The Credit Crunch and the U.S. EconomySteven Rattner

March 27, 2008

1

We begin our story in March 2000, when stock market indices reached all-time highs

A Brief Recent Economic and Financial History

¹Companies with high-yield debt in their capital structure. Source: JP Morgan Research

The dot.com meltdown and accompanying recession inflicted meaningful damage on the U.S. economy and financial system

But the damage proved short-lived as the government injected massive stimulus through repeated tax cuts and reductions by the Federal Reserve in its key interest rate from 6% to 1%

The U.S. economy went into recession in March 2001, with unemployment rising to 5.5% and cumulative job losses of 1.6 million

Equity markets plunged -- the S&P fell 49% from its 2000 peak and the NASDAQ declined 78% over a similar periodBankruptcies among highly leveraged companies¹ increased to 8.3% of outstanding debt from a 20-year average of 3.8%.

2

The Ensuing Golden Age

The economy grew steadily from 2002 through the end of 2007, with real GDP expanding at an annual rate of 2.6% during this period.

Productivity rose at a 3% rate

The unemployment rate fell to 4.4%

Inflation remained low

Consumer spending grew by 5.7% annually

Note: Productivity measured as non-farm business output, from the Bureau of Labor Statistics. Consumer spending measured as per capita personal consumption spending from the BEA

3

The Golden Age (cont’d)

Stock prices began a steady rise

S&P 500

Dec-07

March 11, 2003: Price: 800.7

Oct. 9, 2007: Price: 1565.1

15.7% CAGR

700

800

900

1000

1100

1200

1300

1400

1500

1600

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

4

Borrowers Were Huge Beneficiaries

With capital readily available, the cost of borrowing (relative to Treasuries) fell to record lows and lending grew at a rapid pace

Source: JP Morgan Research

JPMorgan Global High-Yield Index

200bp

300bp

400bp

500bp

600bp

700bp

800bp

900bp

1000bp

2003 2004 2005 2006 2007

Spre

ad to

Wor

st

Long-term average (1987 -07)= 542bp

June 2007: 269 bps

$147.9 $149.1

$106.1

$158.2 $151.6

$67.8

New High-Yield Issuances

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

2002 2003 2004 2005 2006 2007

Split B or Lower Total High Yield Issuance

5

Lenders Were Happy to Lend

One of the primary drivers of this heightened activity in the debt and LBO markets was the historically low level of corporate bond defaultsIn 2007 only 10 companies ($3.0 billion in debt) defaulted in the U.S., the lowest figure by number since 1981 and by dollar volume since 1994

D ollar Weighted High-Yield D efault Rate

- -

5.0%

10.0%

15.0%

2007200620052004200320022001200019991998199719961995199419931992199119901989198819871986198519841983198219811980

Source: JP Morgan Research

6

Record liquidity in the credit markets fueled historic volume in the buyout marketIn 2007 low rated debt – often raised to finance leveraged buyouts – swelled to 35% of the total high yield issuances in the U.S.

Source: Thomson, DeaLogicSource: JP Morgan research

Private Equity Boomed

U.S. Historical High Yield Issuance

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

2007200620052004200320022001200019991998

($U

S in

Bill

ions

)

0%

5%

10%

15%

20%

25%

30%

35%

(Low

er R

ated

Issu

ance

% o

f Tot

al)

Split B or Lower H igh Yield Issuance T otal H igh Yield Issuance

Announced Global M&A Volume

- -500

1,000

1,5002,0002,5003,0003,500

4,0004,5005,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(US$

Bill

ions

)

0%

5%

10%

15%

20%

25%

30%

35%

40%

LBO Volume T otal M&A Volume LBO % of T otal M&A

7

And So, Of Course, Did Housing

As we are now painfully aware, the credit expansion led to a boom in housing prices, which rose far faster than incomes

Note: S&P Case/Shiller 20-market home price index

Housing Price Index vs. Median Household Income

0

50

100

150

200

250

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Inde

x L

evel

(sca

led

to 2

000)

S&P/CS H ome Price Index Median H ousehold Income

10.7% annual decline in January 2008

8

The Age of Turmoil: A Quick Summary

The unwinding of the credit bubble famously began with the dramatic upsurge in defaults by subprime borrowers, followed in short order by near paralysis in the high yield market, where rising supply overwhelmed demand.

During the autumn, these developments spread into the “real” economy, as job losses began to occur in the housing and financial sectors and consumers pulled back on spending as a result of falling home prices and overall nervousness about future economic prospects.

Economic forecasters began to gradually raise their estimates of the probability of a recession; today Intrade puts the odds of a recession at 70%. The credit markets are even more dramatically signaling recession.

9

Recent Economic Indicators Point to Recession

Some leading economic statistics indicate the potential for a recessionReal GDP growth was 0.6% in the Q4 2007, and was not revised upward. This result was lower than the 1.1% expected by economists, and the weakest GDP growth for the economy since 2002The unemployment rate was 4.8% in February 2008, up from 4.4% in March 2007New housing construction was down significantly, with Feb. 2008 declining 28% from Feb. 2007The Institute for Supply Management indices have largely been below 50 since December, signaling contractionThe Conference Board consumer confidence index has declined significantly since July (down 43%, from 114 to 64.5) Retail sales declined 0.6% in February

Source: BEA, White House Economic Report, The Conference Board, ISM, US Dept. of Housing and Urban Development

10

Investment Grade Index (CD X IG9 5-yr)

0bp

20bp

40bp

60bp

80bp

100bp

120bp

140bp

160bp

180bp

200bp

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Spre

ad to

Wor

st

Long-term average (1987 - ytd 08)=

73bps

Investment Grade Spreads vs. Recession

Recession levels(190 bps, 3/17)

The investment grade market is clearly signaling recession.

Source: Goldman Sachs

11

Ambiguous Equity Markets

The S&P index has dropped 10% since January 1 and 15% from its peak on October 9thHowever, the S&P index currently trades at 16.1 times LTM earnings, below its 20 year historic average of 19.3 times

Source: Capital IQ Source: Standard and Poors

S&P 500

1150

1200

1250

1300

1350

1400

1450

1500

1550

1600

6/26/200

77/26

/2007

8/26/200

79/26

/2007

10/26/2007

11/26/2007

12/26/2007

1/26/200

82/26

/2008

3/26/200

8

S&P 500 LT M P/E

0.0x

5.0x

10.0x

15.0x

20.0x

25.0x

30.0x

35.0x

03/31/1998

03/31/1999

03/31/2000

03/31/2001

03/31/2002

03/31/2003

03/31/2004

03/31/2005

03/31/2006

03/31/2007

02/29/08

12

Ambiguous Equity Markets (cont’d)

When comparing the earnings yield of the S&P 500 index to the yield of the 10-year Treasury (known as the Fed Model) the S&P currently has a higher yield, implying that it is relatively cheap when compared to bondsThis barometer of share prices suggests that the stock market is more attractive than at any time over the past 10 years

Source: Standard and Poors, St. Louis Fed

S&P Yield vs. 10-yr T reasury Yield

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

03/31/199809 /30/199803 /31/199909 /30/199903 /31/200009 /30/200003 /31/200109 /30/200103 /31/200209 /30/200203 /31/200309 /30/200303 /31/200409 /30/200406 /30/200509 /30/200503 /31/200609 /30/200603 /31/200709 /30/2007

2/29/2008

'S&P 500 Earnings Yield '10-Year T reasury Yield

13

High Yield Backlog

$0

$20

$40

$60

$80

$100

$120

Summer '07 Completed Deals

CanceledDeals

CurrentBacklog

(US$

Bill

ions

)

Leveraged Loan Backlog

$0

$50

$100

$150

$200

$250

Summer '07 Completed Deals

CanceledDeals

CurrentBacklog

(US$

Bill

ions

)

Credit Market Working Through Backlog

Following the meltdown in the U.S. mortgage and sub-prime lending markets, liquidity dried up for corporate debt as well, including over $300 billion in previously committed LBO financingBanks and investors have been hard at work since July digesting over $100 billion of the backlogMany of the deals that came to market from the backlog were priced at a discount and continue to trade below par

However, banks have maintained discipline in offloading these loans up to this point

Source: JP Morgan research, Bank of America research

Down 44%

Down 32%

14

Ramifications for Private Equity

The aforementioned factors have led to a dramatic slowdown in private equity activity

Source: SDC, CapitalIQ

(US$

in B

illio

ns)

(# of Deals)

Announced Buyout Volume H as Stalled Since the Summer Peak

$0

$25

$50

$75

$100

$125

$150

Jan-0

6Feb

-06M

ar-06

Apr-06

May-06Jun-06Jul- 0

6Aug-0

6Sep

-06Oct-

06Nov-0

6Dec-

06Jan

-07

Feb-07

Mar-

07Apr-0

7M

ay-07Jun-07Jul- 0

7Aug-0

7Sep

-07Oct-

07Nov-0

7Dec-

07Jan

-08

Feb-08

0

5

10

15

20

25

30

$1B+ LBO Deal Volume # of $1B+ LBO D eals

15

Early 2008 activity suggests a continuation or even an acceleration of this trend

Ramifications for Private Equity (cont’d)

Source: Thomson, DeaLogicSource: JP Morgan research

Global M&A Volume YT D

$0

$100

$200

$300$400

$500

$600

$700

$800

2007 2008

(US$

Bill

ions

)

LBO Volume T otal M&A Volume

N ew Issuances YT D

$0$5

$10$15$20$25$30$35$40$45

2007 2008

(US$

Bill

ions

)

Split B or Lower H igh Yield Issuance T otal H igh Yield Issuance

16

Widened Credit Market Spreads

Credit risk premiums – which by July had compressed to record lows – have widenedArguably, even today’s levels may not be sufficient given: a) higher than historic levels of debt in buyouts, b) uncertain economic outlook in the U.S. and c) housing / general credit market weakness

Source: JP Morgan research

JPMorgan Global High-Yield Index

0bp

170bp

340bp

510bp

680bp

850bp

Feb-06

Apr-06

Jun-

06Aug

-06Oct-

06Dec

-06Feb

-07Apr

-07Ju

n-07

Aug-07

Oct-07

Dec-07

Feb-08

Spre

ad to

Wor

st

5/31/07 = 269bp

3/19/08 = 819bpLong-term average

(1987 - ytd 08)= 542bp

17

Private Equity Default Risk

The biggest risk to the debt markets at present is the specter of a significant uptick in default ratesForecasters such as Moody’s expect the global default rate to almost triple over the next yearThe proliferation of highly leveraged deals “priced to perfection” over the past few years suggest that private equity-sponsored companies may suffer during a period of economic weakness

Financing features available in prior deals (e.g. “covenant-lite” and “PIK-toggle” instruments) may mitigate default risk, or delay an eventual default

S&P recently issued a watch list of 74 names, not surprisingly, 50 of which are private equity sponsored companies T otal D ebt / EBIT D A in LBO T ransactions

6.5x5.8x

5.3x5.2x4.7x4.8x4.7x

5.5x5.8x6.5x

5.3x5.0x4.9x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

7.0x

8.0x

2007200620052004200320022001200019991998199719961995

Source: JP Morgan research

18

Near Meltdown in Financial Markets

For the most part, the adjustments in the financial markets have been orderlyOne moment of potential panic occurred in mid-March, when Bear Stearns imploded

$0

$10

$20

$30

$40

$50

$60

$70

$80

3/7/08

3/10/0

83/1

1/08

3/12/0

83/1

3/08

3/14/0

83/1

7/08

3/17/0

83/1

8/08

3/19/0

83/2

0/08

$0

$10

$20

$30

$40

$50

$60

3/7/08

3/10/0

83/1

1/08

3/12/0

83/1

3/08

3/14/0

83/1

7/08

3/17/0

83/1

8/08

3/19/0

83/2

0/08

Bear Stearns Stock Price (3/7-3/20) Lehman Bros. Stock Price (3/7-3/20)

19

Plenty of Volatility

The pace of market volatility has quickened, unnerving many participants (while cheering others)

Source: CapitalIQ

Nasdaq Volatility Index (VIX)

10.0

15.0

20.0

25.0

30.0

35.0

3/26/07 4/26/07 5/26/07 6/26/07 7/26/07 8/26/07 9/26/07 10/26/07 11/26/07 12/26/07 1/26/08 2/26/08

20

Unwinding of Leverage

A prominent feature of the adjustment process has been a significant deleveraging throughout the financial system.The problems of KKR Financial and Carlyle Capital are examples of the consequences of this phenomenon.

$600

$700

$800

$900

$1,000

$1,100

$1,200

$1,300

3/22/06 7/22/06 11/22/06 3/22/07 7/22/07 11/22/07 3/22/08$1,400

$1,500

$1,600

$1,700

$1,800

$1,900

$2,000

$2,100

$2,200

$2,300

3/22/06 7/22/06 11/22/06 3/22/07 7/22/07 11/22/07 3/22/08

Asset-Backed Commercial Paper Outstanding All Commercial Paper Outstanding

Source: Federal Reserve, 3/22/08

$ bil $ bil

21

Where Do We Go From Here?

Since last summer, the consensus economic forecast for 2008 GDP growth has steadily become more pessimistic

Source: Goldman Sachs

Rea

l GD

P G

row

th F

orec

ast

= July 2007 Forecast = Sept. 2007 Forecast = Nov. 2007 Forecast = Mar. 2008 Forecast

(0.5%)

(1.0%)

2.5%

2.0%

1.5%

1.0%

2.0% 2.0%

1.5%

1.0%1.0% 1.0%

3.0%3.0%

2.5%2.5%

(1.5%)

(1.0%)

(0.5%)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Q1 Q2 Q3 Q4

22

But We Should Not Be Overly Pessimistic

The probability is that a recession is likely to be shallowMore sophisticated economic policymaking has led to generally benign economic conditions over the past two decades, a phenomenon known to economists as “The Great Moderation”The last two recessions (1990-91 and 2001-02) were each eight months in duration and relatively mild

The U.S. economy remains productive and flexible, and inflationary pressures appear containedThe massive interest rate reductions by the Federal Reserve and the recently enacted stimulus package will gradually insert a positive influence on growthThe fall in the dollar provides an important push for exportsWhile the possibility of a financial meltdown cannot be ignored, the probability is that the losses from imprudent lending will slowly work through the systemAbsent any cataclysmic events, the adjustments in markets that are now underway will prove healthy and beneficial

23