide cooperation financial that would attempt to avoid a repeat of the economic policy mistakes its key function is to provide countries. following advertisement It will be the US taxpayers that will ultimately interesting: from the FHA's website is particularly pay the price. a first time homebuyer Sound familiar? down payment on a house costing $230.9/27/09. system through "rainy day" funds for fiscally irresponsible relationship of international While the IMF advances a broad range of policy initiatives.P." At least they earn a whopping 0. it The purchase a house with no skin in the game. . Looking at housing data. home buyers are able to This time. including its commitment pay.
Perhaps China recognizes that its citizens deserve compensation of market discipline. 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. The IMF. When we spoke with policy makers in the US that act as the conduit between Washington makers are committing funds to bailouts without highly unlikely.In September commitments generosity preparation 2009.P. As large economies and contributors. routinely ignores these guidelines. but the Chinese for their are in the novel form of 5-year bonds with a market rate of return (it makes you wonder what will be). 9 © 2009 Hayman Advisors L. March 2009. G20 summit. China created much fanfare of "market" by committing USD$50 billion to the IMF. and the IMF. 2009) IMF Loan Commitments 1400% and Borrowings -Total 1200% 1000% 800% 600% 400% 200% 0% _ - Commitments Under Stand-by Agreements Outstanding Borrowings from the IMF Undrawn Flexible Credit Line Borrowing Limit Until March 2009 --Borrowing --Quota Limit Since March 2009 - - - - II II II - - - II II II •• • -- - Source: IMF." is necessary to bailout in the following table. For example. . with implicit permission from the US and Japan. the US and Japan possess outsized influence at the IMF that enables them to impose a facade of commercial discipline on the IMF by They attempted establishing lending limits based on the size of members' quotas and covenants on each member loan. Our policy recognizing that the size of loan relative to the size of the economy makes repayment 8 Source: IMF Public Information Notice no. the IMF's cumulative lending to any individual borrower quota at the IMF (Why set quotas when you can borrow multiples the goalposts by increasing the borrowing itself from international ignoring even these higher banks) as demonstrated of them?). however. the financial crisis would require numerous bailout loans in excess of the 200% limit. the IMF cannot restrain creditors (i. in to transfer China's definition and that the IMF's business model needs an injection for the upcoming by Caijing Magazine that Chinese Central Bank Governor Guo Qing Ping said on September 15 that the IMF should set specific goals and timetables voting rights from developed to developing nations.e. 09/40. until was limited to 200% of the borrower's When it became obvious that the Still. it was reported As a matter of fact. the IMF simply chose to move limits to 600% of the borrowers' limits to lend whatever quota. to steer its lending practices.
5% March 2009 • • • Latvia's new Prime Minister takes office nd IMF withholds 2 installment of bailout plan as Latvia fails to implement loan terms Unemployment reaches 10. 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. 2008.4 billion of which was in the form of a standby credit agreement from the IMF. and assumes that real GDP will shrink by 5% • • February 2009 • • Latvia's Prime Minister and cabinet resign Unemployment hits 9. the Latvian GDP has shrunk to an approximate sheer ridiculousness of Latvia's IMF-Ied bailout. .200% of Latvia's IMF quota IMF bailout is predicated on Latvia maintaining a budget deficit of no more than 5%. assumes unemployment rates to average 9% for 2009. Eurofound.2 million people and reported a GDP of approximately run rate of $28 billion. $2. So far in 2009. "Latvian Parliament 10 © 2009 Hayman Advisors L.7% necessary conditions to meet May 2009 • • Latvia reports an 18% decline in GDP for the first quarter of 2009 Unemployment reaches 11. 17." November 2008 • • Below is a chronology Standard & Poor's cuts its ratings on Latvia to BBBLatvia projects a 2009 budget deficit of less than 2% December 2008 • Latvia enters into a $10.P.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). 2009.Latvia . Latvia has a of the 2. November Passes Amendments to 2009 State Budget.3% 9 All data pertaining to Latvia bailout chronology was sourced from the IMF and Bloomberg. they rarely enforce these conditions as evidenced by the case of Latvia." The Baltic Course. 10 Source: "Latvian Saema Passed 2009 Budget in Final Reading. June 16.A Case Study of an IMF Bailout While the IMF attempts of approximately to impose covenants on loans in the form of fiscal austerity measures and macroeconomic population targets. $34 billion for 2008.
Latvia's gross domestic product (GDP) will have contracted by 25%. his credit score declines. the bank lifts the restrictions." It is only a matter of time before Latvia recognizes this folly repays its loan from the IMF. from September 2008 to September 2009. expenses are spiraling out of control.6% from July 2008 Unemployment reaches 11. with no additional prepayments or increases in interest expense) and agree to a 13% budget deficit for 2009 Unemployment reaches 12. the situation worsens for His family's make sure Latvia is as prudent as can be with the new funds.5 billion IOU. compared with the highest point it reached in 2007. Latvia is elated to learn that he has been granted credit in the risk. important Now Latvia finds out that he is getting a pay cut and expects to only make $250. he to $285. September 2009 • Latvian Financial and Capital Markets Commission almost 14% overdue by more than 90 days reports nearly 25% of all loans are delinquent with • According to Latvia's State Employment Agency Director Baiba Pasevica.3% covenants. and other developed countries that fund the IMF's activities on terms are simply writing The IMF preaches against © 2009 Hayman Advisors L. amount of $240. his family's bills are coming in higher than expected.July 2009 • • • Latvia and the IMF renegotiate the bailout package and now preliminarily deficit for 2009 (no apparent penalty was charged for this "renegotiation") Latvia July new car sales drop 86. Additionally. he has certain expenses that he simply cannot cut. by the middle of 2010. and at the Recognizing the implications Fearing the worst.000 credit line from a bank and income of It is is his total income.000 household. Japan. of lenders led by the IMF will be left with a $10. 11 .0001 In return for the bank's additional Latvia and his family. not disposable income.000. same time. for the third time. Would your bank be as accommodating Latvia failed to comply with virtually worsen. it sets certain legally-binding financial limitations As the months pass. and will be back to 2004 levels • To put this into perspective. and he lets the bank know he cannot even come close to complying with restrictions He is scared that the bank will call its loan back keeps the credit line the same and as the IMF? and its prospects continue to but to his pleasant surprise. the financial immediately. imagine Latvia is a person with a $10. the unemployment level in Latvia has increased approximately 250% According to the chief economist at Swedbank (one of Latvia largest lenders). yet the IMF continues and the international non-commercial coalition all of the material financial covenants to fund a large loan to Latvia that will likely never be repaid.P. As frequently If Latvia never stated. previously set by the bank.8% agree to a revised 10% budget August 2009 • • • Latvia reports an 18. to note here that $250. "you cannot borrow your way out of debt. applies for additional credit.000 this year.000. charges the same rate as before. As is the case with any of his situation. charity checks to fund creditor bailouts. then the US. He takes another pay cut and learns that his income will only be $200.7% decline in GDP for the second quarter of 2009 Latvia and the IMF renegotiate bailout package (again.
uk/finance/financetopics/financialcrisis/6011674/Credit-tightening-threatens-Chinas-giant- Ponzi-scheme. and then loan money to troubled We devaluations nations. not their stock market. The People's Bank of China (PBoC) expanded Chinese M1 money supply by a staggering 28.html 12 © 2009 Hayman Advisors L. China . 20% of the RMB 18 trillion went directly into the stock Evidence of this is clear from the 80% rebound in the by almost Index from its low in October 2008 (despite profits declining prices to previous inflated levels that leave the ratio of median price to We believe the data set to watch is represents 40% of median income in China at 7x that of the US (and we are well aware of how bad our US housing problem is). Total Chinese to the todav. and strong GDP growth is viewed as the essential tool to surpassed even the Federal Reserve and Bank of England in achieve it.e.telegraph. stability and order is the absolute priority. Many economic and political strategists have suggested that a growth rate of at least 8% is needed by China just to maintain Maintaining stability as it seeks to modernize the western half of the nation still stuck in the Middle Ages. etc.). With this tsunami of money and credit creation. As such. Source: Federal Deposit Insurance Corporation. where FDIC insured institutions September 73. . and the PBoC has suggested that up to 20% of the new credit has flowed into asset speculation" market. loan ("NPL") problems. But in this case.7% year-over-year from September 2008 to September 2009. which currently Food price inflation could be the tipping point for China. the Chinese government responding to the crisis with free money. RMB 57. as they should have learned in the case of Argentina early in this decade. not as I do" policy. 13 Source: China Banking Regulatory Commission. We wonder what the encore in 2010 will have to be to sustain such "growth.exactly this type of behavior to its troubled believe the IMF should force restructurings borrowers and/or in an example of "do as I say." household expenditures. speculative real estate investments. bond market or GDP.5 trillion in a single year. 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.5 trillion 13 have seen a decrease in total assets between rate. borrowers with non-performing loans at Aggressive loan growth of this type usually creates real non-performing the expanded lending has brought a temporary reprieve for troubled 11 Source: 12 Bloomberg.P.Exploding Like a Fire-Cracker? Despite the historic size of the fiscal stimulus injected into 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. The real economy has been unable to absorb all of the inflow.equivalent US increasing total bank assets by USD$7.co. rather." the Chinese banking system has grown at an extraordinary at the end of June 2008. 14 http://www. UK and Japanese economies. it is their cost of food. 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. Shanghai Stock Exchange Composite 30%) as well as a rebound in property (i. Unlike in the US.7trillion 2008 and banking assets were approximately by the end of June 2009.11 On top of this core money supply increase. and had grown to over RMB This increase represents almost 54% of Chinese GDP .
9%)) in an environment sales are increasing at double-digit percentage Prices (-7.4% year-over-year. with a 20%+ decline"). and Producer where not only money supply. factories and infrastructure We believe it is the latter. investment rates. being exacerbated by the continued weakness in exports (down 23. The current situation is only sustainable as long as credit continues to expand at a dizzying pace. think credit increasing the and Admittedly. but also credit. 15 16 13 © 2009 Hayman Advisors L.77% of assets from denominator underwriting originally to reduce the percentage). Price Index (-7. The domestic demand for raw materials This situation is capacity in in the sixth month this year and industrial China.1%). It feels eerily similar to credit markets in the United States in 2006-2007. may have driven a rebound prices. refinanced or termed standards are all but non-existent. where is unlimited it is pretty hard to default or be delinquent on a loan when it an ancient proverb can be constantly out to an even larger one. in terms of volume. To us.Chinese banks falling to just 1. Source: Bloomberg. 17 Source: Bloomberg. Imports have recovered modestly from their lows at the beginning of the year and. In China. The key question with regard to China is whether this story is too good to be true. Are the trillions of Renminbi of new lending being devoted to profit maximization and the investment in assets that genuinely generate by building income sufficient to service the debt? Or is China compounding more and more real estate assets. one of the most compelling sets of data points to come out of China is the substantial Wholesale drop in prices for and "retail" the existing problem of overcapacity when a huge inventory overhang already exists? goods and services (Purchasing Price Index (-11. 16. but the prices for consumable goods and services are plunging.P. but recent official comments about curbing domestic cement and steel production may be a signal that the stock piling is slowing down. . Source: Bloomberg.4% year-over-year). asset prices are rising. which suggests that there is simply too much manufacturing have exceeded commodity last year's levels." This downturn started after the financial collapse last September and has not responded to any of the fiscal and monetary stimulus so far. We have adapted published by Erasmus around the year 1500 to describe this phenomenon: A rolling loan gathers no loss.6% in March of 2004 in an environment 15 (again.
credit and investment expansion can.Chinese YoY Change in Consumer..3%) could place pressure on this structure." If this structure were to unravel..:---.. it is crucial to identify continued decline in speculative down 17. .-- Producer Price Index -15% ~---------------------------------------------------------------- Source: Bloomberg. investment exerts substantial domestic savings.. services and assets (as represented in the build-up of foreign by the net of the domestic banks where the credit machine can spin around and around...----. Wholesale and Purchaser Prices (June 2008 .jjiiiiiic:::::-. the potential to keep the balls in the air is greater than that of a more open investments and hidden by massive liquidity injections and yet more system. at most. ever larger for some time yet. As such.. spigot must be turned off.. monetary. foreign direct investment credit.August 2009) 20% ... driven by the over expansion of credit into non-economic credit expansion. deliver trend At some point the liquidity growth while increasing deflationary pressures. Fuels and Power Price Index 15% +--------::. we are skeptical of its sustainability.. We believe there is an NPL time bomb waiting to go off in the Chinese banking system. If the world's most aggressive fiscal. 14 © 2009 Hayman Advisors L. we believe that the Chinese monetary and banking systems could face substantial and default pressure.P. a (which has rebounded slightly but is still and trade surplus income (down 19.------------------------------------------------------------------Consumer Price Index Price Index of Raw Materials.. 18 Source: Bloomberg. In our view..01~!!!!!!!!!!!!!!1-=::------------- --Purchasing --Wholesale 10% i. control over credit allocation. All the while domestic capital is prevented from leaving the country and forced into the hands external demand for Chinese goods...52% year-over-year) devaluation the catalyst that will set fire to all this combustible inflows. Likewise the continued inflow of foreign government capital which is clearly apparent exchange reserves) allows the to maintain the currency controls that prevent domestic capital from escaping the country in any meaningful way. in an economy where the government and particularly will be a massive shock to the system. . and the resulting change in momentum However.
more developed economies. may realize. The National Institute trends shows why this model may be closer to breaking than many of Population actually peaked in 2004 and is and Social Security Research ("IPSSR") estimates that the Japanese population now on a long-term negative trajectory. Japan's population The ability to fund almost entirely Bonds ("JGBs") to remain low as point in capital. Japan experienced more than a decade of low (near zero "official") interest borrowing have and high (nominal) interest rates. The relative resilience of emerging markets (and China in particular) and bullish sentiment for equity and fixed-income Chinese growth turns out to be the flaming destruction of a meteor crashing to earth.Land of the Setting Sun Japan is one peculiar case where decades of chronic deficit spending and central government not led to material currency devaluation history. at an accelerating pace. An anomaly of developed economic rates and almost nondebt burden to grow its central government's existent growth in both real and nominal terms. Please see the chart below: 15 © 2009 Hayman Advisors L. however. A review of Japanese demographic First and foremost. of the Chinese economy substantial social reform and re-distribution required to allow the kind of growth seen in does exist.P. Along the way. Japan . this could be the shock that instigates another round of frenzied risk aversion in global markets. but without there will not be the level of domestic demand and consumption that we have of wealth. by selling bonds to their own citizens allowed rates on Japanese Government becomes unsustainable. Cultural forces spawned the generally accepted belief among Japanese citizens that it is Combined with an abnormally and individuals. this ideal allowed the Japanese government its bond sales by selling them directly to Japanese institutions they did not have to compete for international growth. however. high savings rate (when to fund 95% of all of compared to the rest of the developed world). this model eventually 2009. lip service has been paid to the restructuring in order to increase domestic consumption. Along the way the Chinese will slowly has been a source of optimism If the bright shining light of to rebalance their economy in favor of domestic demand.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 seen for the past six years. if net new issuance of JGBs outstrips economic We believe that Japan has reached its inflection is in secular decline. while continuing their patriotic duty to lend their government money. services and assets. danger to this recovery narrative investors in the developed world. . The best case scenario for China is that the current stimulus buys enough time for the developed world to return to 2006/2007 attempt levels of demand for Chinese goods.
importance than the total population is the composition of the population.-i en Lll co Lll en ..0 e-i en 1.. .. ~ Source: OECD.0 N 0 .6% globallv). Percentages represent 2009 estimates.0 N 0 Lll 0 Source: National Institute of Population and Social Security Research. " +--------------~~~----_~-~~-----....-i co en N e-i co en 1.-i 0 N 0 e-i '<t N 0 e-i co N 0 N N N 0 1.. the chart below illustrates that Japan's household savings rate as a percent of disposable 19 Source: DECO.-i .-i en I' 0 en I' '<t ." The DECO estimates that the ratio will reach 29% by 2020 and will continue to grow thereafter... The roughly chart shows the percent of the population under a common economy aged 65 or older projected out to 2050. a at a rate that program keeps the senior utilizes pay-as-you-go Currently will reproduce especially in a society whose public retirement seniors make up 22.r " +---------------------------/----~~----------_~---~--~--~£ ~.-i co I' en . and (ii) the positive savings rate that Japan has enjoyed for decades will turn negative.. Dotted lines denote 2009 .-===::::~~~~~~~~~::~==~----------.Japanese Total Population (1950 . ..-i co en en N 0 0 N N 0 0 1.0 N N 0 I'Y'I 0 N 0 I'Y'I '<t N 0 I'Y'I co N '<t 0 N N '<t 0 1.. The impact of this trend is twofold: accelerating (i) the central government and ultimately Japanese workers will carry an social security burden which will require some combination of increased with holdings (effectively higher taxes) and further debt issuance.--=~-~=- _.. 90. In an ideal world.- ---' ".8% of Japan's population (versus 12..o:--------- ..2050E) (In Thousands) 130..000 80.20S0 estimates.-i en N 1.-i . Perhaps of even greater following population constant. .0 ... i 5% ~---- I~~--~~------~~::~~~::::::::~~~~r-AC~~-~-~~---~~ -.000 ----(Census) Projected (iPSSR)-~~----------~ ..000 ... 16 © 2009 Hayman Advisors L.000 0 en Lll '<t ..-i en en 0 e-i en en '<t . . Solid lines denote historical actuals..000 .0 1. 100..0 ... Percent of Population Aged 65 or Older (1950 . 110.- " -- +-----------------------------------~~------------------_/.P. proportion funding.-i ._-..9% in the US and 7.2050E) 40% 35% 30% 25% 20% 15% 10% ~-----------------------------_-=rr- --Japan --United States --World .000 --Actual 120. In fact.
" What 15% of total central government debt and 19% of GPIF owns 19% of all FILP bonds outstanding and for years had been a net purchaser.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%. we certainly are not. 21 Source: GPIF. The problem is that all the current savings pool allows is the rolling of existing government all the savings to date are presumably already invested. savings will actually become negative. FILP bonds represent GPIF holds 19. the Government Pension Investment Fund ("GPIF").0 ¥30. Annual Household Savings and Savings Rate (FY 1980 .0 ¥2S. the current detriment pool of savings is some reallocation to other securities (corporate toward The best the central government a higher weighting we often hear the large pool of Japanese savings referenced as the reason Japan will be able to continue to sustain debt.0 ¥1S. Another Granted.0 ¥S. because the additional being a consistent The trend.P." basis. is only JPV 4-5 trillion importance maturing distinction than the nominal amount.O ¥_ Annual Net Savings (Left Axis) --Savings Rate (Right Axis) --Savings as % of GOP (Right Axis) 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Source: ESRI. on a net impact the markets. July 8. 22 Source: Japanese Ministry of Finance. this model. June 15. said in June that it may become a net seller of securities this fiscal year (ending March 2010) in order to pay benefits. 20 22 Program"].2007) (JPYin Trillions) ¥SO. "World's Biggest Pension Fund May Sell Source: "GPIF: may become net seller in 2009/10. .0 ¥40. 2009. which would come at the bonds and equities). Japanese Ministry of Finance.O ¥4S. Are you willing to lend the profligate Japanese money for 10 years at 1. the amount the GPIF is talking about selling.0 ¥3S. 17 © 2009 Hayman Advisors L.2009. age.not buyers. creating a pool of JGB sellers . Japan's public pension fund and historically the biggest individual net buyer of JGBs. there . shortfall is of more key statement made by GPIF President Takahiro Kawase was will be made up from is no maturities. government bonds.not enough to materially that the fund should only need to sell JPV 4-5 trillion In the case of a borrower between the lender becoming a seller of debt and ceasing to roll near-term "General" JGBs." Reuters. and Loan Currently net issuer of debt. as could hope for from of JGBs.6% of its assets in a type of JGB called a FILP bond ("Fiscal Investment While not considered total JGBS.3%? As prudent fiduciaries. In the course of our discussions with our investing peers as well as analysts across the major broker-dealers. For domestic household savings to continue to As a greater percent of the population support net new JGB issuance.0 ¥10. The and savings trends suggest that this is not far off." Bloomberg. however. reaches retirement demographic government Interestingly. there must be net new savings as well. Japanese Bonds.0 ¥20.
Japanese Central Government Debt 200% 180% 160% 140% 120% 100% I-. In reality.------------------------------------------------------------Central Govt.2009E) 220% .---. 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Ministry of Finance.---.5%.-Total I-./ / +-----------------~----~£------------------------------------+--------~----~~~------------------------------------------+---. Japan's central government Through a combination debt as a percent of GDP GDP and additional has increased from 99%.----.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. the government interest expense was at its peak through interest expense which would only exacerbate the problem of needing to convince more buyers to lend the allowed total debt to Through zeroactually declined markedly. becomes cheaper to borrow.0 trillion As it 2006 when it reached the trough. simple financial alchemy and arithmetic instituted by the Bank of Japan ("BOJ"). remaining low indefinitely? Below is a comparison of JGB issuance to government interest expense. to a staggering 170% in the last ten years (as of the latest fiscal year ended March 2009).----.----. Bank of Japan. increase while interest expense paid by the Japanese government interest-rate-policy JPV 365 trillion between was able to issue an aggregate of to JPV 7. . Debt/GOP Estimate +--------------------------------~----~~~~~~~~=-------+------------------------~--~~~=---------------------------- _. of General JGBs while annual interest expense declined from JPV 11.-Hayman I GOP (FY 1996 . which is a dangerous number in and of itself.----.. we expect this number to exceed 200% by the end of the current fiscal year.---. 80% +--~--~~=-------------------------------------------------60% Source: Japanese Any rational compounding government person (we'll leave it to you to decide whether we at Hayman qualify) would expect the rise in impacts of issuing debt to service debt and fund budget shortfalls to lead to an exponential money at less than 1.---.---.---. Hayman estimates. how much of your own personal balance sheet are you willing to bet on rates 18 © 2009 Hayman Advisors L.0 trillion 1991 when government Rates declined enough to more than offset interest expense incurred as a result of new debt issuance.---.---. of declining issuance.---.
....0 ¥20.0 - General JGB Issuance (Right Axis) --Interest Expense (Left Axis) / / /' - ---. As an aside.. Bank of Japan.. the homebuyer in Las Vegas. The next chart shows that.0 ¥9. for which we have detailed data back to 1996. en en en en en co "<t en co 1.0 co I' co co co en co en 0 en en en en N en en ron en en en en "<t en en en 1... Japan has milked zero-interest-rate-policy of The inclusion of those debts. Japanese government nominal impact of zero-interest-rate-policy continues to borrow at significantly with any slight uptick in rates.. __" ..0 - ¥13.0 ¥8. ..0 ¥30.1%. .. the appears to have run its course.0 ¥11.. . suit and continued declining even after the BOJ rate ..2009E) (JPYin Trillions) ¥SO... ..0 ¥2S. ss...0 " I\......0 ¥7. Bloomberg.0 ¥6. expense has begun to explode again.. Hayman estimates.. ..._~~-3~~---- S% 3% -Generic10-Yr 4% O%+-~~~~~~~~~~~~~~~~~~~~~~~ . bond rates.. JGB yields followed 19 © 2009 Hayman Advisors L.. . in terms of government it's worth. like an American subprime has been able to borrow below-market rates and has set itself up to be dealt a potentially for all Hayman believes the piper must be paid in the near future.- ¥12..... BOJ Discount Rate and Central Government Bond Yields (March 1983 . .. As to be expected.o ¥- I_ I I I •I I I - " iIoo...June 2009) 9% . ..~pL~~~~----3~~----------- ten Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Nl Source: Japanese Ministry of Finance. . paints an The key thing to note about the chart above is that interest Since debt has been so cheap......... which was reached in September 2001... ....0 ¥3S. / J ¥10.------------------------------------- 8% +----------~--------7% 6% - BOJDiscount Rate Sovereign Interest Rate t-------~~~~~~--------+-~----r_-~~~~=-~~~~~~~~- -Implied -GenericS-Yr +-------r~-~. .0 III Source: Japanese Ministry of Finance.0 0 0 N E:. 0 N gg ~ 0 0 N N July 1991 marked the beginning of a series of cuts in the BOJ discount rate toward 0. Japan fatal blow As older debts have rolled to newer debts at the new lower rates.. . . . 1% ron co 2%'=============~~~~~~~~~~~ +----~--~#_~--~~MH~~---~~~-------------+~--~~--~=.0 ¥40..Japanese Net General JGB Issuance and Interest Expense (FY 1983 .. . this analysis considers only General JGBs and does not consider FILP bonds or other borrowings the central government. uglier picture in terms of true debt issuance..0 en en en en I' co en en en en en 8 0 N 0 0 N N 0 0 N ron 0 0 N 8 0 N en 0 0 N 1.0 ¥10..O ¥4S. ..0 ¥1S. . .P.
II~ I':""~••• (. 'P'IIII . According to Bloomberg. government JGB yields effectively borrowing bottomed out in 2003 and have moved more-or-Iess sideways since then.. iIIId..:: . costs of JPY 223 trillion debt (including of government all bonds... l.~.fl.01:.. the Ministry of Finance says in the advertisement.10% today) the impact on costs would be de minimis. to be significantly good tools for the bonds turns secularly There are no further Considering the demographic years ago. 23 24 Source: Japanese Ministry of Finance." 11bi1 •. 20 © 2009 Hayman Advisors L.I "~I' . challenge facing the country and the fact that the BOJ maxed out on rate cuts scenario unfolding whereby JGB issuance will continue negative.. there positive while domestic is a frightening demand available to keep the government's interest costs from growing. .. n . You too might have a 18% of tax revenues are already used just to pay interest expense.flattened." What will happen to rates when the central government themselves becoming net sellers and net consumers? bond internationally. :.~'. . Source: Japanese Ministry of Finance. 1. "Government bonds are worth another look." We can sympathize with former Minister of Finance Shiochi Nakagawa. bonds.P.. who are Ultimately Japan will have to compete think so.:: if/) 1: tt Iu fJ' ? #I I· ~" .j 1...::".:II~ .11-rl.. 11...:.. further increasing the need to issue more debt. it appears that the Japanese government • ~1J: ~f~ 5-1 :""7"1 /'" ~1fc·Jl. L 'it t. (from a whopping Even if the BOJ were to cut the discount rate to zero tomorrow 0. and judging for capital by the new We don't be attractive? in Japanese taxi cabs encouraging citizens to continue purchasing government shares our concerns .r IUllllllltjl ~ Ili'D. It is also worth government pointing out that approximately bills and other 26% of Japan's total central government matures within one year. advertisements Will a 1.= ~I ~~." The ad features a picture of former NHKanchor Junko Kubo.3% 10-year asks to borrow more money from its citizens. f. Hayman estimates.. .11J~ 1:1 . ... last February.. I . financing borrowings) This means that a 1% debt increase in interest rates would massively increase the borrowing within the next twelve months.. who appeared drunk at a G7 news conference few too many drinks if you were responsible for Japan's budget. .1 hi 'I . 37..i§: .
e. Real GDP and its Primary Components. 21 and the second greatest (after of the last twenty years shuts down. competitive government consumers). perspective. or We have arguably just lived through the greatest Asian boom in output history.7% of GDP growth from December 1989 to the peak was due to growth in exports. declined 20.P. Quarterly. who are experiencing (i. (the The persistent strengthening their own financial of the Yen recently and its reputation Japanese exports growth become engine as less a "safe haven" currency are puzzling. Seasonally Adjusted (December 1989 = 100%) 300% . but also that any growth seen over the last twenty years has been driven almost exclusively by exports and government consumption. declined 2. last quarter). Government consumption the second largest component Private non-residential investment. The chart below illustrates not only that the bulk of the GDP decline has been a result of export decline.6%. Gross exports currently For those of you keeping score at 12. During the course (calendar first quarter 2008 to To put it in GDP is still off 7. and Japan never got off its back. wiped out 17 quarters of GDP growth. which spanned four quarters. Examining the major components is the largest component investment).1% of GDP. but it still does not explain an 8.4% over the peak-to-trough period (and declined further Now we are getting somewhere. Japan is an export economy. As the Yen strengthens against the currencies of its major trading partners us being one). decline. grew by 0. How do you think the country will do now with double-digit gaps and structural demographic issues coming to a head? of GDP reveals the primary drivers of the decline.4% decline in GDP. home.8% peak-to-trough. 32.While our discussion of Japan up to this point has focused on their sovereign debt burden and implications interest rates. In fact. it is also important first quarter everything 2009) in real terms.------------------------------------------------------------------- -GDP -Exports 250% -Imports Private Consumption Government Consumption Private Investment Public Investment 200% - Source: Japanese Ministry of Finance. Like it or not. the decline in gross exports comprised 72.2% peak-to-trough.9% from its peak. . © 2009 Hayman Advisors L.8%. since the fourth quarter of the recession. at 18. 2003. more consumption) expensive to foreign challenges.4% peak-to-trough As of the latest quarter. 13.4% of the total GDP decline. the peak-to-trough for to focus on the state of the Japanese economy and the Yen. quarterly seasonally adjusted GDP declined 8. representing represent which (not at 58% currently. Private consumption.4% of GDP and declined a staggering 36.
" Standard in Finance and Poor's. from two years ago (this does not include JGB or FILP debt issuance. tax hikes and without of public funds. until the next fiscal year (beginning April 1. they will need income growth which requires All else equal. victory in the August 2009 general election. a weaker Yen. which the Ministry of Finance includes in Expenses including interest are expected to be JPY 91.6 trillion. are not scheduled to be implemented for capital. . We believe the net result of all of the above will be higher rates and a weaker Yen. or they to keep rates low. Japan's fiscal 2009 budget (ending March 31. JPY 40.6 trillion stocks that the BOJ is authorized is on full tilt with the government cards. upward pressure. Hatoyama details of exports. the compounding the deficit) impacts of issuing more even further. Now that zeroSoon the benefits.P. Compensating Measures Will Be Key. 22 © 2009 Hayman Advisors L.The Democratic fiscal stimulus Party of Japan ("DPJ") took power from the Liberal Democratic and domestic consumption with a disregard for the importance and welfare. has outlined policies of the LDP. will create significant headwinds for income growth. A persistently tax revenues." consumer. in deployment increasing the fiscal deficit via budget He has yet to provide substantive plans. The DPJ leader. or the JPY 3 trillion buying all classes of financial assets in an attempt JPY450 billion of corporate bonds authorized for purchase between October and December ofthis year.0 trillion.6 trillion. lower GDP and lower government debt will increase Japan's interest The Japanese government can increase quantitative dots. stimulus spending. Party ("LDP") in a landslide policies focusing on Relative to the noble) initiatives Mr. 2010) should concern investors who Revenues are expected to be JPY 51. Never mind the JPY 1 trillion to purchase through April 2010. Hatoyama has made public statements in Given the DPJ's focus on the Japanese domestic support of a strong Yen as it theoretically trade-balanced economies domestic consumption (without and net importers. Hatoyama's This is true for logic is that in order to promote firing up the leverage machine). 25 Source: "DPJ Policy Implementation Could Inflate Japan's Fiscal Deficits. which will lead to greater expense burden (and consequently policy has reached the extent of its potential issuance of JGBs will be met with a lack of domestic demand. 2009 regarding incremental 27 Source: Bank of Japan. The implied deficit is of financial institution paper and or 44% of government expenditures. and an abolition of highway tolls. Many of the DPJ's initiatives 2010). drives prices down and increases purchasing power. and rates will feel significant easing to attempt can either allow rates to rise. which they probably know they cannot afford. Mr. The flaw in Mr. down nearly 10% In the mean time. 26 All fiscal 2009 budget data sourced from the Japanese Ministry of Finance and adjusted to reflect comments Minister Yosano's speech on April 27. Yukio Hatoyama. free public high school education. regard Japan as a "safe" destination their budget as revenue). August 31. he has placed emphasis on distribution believes they can fund these programs without reforms and efficiency improvements with respect to these Among his (admittedly are increased child benefits." Interestingly. we expect either higher rates in Japan. Yen per year of JGBs. or (most strong Yen will keep pressure on exports which will result in debt issuance. a strong Yen will punish Japanese exporters which growth in corporate gross profit and dividends. 2009. the Bank of Japan ("BOJ") has authorized of commercial itself to purchase JPY 21.27 Japan to prop up their house of When we connect all of the proverbial likely) some combination interest-rate thereof.
. of private debt onto the public balance sheet in the form of The creditworthiness affected of many major economies of new by the rapid accumulation quantitative Hayman continues to believe that the transfer deficit spending and government guarantees is unsustainable. risk-adjusted yields based on our assumptions. We are not particularly bullish on the world macro environment or the US consumer for that matter. but we lead to high levels of inflation global it has taken 18 months to two years to take hold. standards take into consideration home price depreciation. asymmetrical We have also allocated a portion in natural resources. we are investing cautiously in credit. in Western Europe.9% of Eurozone GDP. UK and Japan) and indirectly supply. central banks will have to choose at some point between the integrity We are positioned for both outcomes. in the labor market. In the core Hayman portfolio. We believe that certain securities remain attractive buyers shying away from the market which will provide opportunity credit positions. but we believe and fiscal stimulus as well as the coordinated continue to invest slowly and defensively. equal to approximately duration performing we expect corporate meet our criteria. have relatively for sovereign capital as world governments Hayman has built a mortgage short weighted position run huge equal to securities provide a balance due fiscal deficits (and sell debt to finance them).P. we will continue to selectively invest in corporate credits that 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. 23 © 2009 Hayman Advisors L. We believe that in the ability for of Unless a new dose of fiscal This has allowed artificial demand for sovereign debt and low interest rates despite the massive amount of new banks from Ireland have absorbed has become very dependent policy is actively tightened liquidity injections. range of macro variables including further sheets and a prolonged downturn to many of the traditional going forward. and the borrowing needs of sovereign governments. credits that provide current income and distressed credits with solid asset coverage. maintained we look at a broad array of pool-specific traits and servicing techniques when determining mortgage-backed Additionally. despite representing only 1. The core strategy is to invest in mortgage-backed average lives and that stress on consumer Our underwriting Additionally. primarily high-yield bonds and bank We target two types of situations . 25% of assets under management. sovereigns to fund themselves at the current rate of deficit spending is questionable. defaults to remain elevated.Capitalizing on Our Views To summarize our views.short While Hayman has added corporate loans. Asia and North America has been substantially have committed debt in the name of stimulus spending and bailouts. value. however. that it could be sooner due to the size of both monetary nature of the actions. Historically. outstanding sovereign governments the event this monetary repurchase agreements with favorable terms (Eurozone and elsewhere). 50% of assets under management. the money supply. we believe that global currency printing will inevitably outright currency debasement. that are very high in the capital structure. of the portfolio to precious metals and are seeking out tend to have the same kind of unique opportunities Many of our larger positions risk/return characteristics that we strive to build into the portfolio. For example. the central banks of the world to funding the issuance of new sovereign debt directly through through easing (in the US. Based on our thesis of impending inflation and competition we are invested approximately attractive in short duration credit and mortgages. in the short term. approximately 15% of the European Central Bank's policy. sobriety emerges around the world. The debt financing position of on historically loose monetary or indeed not actively loosened further.
J. 24 © 2009 Hayman Advisors L.Respectfully. . fund and this summary is qualified in its entirety by the more complete information contained therein and in the related This may not be reproduced. solicitation or recommendation to sell or an offer to buy any securities.P. The information and of the particular 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. 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. opinions expressed herein are provided for informational purposes only. distributed or used for any other purpose. investment products or investment advisory services. An investment in the Hayman Funds is speculative due to a variety of risks and considerations as detailed in the confidential private placement memorandum subscription materials. Reproduction and distribution of this summary may constitute a violation of federal or state securities laws.
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