Housing Credit Crisis T2 Research

8/14/2019 Housing Credit Crisis T2 Research

1/63

An Overview of the Housing/Credit Crisis

and Why There is More Pain to Come

T2 Accredited Fund, LP

Tilson Offshore Fund, Ltd.

T2 Qualified Fund, LP

April 3, 2009

T2 Partners Management L.P. is a Registered Investment Advisor

145 E. 57th Street

10th Floor

New York, NY 10022

(212) 386-7160

[email protected]

www.T2PartnersLLC.com

This document is not a solicitation to invest in any investment product, nor is it intended to provide investment advice. It is intended for informationpurposes only and should be used by sophisticated investors who are knowledgeable of the risks involved. All data and comments herein are believed tobe correct, but there are no guarantees and readers should do their own work. Please refer to the relevant Confidential Private Placement Memorandum forfull details on investment roducts and strate ies of T2 Partners LLC.


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-2-

Prior to This Decade, Housing Had Been a Stable Investment,Increasing at Less Than of 1% Per Year After Inflation

Source: Robert J. Shiller, Irrational Exuberance, Princeton University Press 2000, Broadway Books 2001, 2nd edition,2005, also Subprime Solution, 2008, as updated by the author at http://www.econ.yale.edu/~shiller/data.htm

10 0

12 0

14 0

16 0

18 0

20 0

22 0

Real Home Price Index

(1890=100)

Trend Line


3/63


4/63

-4-

From 2000-2006, the Borrowing Power of a TypicalHome Purchaser More Than Tripled

Source: Amherst Securities

Factors contributing to the ability to borrow more and more were:

1. Slowly rising income

2. Lenders being willing to allow much higher debt-to-income ratios

3. Falling interest rates

4. Interest-only mortgages (vs. full amortizing)

5. No money down

$0

$100,000

$200,000

$300,000

$400,000

Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Pre-Tax Income

Borrowing Power

3.3x in January 2000

9.2x in January 2006


5/63

-5-

Housing Became Unaffordable in Many Areas

0

10

20

30

40

50

60

70

80

Q1 1996 Q1 1997 Q1 1998 Q1 1999 Q1 2000 Q1 2001 Q1 2002 Q3 2004 Q3 2005 Q3 2006 Q3 2007

HousingOpportunityIndex

Los Angeles, CA

Riverside, CA

San Diego, CA

Source: NAHB/Wells Fargo Housing Opportunity Index, which measures percentageof households that could afford the average home with a standard mortgage


6/63

Americans Have Borrowed Heavily Against Their HomesSuch That the Percentage of Equity in Their Homes HasFallen Below 50% for the First Time on Record Since 1945

-6-

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

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

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

MortgageDebt(Bn)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Equityasa%

ofHomeV

alue

1945

Mortgage Debt: $18.6 billion

Equity: $97.5 billion

2008

Mortgage Debt: $10.5 trillion

Equity: $8.5 trillion


7/63-7-

There Was a Dramatic Decline in MortgageLending Standards from 2001 through 2006

Source: LoanPerformance, Paulson presentation; USA Today (www.usatoday.com/money/economy/housing/2008-12-12-homeprices_N.htm)

In 2005, 29% ofnew mortgageswere interest

only or less,in the case ofOption ARMs vs. 1% in 2001

In 1989, theaverage downpayment for first-

time homebuyers was10%; by 2007, itwas 2%

The sale of newhomes costing$750,000 or

more quadrupledfrom 2002 to2006. Theconstruction ofinexpensivehomes costing$125,000 or less

fell by two-thirds

74

74

76

81

83

84

81

68

70

72

74

76

78

80

82

84

86

2001 2002 2003 2004 2005 2006 2007

CombinedLoantoValue(%)

1%1%

3%

9%

14%

17%

8%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2001 2002 2003 2004 2005 2006 2007

PercentofOriginations

33%

39%

45%

49%

56%

63%65%

0%

10%

20%

30%

40%

50%

60%

70%

2001 2002 2003 2004 2005 2006 2007


0% 0%

1%

4%

8%

11%

5%

0%

2%

4%

6%

8%

10%

12%

2001 2002 2003 2004 2005 2006 2007


Combined Loan to Value 100% Financing

Limited Documentation 100% Financing & Limited Doc


8/63-8-

The Decline in Lending Standards Led to aSurge in Subprime Mortgage Origination

Source: Reprinted with permission; Inside Mortgage Finance, published by Inside MortgageFinance Publications, Inc. Copyright 2009.

10%9%

9%

10%9%

10%10%

7%7%

8%

18%

20%20%

8%

$0

$100

$200

$300

$400

$500

$600

$700

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

Originations

(Bn)

0%

5%

10%

15%

20%

25%

% of

Total


9/63-9-

$0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 $5.0

CDO/ CLO

Other Consumer

Construction & Development

Option ARM

Auto

Credit Card

Home Equity

Jumbo Prime

High-Yield / Leveraged Loans

Subprime

Commercial & Industrial

Other Corporate

Alt-A

Commercial Real Estate

Prime Mortgage

Amount Outstanding (Trillion)

But Subprime Mortgages Are Only aTiny Part of the Mortgage Problem

Sources: Federal Reserve Flow of Funds Accounts of the United States, IMF Global Financial Stability Report October 2008, Goldman Sachs

Global Economics Paper No. 177, FDIC Quarterly Banking Profile, OFHEO, S&P Leverage Commentary & Data, T2 Partners estimates


10/63-10-

Among the Many Causes of The GreatMortgage Bubble, Two Stand Out

The companies making crazy loans didnt care very much if thehomeowner ended up defaulting for two reasons:

1. Either they didnt plan to hold the loan, but instead intended to pass it alongto Wall Street, which would bundle, slice-and-dice it and sell it (along withany subsequent losses) to investors around the world;

2. Or, if they did plan to hold the loan, they assumed home prices would keeprising, such that homeowners could either refinance before loans reset or, ifthe homeowner defaulted, the losses (i.e., severity) would be minimal.

There were many other reasons, of course a bubble of this

magnitude requires what Charlie Munger calls Lollapalooza Effects The entire system real estate agents, appraisers, mortgage lenders,banks, Wall St. firms and ratings agencies became corrupted by the vastamounts of quick money to be made

Regulators and politicians were blinded by free market ideology or thedream that all Americans should own their homes, causing them to fallasleep at the switch, not want to take the punch bowl away and/or getbought off by the industries they were supposed to be overseeing

Debt became increasingly available and acceptable in our culture Millions of Americans became greedy speculators and/or took on too much

debt Greenspan kept interest rates too low for too long Institutional investors stretched for yield, didnt ask many questions and

took on too much leverage In general, everyone was suffering from irrational exuberance


11/63-11-

As Long As Home Prices Rise Rapidly, Even Subprime MortgagesPerform Well But If Home Prices Fall, Look Out Below!

Source: T2 Partners estimates

0%

10%

20%

30%

40%

50%

60%

20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40%

Home Price Appreciation

CumulativeLoss(%)


12/63-12-

Wall Streets Demand for Loan Product Was aMajor Driver of the Decline in Lending Standards

As discussed later in this presentation, the Asset-Backed Securities (ABSs) andCollateralized Debt Obligation (CDO) businesses were enormously profitable forWall Street firms

Structured finance was a big driver of the surge in profitability of financial firms andtheir employees:

To produce ABSs and CDOs, Wall Street needed a lot of loan product

Mortgages were a quick, easy, big source

It is easy to generate higher and higher volumes of mortgage loans: simply lendat higher loan-to-value ratios, with ultra-low teaser rates, to uncreditworthyborrowers, and dont bother to verify their income and assets (thereby invitingfraud)

Theres only one problem: DONT EXPECT TO BE REPAID!

Source: Moodys Economy.com

5%

6%

7%

8%

9%

10%

11%

1975 1980 1985 1990 1995 2000 2005

PercentofUST

otal

Financial Services Profits as a % of U.S. Total Financial Services Wages as a % of U.S. Total

0%

10%

20%

30%

40%

50%

1975 1980 1985 1990 1995 2000 2005

PercentofUSTotal

Th W S f T i M t


13/63-13-

There Was a Surge of Toxic MortgagesOver the Past 10 Years

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Originations

(Bn)

Conforming, FHA/VA

Jumbo

Alt-A

Subprime

Seconds

Source: Reprinted with permission, Inside Mortgage Finance, published by Inside Mortgage Finance Publications, Inc. Copyright 2009


14/63-14-

Private Label Mortgages (Those Securitized by Wall St.) Are 15%of All Mortgages, But Are 51% of Seriously Delinquent Mortgages

Number of Mortgages (million)

Approximately two-thirds of homes have mortgages and of these, 56% are owned orguaranteed by the two government-sponsored enterprises (GSEs), Fannie & Freddie

Source: Freddie Mac, Q4 08

Number of SeriouslyDelinquent Mortgages (000)

Total: 55.0 million Total: 3.5 million

Freddie Mac13

Ginne Mae /FHA6

Private Label8

Fannie Mae18

Banks & Thrifts8

15%

Private Labe l

1734

Banks & T hrifts397

Freddie Mac232

Fannie Mae444

Ginne Mae/FHA378

51%


15/63-15-

Nearly 8% of Mortgages on 1- to 4-Family Homes WereDelinquent or in Foreclosure as of the End of 2008

Source: National Delinquency Survey, Mortgage Bankers Association. Note: Delinquencies (60+ days) are seasonally adjusted

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Q41979

Q41

980

Q41

981

Q41

982

Q4198

3

Q419

84

Q4198

5

Q4198

6

Q4198

7

Q4198

8

Q4198

9

Q41990

Q41

991

Q41

992

Q41

993

Q41

994

Q4199

5

Q4199

6

Q4199

7

Q4199

8

Q4199

9

Q4200

0

Q420

01

Q420

02

Q42

003

Q42

004

Q42

005

Q4200

6

Q4200

7

Q4200

8

Percentageof

HomeLoans


16/63-16-

All Types of Loans, Led by Subprime, Are Seeing a Surgein Delinquencies

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Q11999

Q31999

Q12

000

Q320

00

Q12

001

Q320

01

Q120

02

Q32

002

Q120

03

Q32

003

Q120

04

Q320

04

Q120

05

Q320

05

Q12

006

Q320

06

Q12

007

Q320

07

Q120

08

Q32

008

PercentNo

ncurrent

Alt A

Option ARM

JumboSubprime

Prime

Home Equity Lines of Credit

Source: Amherst Securities, LoanPerformance; National Delinquency Survey, Mortgage Bankers Association;

FDIC Quarterly Banking Profile; T2 Partners estimates. Note: Prime is seasonally adjusted.

S f


17/63-17-

Sales of Existing Homes Are Falling and ForeclosuresAre Rising, Leading to a Surge in Inventories

Source: NATIONAL ASSOCIATION OF REALTORS Existing Home Sales data series

Months SupplyExisting Home Sales

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Millions

4.7 million units as of

the end of February 2009

3

4

5

6

7

8

9

10

11

12

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Months

3.8 million units, equal to 9.7

months as of the end of February

24% f H With M t O M Th th


18/63-18-

24% of Homeowners With a Mortgage Owe More Than theHome Is Worth, Making Them Far More Likely to Default

There Has Been a Dramatic Rise inHomeowners Who Are Under Water

In Bubble Markets, Far MoreHomeowners Are Under Water

Source: Zillow.com Q4 08 Real Estate Market Report; Moody's Economy.com, First American CoreLogic, T2 Partners estimates;

Among people who bought homes in the past five years, 30%+ are under water

4%

6%

16%

20%

24%

0%

5%

10%

15%

20%

25%

Dec-06 Dec-07 Sep-08 Dec-08 Mar-09

PercentUnderwater

Price Index Is % of Last 5 Yrsat Lowest Price Drop Purchasers Who

Metro Area Level Since Since Peak Are Under Water New York 2004-Q3 -15.2% 23.0%Los Angeles 2003-Q4 -32.0% 56.4%Boston 2002-Q2 -21.8% 27.8%Washington 2004-Q1 -24.8% 50.3%Miami 2004-Q1 -36.6% 65.1%

San Francisco 2003-Q3 -27.8% 51.2%Atlanta 2004-Q4 -10.4% 23.2%San Diego 2002-Q4 -34.4% 63.9%Phoenix 2004-Q3 -37.7% 36.4%Las Vegas 2003-Q4 -41.8% 61.4%


19/63-19-

Certain Types of Loans are Severely Under Water

Source: Amherst Securities, LoanPerformance, Standard & Poors

73%

50%

45%

25%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Prime Alt A Subprime Option ARM

PercentUnderwater


20/63-20-

Foreclosure Filings Have Increased Dramatically

Note: Foreclosure filings are defined as default notices, auction sale notices and bank repossessions

Sources: RealtyTrac.com U.S. Foreclosure Market Report

Foreclosures in February rose 30% year-over-year and 6% sequentially

Starting to flatten due to a number of states and banks plus Fannie and Freddieimplementing foreclosure moratoria

RealtyTrac estimates that over 1.5 million bank-owned properties are on the market,representing around a third of all properties for sale in the U.S.

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

Jun-

05

Aug-

05

Oct-0

5

Dec-

05

Feb-

06

Apr-0

6

Jun-

06

Aug-

06

Oct-0

6

Dec-

06

Feb-

07

Apr-0

7

Jun-

07

Aug-

07

Oct-0

7

Dec-

07

Feb-

08

Apr-0

8

Jun-

08

Aug-

08

Oct-0

8

Dec-

08

Feb-

09

NumberofForeclosures

In B bble Markets Prices Are Wa Do n Dri en B a


21/63-21-

$0

$100

$200

$300

$400

$500

Jan-

06

Apr-0

6

Jul-0

6

Oct-0

6

Jan-

07

Apr-0

7

Jul-0

7

Oct-0

7

Jan-

08

Apr-0

8

Jul-0

8

Oct-0

8

Jan-

09

MedianHomePrice(000s)

0%

10%

20%

30%

40%

50%

60%

70%

ForeclosureRe

sale%

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

Source: MDA Dataquick. Note: Includes new construction

California


22/63-22-

Home Prices Are in an Unprecedented Freefall

Source: Standard & Poors, OFHEO Purchase-Only Index, NATIONAL ASSOCIATION OF REALTORS Existing Home Sales data series

100

120

140

160

180

200

220

Q12000

Q22000

Q32000

Q42000

Q12001

Q22001

Q32001

Q42001

Q12002

Q22002

Q32002

Q42002

Q12003

Q22003

Q32003

Q42003

Q12004

Q22004

Q32004

Q42004

Q12005

Q22005

Q32005

Q42005

Q12006

Q22006

Q32006

Q42006

Q12007

Q22007

Q32007

Q42007

Q12008

Q22008

Q32008

Q42008

S&P/Case-Shiller U.S. National Home Price Index

S&P/Case-Shiller 20-City Composite

OFHEO Purchase-Only Index

NAR Median Sales Price of Existing Homes


23/63

-23-

Home Prices Need to Fall Another 13% to Reach Trend Line

Sources: Robert J. Shiller, Irrational Exuberance, 2nd. Edition, Princeton University Press,2005, Broadway Books 2006,also Subprime Solution, 2008, as updated by author at http://www.econ.yale.edu/~shiller/data.htm

100

120

140

160

180

200

220

1950

1954

1958

1962

1966

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

RealHomePriceIndex(1890=100)

-13% to

Trend

Trend Line

-32% from

Peak

The Housing Affordability Index Shows


24/63

-24-

14

16

18

20

22

24

26

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

MortgagePaymentonMedianPricedHomeas%o

fFamilyIncome

The Housing Affordability Index ShowsHouses Are Now Affordable

Source: NATIONAL ASSOCIATION OF REALTORS Housing Affordability Index

Before concluding that houses are cheap, however, there are three big caveats: first, low rates are onlyavailable to those who qualify for conforming mortgages, which doesnt help millions of homeowners orpotential homeowners who have spotty credit histories or are underwater on their current mortgages.Second, with low enough interest rates, almost anything looks affordable; if rates rise, houses wont lookso reasonably priced based on these metrics. Finally, in light of the severe economic downturn, averageincome may fall for quite some time.


25/63

-25-

Mortgage Rates Have Fallen Recently

Source: HSH Associates, Yahoo! Finance.com

2

3

4

5

6

7

8

Feb-

04

May

-04

Aug-

04

Nov-0

4

Feb-

05

May

-05

Aug-

05

Nov-

05

Feb-

06

May

-06

Aug-

06

Nov-0

6

Feb-

07

May-

07

Aug-

07

Nov-0

7

Feb-

08

May-

08

Aug-

08

Nov-0

8

Feb-

09

Rate(%

)

Jumbo 30 Yr FRM

Jumbo 5/1 Hybrid ARM

Conforming 30 Yr FRM

Conforming 5/1 Hybrid ARM

10-Year Treasury

The Home Price-to-Rent Ratio Has


26/63

-26-

The Home Price-to-Rent Ratio HasReturned to Normal Levels

Source: NATIONAL ASSOCIATION OF REALTORS Existing Home Sales data series, U.S. Census Bureau, T2 Partners estimates

15

17

19

21

23

25

27

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

MedianHomePricetoMe

dianGrossRent

A Study of Bubbles Shows That All of Them


27/63

-27-

Commodities

Currencies

Note: For S&P charts, trend is 2% real price appreciation per year. Source: GMO. Data through 10//10/08.

* Detrended Real Price is the price index divided by CPI+2%, since the long-term trend increase in the price of the S&P 500 has been on the order of 2% real.

StocksS&P 500

1920-1932

0.3

0.8

1.3

1.8

2.3

20 21 22 23 24 25 26 27 28 29 30 31

DetrendedRea

lPrice

Trend Line

S&P 5001946-1984

0.0

0.5

1.0

1.5

2.0

2.5

4 6 5 0 5 4 5 8 6 2 6 6 7 0 7 4 7 8 8 2

DetrendedRealPrice

Trend Line

Japan vs. EAFE ex-Japan1981-1999

0.0

0.5

1.0

1.5

2.0

2.5

3.0

8 1 8 3 8 5 8 7 8 9 9 1 9 3 9 5 9 7 9 9

RelativeReturn

Trend Line

S&P 5001992-October 2008

0.8

1.2

1.6

2.0

2.4

9 2 9 4 9 6 9 8 0 0 0 2 0 4 0 6 0 8

DetrendedRea

lPrice

Trend Line

U.S. Dollar1979-1992

0.8

1.0

1.2

1.4

1.6

1.8

2.0

79 81 83 85 87 89 91

CumulativeReturn

U.K. Pound1979-1985

0.8

0.9

1.0

1.1

1.2

1.3

1.4

79 80 81 82 83 84

CumulativeReturn

Japanese Yen1983-1990

0.8

0.9

1.0

1.1

1.2

1.3

1.4

83 84 85 86 87 88 89 90

CumulativeReturn

Japanese Yen1992-1998

0.8

0.9

1.0

1.1

1.2

1.3

1.4

92 93 94 95 96 97

CumulativeReturn

Gold1970-1999

0

40 0

80 0

1200

1600

2000

70 74 78 82 86 9 0 94 98

RealPrice

Crude Oil1962-1999

0

20

40

60

80

6 2 6 6 7 0 7 4 7 8 8 2 8 6 9 0 9 4 9 8

RealPrice

Nickel1979-1999

0

50

100

150

200

250

79 8 1 8 3 85 87 8 9 91 9 3 9 5 97

RealPrice

Cocoa1970-1999

0

10 0

20 0

30 0

40 0

50 060 0

70 74 78 82 86 90 94 98

RealPrice

*

A Study of Bubbles Shows That All of ThemEventually Return to Trend Line

The Biggest Danger is That Home Prices Overshoot on the


28/63

-28-

The Biggest Danger is That Home Prices Overshoot on theDownside, Which Often Happens When Bubbles Burst

Source: GMO

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

2.25

2.50

1927 1930 1933 1936 1939 1942 1945 1948 1951 1954

D

etrendedRealS&P500StockPriceIndex

-59%

Overrun: 59%

Fair Value to Bottom: 1.5 Years

Fair Value to Fair Value: 23 Years

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

2.25

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

DetrendedRealS&P500StockPriceIndex

-45%

Overrun: 45%

Fair Value to Bottom: 7 Years

Fair Value to Fair Value: 12 Years

S&P 500 1927-1954

S&P 500 1955-1986

Home Prices Have Already Crashed Through the Trend


29/63

-29-

Home Prices Have Already Crashed Through the TrendLine in California And There Is No Sign of Stabilization

Source: Reprinted with permission of the California Association of REALTORS . All rightsreserved. www.rebsonline.com, T2 Partners estimates.

$0

$100

$200

$300

$400

$500

$600

Jan-79

Jan-

81

Jan-

83

Jan-

85

Jan-

87

Jan-

89

Jan-91

Jan-93

Jan-95

Jan-97

Jan-99

Jan-

01

Jan-

03

Jan-

05

Jan-

07

Jan-

09

MedianPrice

($000s)

Median Sales Price

4% Trend


30/63

-30-

Outlook for Housing Prices

We think housing prices will reach fair value/trend line down 40% from the peakbased on the S&P/Case-Shiller national (not 20-city) index, which implies a 10-15%further decline from where prices where as of the end of 2008. Its almost certain that

prices will reach these levels The key question is whether housing prices will go crashing through the trend line andfall well below fair value? Unfortunately, this is very likely. In the long-term, housingprices will likely settle around fair value, but in the short-term prices will be driven bothby psychology as well as supply and demand. The trends in both are veryunfavorable Regarding the former, national home prices have declined for 30 consecutive months since

their peak in July 2006 through January 2009 and theres no end in sight, so this makesbuyers reluctant even when the price appears cheap and sellers desperate.

Regarding the latter, there is a huge mismatch between supply and demand, due largely tothe tsunami of foreclosures. In January 2009, distressed sales accounted for 45% of allexisting home sales nationwide and more than 60% in California. In addition, the shadowinventory of foreclosed homes already likely exceeds one year and there will be millions moreforeclosures over the next few years, creating a large overhang of excess supply that willlikely cause prices to overshoot on the downside, as they are already doing in California.

Therefore, we expect housing prices to decline in the 45-50% range, bottomingin mid-2010

We are also quite certain that wherever prices bottom, there will be no quick rebound Theres too much inventory to work off quickly, especially in light of the millions of

foreclosures over the next few years. While foreclosure sales are booming in many areas, regular sales by homeowners have

plunged, in part because people usually cant sell when theyre under water on theirmortgage and in part due to human psychology: people naturally anchor on the price theypaid or what something was worth in the past and are reluctant to sell below this level. Wesuspect that there are millions of homeowners like this who will emerge as sellers at the firstsign of a rebound in home prices.

Finally, we dont think the economy is likely to provide a tailwind, as we expect it to contractthe rest of 2009, stagnate in 2010, and only then grow tepidly for some time thereafter.

There Have Been 5 Million Jobs Lost So Far in This


31/63

-31-

There Have Been 5 Million Jobs Lost So Far in ThisRecession, More Than 3 Million in the Past Five Months

Source: Bureau of Labor Statistics

-1000

-800

-600

-400

-200

0

200

400

600

Jan-90

Jan-91

Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

ChangeinNonfarm

PayrollEmployment(000s)

There have been job

losses every monthsince December 2007

The Unemployment Rate Jumped to 8 5% in March


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3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

Jan-70

Jan-73

Jan-76

Jan-79

Jan-

82

Jan-

85

Jan-

88

Jan-91

Jan-94

Jan-97

Jan-

00

Jan-

03

Jan-

06

Jan-

09

Unemployment

Rate

The Unemployment Rate Jumped to 8.5% in March,the Highest Level Since 1983


If part-time and discouraged workers are factored in, the unemploymentrate would have been 15.6% in March. In addition, the average workweek in dropped to 33.2 hours, a new record low.

The Decline from Peak Employment Now


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The Decline from Peak Employment NowExceeds the Past Five Recessions


-4.0%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0 6 12 18 24 30 36 42 48

Months after pre-recession peak

1980 2001-051990-931974-76

2007-

1981-83


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Consumer Confidence is at an All-Time Low

0

20

40

60

80

100

120

140

160

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

ConsumerConfide

nceIndex

Near all-time low

Note: 1985=100

Source: The Conference Board (www.pollingreport.com/consumer.htm)

Banks are Tightening Consumer Credit and


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Banks are Tightening Consumer Credit andNew Household Borrowing Has Plunged

Source: Federal Reserve

Household Borrowing 1990-2008(Seasonally-Adjusted Annual Rate)

$0

$200

$400

$600

$800

$1,000

$1,200

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

($ billions)

Percent of US Banks Tightening Consumer Credit

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

Jan-

00

Sep-

00

May

-01

Jan-

02

Sep-

02

May

-03

Jan-

04

Sep-

04

May

-05

Jan-

06

Sep-

06

May

-07

Jan-

08

Sep-

08

Credit Cards Other Consumer Loans

The Credit Bubble Led to a Bubble in


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

Low Debt Era Rising Debt Era

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05

FinancialProfits

asPercentofGDP

100%

150%

200%

250%

300%

350%

TotalDebtasPercentofGDP

Dec-

Total Debt

Financial Profits

The Credit Bubble Led to a Bubble inFinancial Profits (& Share of GDP)


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The Outlook Is Grim

Defaulting subprime and Alt-A loans drove the first stage of the

mortgage crisis The next leg down of the mortgage crisis will be driven by

defaulting Alt-A, Option ARM, jumbo prime and prime loans aswell as home equity lines of credit (HELOCs) and second liens(closed-end seconds)

Losses outside of the mortgage sector will also continue to risedue to commercial real estate, leveraged loans, junk bonds, etc.

The Wave of Resets from Subprime Loans


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$0

$5

$10

$15

$20

$25

$30

$35

Jan-

06

Apr-0

6

Jul-0

6

Oct-0

6

Jan-

07

Apr-0

7

Jul-0

7

Oct

-07

Jan-

08

Apr-0

8

Jul-0

8

Oct-0

8

Jan-

09

Apr-0

9

Jul-0

9

Oct-0

9

Jan-

10

Apr-1

0

Jul-1

0

Oct

-10

LoanswithPaym

entShock(Bn)

Sources: LoanPerformance, Deutsche Bank; slide from Pershing Square presentation, How to Save the Bond Insurers, 11/28/07.

The Wave of Resets from Subprime LoansIs Mostly Behind Us

We arehere

B t a Wa e of Alt A Resets Is Ahead of Us


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$0

$1

$2

$3

$4

$5

$6

$7

$8

$9

$10

Jan-

10

Jul-1

0

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Months to 1st reset

Amount(Bn)

$0

$50

$100

$150

$200

$250

$300

EstimatedCumulativeResetAmount(Bn)

Sources: Credit Suisse, LoanPerformance

But a Wave of Alt-A Resets Is Ahead of Us

We are

here

There Are $2.5 Trillion of Alt-A Loans Outstanding


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$0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 $5.0

CDO/ CLO

Other Consumer


Option ARM

Auto

Credit Card

Home Equity

Jumbo Prime


Subprime


Other Corporate

Alt-A


Prime Mortgage

Amount Outstanding (Trillion)

$ gWhen One Includes Those Held by the GSEs

Sources: Federal Reserve Flow of Funds Accounts of the United States, IMF Global Financial Stability Report October 2008, Goldman Sachs

Global Economics Paper No. 177, FDIC Quarterly Banking Profile, OFHEO, S&P Leverage Commentary & Data, T2 Partners estimates

D li i f S iti d Alt A M t A S i


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Delinquencies of Securitized Alt-A Mortgages Are Soaring

0%

5%

10%

15%

20%

25%

Jan-99

May-99

Sep-99

Jan-

00

May

-00

Sep-

00

Jan-

01

May-

01

Sep-

01

Jan-

02

May

-02

Sep-

02

Jan-

03

May

-03

Sep-

03

Jan-

04

May

-04

Sep-

04

Jan-

05

May

-05

Sep-

05

Jan-

06

May

-06

Sep-

06

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

PercentNoncurr

ent(60+days)

Sources: Amherst Securities, LoanPerformance

Alt-A Delinquencies By Vintage Show the Collapse


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q y g pin Lending Standards in 2006 and 2007

0%

5%

10%

15%

20%

25%

30%

0 5 10 15 20 25 30 35 40 45 50 55 60

Months of Seasoning

PercentNoncurrent(60+days)

2007 2006

2005

2004

2003



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An Option ARM is an adjustable rate mortgage typically made to a primeborrower

Sold under various names such as Pick-A-Pay Banks typically relied on the appraised value of the home and the borrowers

high FICO score, so 83% of Option ARMs written in 2004-2007 were low- or no-doc (liars loans)

Each month, the borrower can choose to pay: 1) the fully amortizing interest andprincipal; 2) full interest; or 3) an ultra-low teaser interest-only rate (typically 2-3%), in which case the unpaid interest is added to the balance of the mortgage

(meaning it is negatively amortizing) Approximately 80% of Option ARMs are negatively amortizing

Lenders, however, booked earnings as if the borrowers were making full interestpayments

A typical Option ARM is a 30- or 40-year mortgage that resets (recasts) afterfive years, when it becomes fully amortizing If an Option ARM negatively amortizes to 110-125% of the original balance (depending

on the terms of the loan), this triggers a reset even if five years have not elapsed Upon reset, the average monthly payment jump 63% from $1,672 to $2,725

($32,700 annually)

My sense is that many option ARM borrowers are in a worse position thansubprime borrowers, says Kevin Stein, associate director of the CaliforniaReinvestment Coalition, which combats predatory lending. They wind up owingmore and the resets are more significant.

A Primer on Option ARMs

About $750 Billion of Option ARMs Were Written


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Source: Reprinted with permission, 2008 Mortgage Market Statistical Annual, published by InsideMortgage Finance Publications, Inc. Copyright 2008. T2 Partners estimates

About $750 Billion of Option ARMs Were Written

5%

9%

1%

8%

5%

$0

$50

$100

$150

$200

$250

$300

2004 2005 2006 2007 2008

Originations

(Bn)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

PercentofT

otal

Options ARMs Were a Bubble State Phenomenon


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Options ARMs Were a Bubble State Phenomenon

Source: Amherst Securities, LoanPerformance

CA, 58%

FL, 10%

NV, 3%

AZ, 3%

HI, 1%

Other, 25%

Beginning in March 2005, High-FICO-Score Borrowers Opted for an


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g g , g pAbove-Market-Rate Option ARM in Exchange for the Low Teaser Rate

Source: Amherst Securities, Bloomberg Finance L.P.

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

Jan-

02

Apr-0

2

Jul-0

2

Oct-0

2

Jan-

03

Apr-0

3

Jul-0

3

Oct-0

3

Jan-

04

Apr-0

4

Jul-0

4

Oct-0

4

Jan-

05

Apr-0

5

Jul-0

5

Oct-0

5

Jan-

06

Apr-0

6

Jul-0

6

Oct-0

6

Jan-

07

Apr-0

7

Jul-0

7

Oct-0

7

Jan-

08

InterestRate(%)

Fannie Mae 30 Year FRM Index

Option ARM Index

Option ARM borrowers during this period(when nearly all option ARMS were written)were saying they couldnt afford a fully-amortizing mortgage otherwise theywould have taken one

Delinquencies of Securitized Option ARMs Are Soaring


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Delinquencies of Securitized Option ARMs Are Soaring


0%

5%

10%

15%

20%

25%

30%

35%

Jan-99

May-99

Sep-99

Jan-

00

May

-00

Sep-

00

Jan-

01

May-

01

Sep-

01

Jan-

02

May

-02

Sep-

02

Jan-

03

May

-03

Sep-

03

Jan-

04

May

-04

Sep-

04

Jan-

05

May

-05

Sep-

05

Jan-

06

May

-06

Sep-

06

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

PercentNoncurr

ent(60+days)

Option ARM Delinquencies By Vintage Show the


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y gCollapse in Lending Standards in 2005-2007


0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0 5 10 15 20 25 30 35 40 45 50 55 60

Months of Seasoning

PercentNoncurrent(60+days) 2007

2006

2005

2004

2003

Delinquencies of Securitized Jumbo Prime


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Mortgages Are Soaring


0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

Jan-99

May-99

Sep-99

Jan-

00

May-0

0

Sep-

00

Jan-

01

May-

01

Sep-

01

Jan-

02

May-0

2

Sep-

02

Jan-

03

May-

03

Sep-

03

Jan-

04

May-

04

Sep-

04

Jan-

05

May-

05

Sep-

05

Jan-

06

May-

06

Sep-

06

Jan-

07

May-0

7

Sep-

07

Jan-

08

May-0

8

Sep-

08

Jan-

09


Delinquencies of Prime Mortgages Are Soaring


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Delinquencies of Prime Mortgages Are Soaring

Sources: Mortgage Bankers Association National Delinquency Survey

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

Q11999

Q31999

Q120

00

Q320

00

Q120

01

Q320

01

Q120

02

Q320

02

Q120

03

Q320

03

Q120

04

Q320

04

Q120

05

Q320

05

Q120

06

Q320

06

Q120

07

Q320

07

Q120

08

Q320

08


HELOCs and Home Equity Loans Soared


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in Popularity During the Bubble

Home Equity & Junior Lien Loans ($ in billions)

$-

$100

$200

$300

$400

$500

$600

$700

$800

$900

$1,000

Mar-0

0

Jun-

00

Sep-

00

Dec-

00

Mar-0

1

Jun-

01

Sep-

01

Dec-

01

Mar-0

2

Jun-

02

Sep-

02

Dec-

02

Mar-0

3

Jun-

03

Sep-

03

Dec-

03

Mar-0

4

Jun-

04

Sep-

04

Dec-

04

Mar

-05

Jun-

05

Sep-

05

Dec-

05

Mar

-06

Jun-

06

Sep-

06

Dec-

06

Mar

-07

Jun-

07

Sep-

07

Dec-

07

Mar

-08

Jun-

08

Sep-

08

Home Equity Loans Junior Lien Mortgages

Note: Does not include approximately $200 billion of securitized HELOCs and junior liens

Source: FDIC Quarterly Banking Profile

Man Borro ers Used HELOCs to B Ne Cars


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As home prices have declined and other funding sources have driedup, millions of consumers have maxed out on home equity debt.

In hot markets like California and Florida, a significant percentage of allconsumers tapped into the value of their homes to help finance theirnew cars, according to CNW Marketing Research.

Clearly this dynamic does not bode well for HELOC recovery rates ornew car sales.

Source: New York Times 5/27/2008

Many Borrowers Used HELOCs to Buy New Cars

Delinquencies of HELOCs and CESs Are Soaring


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Delinquencies of HELOCs and CESs Are Soaring

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Q120

04

Q220

04

Q320

04

Q42

004

Q120

05

Q220

05

Q3200

5

Q420

05

Q1200

6

Q2200

6

Q320

06

Q4200

6

Q1200

7

Q2200

7

Q3200

7

Q420

07

Q1200

8

Q2200

8

Q320

08

Q4200

8

PercentNoncurre

nt(90+days)

Closed-End Junior LienMortgages

Home Equity Lines of Credit

Source: FDIC Quarterly Banking Profile

Pools of HELOCs and CESs Can Suffer


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0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59

Months Since Close

MonthlyLossRate(3m

average)

Ambac Projection April 2008 Actual

Astronomical Losses Due to 100%+ Severities

Source: Ambac Q1 08 presentation, Amherst Securities; funds managed by T2 Partners are short Ambac

On one second lien deal, Ambac expected losses of 10-12% when it guaranteed the seniortranche. A year ago, Ambac admitted that the pool would likely lose 81.8% of its value andbased on the pools performance since then, this will almost certainly prove to be conservative.

From Ambac slide, 4/08:

This is a second lien deal that closed in April 2007 Loss to date 9.9%

Projected loss: 81.8% Projected collateral loss as a % of current collateral: 86% A reasonable estimate of projected collateral loss for the

above transaction might have been 10-12%, with thetransaction having an A+ rating at inception and beingstructured to withstand 28-30% collateral loss

The Timing Indicates That We Are Still in the MiddleI i f th B ti f th G t M t B bbl


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Innings of the Bursting of the Great Mortgage Bubble Mortgage lending standards became progressively worse starting in 2000, but really

went off a cliff beginning in early 2005 The worst loans were subprime ones, which generally had two-year teaser rates and

are now defaulting at unprecedented rates Such loans made in Q1 2005 started to default in high numbers upon reset in Q1

2007, which not surprisingly was the beginning of the current crises The crisis has continued to worsen as even lower quality subprime loans made over

the remainder of 2005 reset over the course of 2007, triggering more and moredefaults

It takes an average of 15 months from the date of the first missed payment by ahomeowner to a liquidation (generally a sale via auction) of the home

Thus, the Q1 2005 subprime loans that defaulted in Q1 2007 led to foreclosures andauctions in early 2008

Given that lending standards got much worse in late 2005 through 2006 and into thefirst half of 2007, and the many other types of loans that are now with longer resetdates that are now starting to default at catastrophic rates, there are soberingimplications for expected defaults, foreclosures and auctions in 2009 and beyond,which promise to drive home prices down further

In summary, today we are only in the middle innings of an enormouswave of defaults, foreclosures and auctions that is hitting the UnitedStates. We predicted in early 2008 that it would get so bad that it wouldrequire large-scale federal government intervention which hasoccurred, and were likely not finished yet.

Total Losses Are Now Estimated at $2.1-$3.8 Trillion A d L Th H lf f Thi H B R li d T D t


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And Less Than Half of This Has Been Realized To Date

Sources: Goldman Sachs, International Monetary Fund, RGE Monitor, Bloomberg Finance L.P., T2 Partners estimates

Consumer

Corporate

ResidentialMortgages

Banks/Brokers

Residential

MortgagesResidential

Mortgages

Commercial

Real Estate

Insurers

CommercialReal Estate

CommercialReal Estate

Consumer

GSEs

Consumer

Corporate

Corporate

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

Goldman Sachs Jan2009

IMF Jan 2009 Roubini Jan 2009 T2 Partners March2009

Writedowns to Date Capital Raised

Amount(Bn) $2,083 Bn

$1,288 Bn $1,103 Bn

$2,200 Bn

$3,552 Bn

$3,778 Bn

A Breakdown of Our Financial Sector Loss Estimates


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A Breakdown of Our Financial Sector Loss Estimates

Sources: T2 Partners estimates

$0 $100 $200 $300 $400 $500 $600 $700 $800

CDO/ CLO

Other Consumer


Option ARM

Auto

Credit Card

Home Equity

Jumbo Prime


Subprime


Other Corporate

Alt-A


Prime Mortgage

Amount ( Bn)

Total EstimatedFinancial Sector

Losses = $3.8 trillion

Institutions Have Been Able to Raise Capital to Mostly KeepU With W it d B t Thi Will Lik l N t C ti


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Up With Writedowns, But This Will Likely Not Continue

Sources: Bloomberg Finance L.P.

$0

$250

$500

$750

$1,000

$1,250

$1,500

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

Amount(B

n)

Losses & Writedowns

Capital Raised


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To Learn More

More Mortgage Meltdown Will Be Available in Mid-May


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More Mortgage Meltdown Will Be Available in Mid-May

The Next Value Investing Congress is May 5-6 in Pasadena


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The Next Value Investing Congress is May 5 6 in Pasadena

Value Investor Insight and SuperInvestor Insight


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Value Investor Insight and SuperInvestor Insight

Housing Credit Crisis T2 Research

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Transcript of Housing Credit Crisis T2 Research