Housing Credit Crisis T2 Research

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 information purposes only and should be used by sophisticated investors who are knowledgeable of the risks involved. All data and comments herein are believed to be correct, but there are no guarantees and readers should do their own work. Please refer to the relevant Confidential Private Placement Memorandum for full details on investment products and strategies of T2 Partners LLC.

Prior to This Decade, Housing Had Been a Stable Investment, Increasing at Less Than ½ of 1% Per Year After Inflation… 220

200 Real H ome Price Index (1890=100) 180

160

140

Trend Line 120

100

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 -2-

…And Then Housing Prices Exploded

220

200 R e a l H ome P rice Inde x (1890=100) 180

Housing Bubble 160

140

Trend Line 120

100

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 -3-

From 2000-2006, the Borrowing Power of a Typical Home Purchaser More Than Tripled $400,000 Pre-Tax Income Borrowing Power

$300,000

$200,000

9.2x in January 2006

$100,000

3.3x in January 2000 $0 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

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

Source: Amherst Securities

-4-

Housing Became Unaffordable in Many Areas 80

Los Angeles, CA Riverside, CA San Diego, CA

70

Housing Opportunity Index

60

50

40

30

20

10

0 Q1 1996

Q1 1997

Q1 1998

Q1 1999

Q1 2000

Q1 2001

Q1 2002

Q3 2004

Q3 2005

Q3 2006

Q3 2007

Source: NAHB/Wells Fargo Housing Opportunity Index, which measures percentage of households that could afford the average home with a standard mortgage -5-

Americans Have Borrowed Heavily Against Their Homes Such That the Percentage of Equity in Their Homes Has Fallen Below 50% for the First Time on Record Since 1945 $12,000

90%

80% $10,000

Mortgage Debt (Bn)

$8,000

60%

1945 Mortgage Debt: $18.6 billion Equity: $97.5 billion

$6,000

50%

2008 Mortgage Debt: $10.5 trillion Equity: $8.5 trillion

40%

$4,000

30%

Equity as a % of Home Value

70%

20% $2,000 10%

$0

0% 1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

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

-6-

There Was a Dramatic Decline in Mortgage Lending Standards from 2001 through 2006 Combined Loan to Value

100% Financing

86

18%

17%

84 84

16%

83

81

80

12%

78 76 76 74 74

74

10%

9% 8%

8%

6%

72

4%

70

2%

68

0%

2001

2002

2003

2004

2005

2006

2007

3%

1%

1%

2001

2002

2003

2004

2005

2006

2007

100% Financing & Limited Doc

Limited Documentation

• In 1989, the average down payment for firsttime home buyers was 10%; by 2007, it was 2%

12%

70% 63%

65%

11%

60%

10%

56%

49%

50% 45%

39%

40%

8%

8% Percent of Originations

Percent of Originations

14%

14%

81

Percent of Originations

Combined Loan to Value (%)

82

• In 2005, 29% of new mortgages were interest only — or less, in the case of Option ARMs — vs. 1% in 2001

33% 30%

6% 5% 4% 4%

20%

2%

10%

1%

0%

0%

2001

2002

0%

0% 2001

2002

2003

2004

2005

2006

2007

2003

2004

2005

2006

2007

• The sale of new homes costing $750,000 or more quadrupled from 2002 to 2006. The construction of inexpensive homes costing $125,000 or less fell by two-thirds

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

-7-

The Decline in Lending Standards Led to a Surge in Subprime Mortgage Origination 25%

$700

$600 20% 20%

20%

18%

% of T ota l

$500 Origina tions (Bn)

15% $400

$300 10%

9%

10% 9%

10% 9%

10%

10% 8% 7%

$200

8%

7%

5% $100

$0

0% 1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Source: Reprinted with permission; Inside Mortgage Finance, published by Inside Mortgage Finance Publications, Inc. Copyright 2009. -8-

But Subprime Mortgages Are Only a Tiny Part of the Mortgage Problem Prime Mortgage Commercial Real Estate Alt-A Other Corporate Commercial & Industrial Subprime High-Yield / Leveraged Loans Jumbo Prime Home Equity Credit Card Auto Option ARM Construction & Development Other Consumer CDO/ CLO $0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

$3.5

$4.0

$4.5

$5.0

Amount Outstanding (Trillion)

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 -9-

Among the Many Causes of The Great Mortgage Bubble, Two Stand Out •

The companies making crazy loans didn’t care very much if the homeowner ended up defaulting for two reasons: 1. Either they didn’t plan to hold the loan, but instead intended to pass it along to Wall Street, which would bundle, slice-and-dice it and sell it (along with any subsequent losses) to investors around the world; 2. Or, if they did plan to hold the loan, they assumed home prices would keep rising, such that homeowners could either refinance before loans reset or, if the 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 vast amounts of quick money to be made Regulators and politicians were blinded by free market ideology or the dream that all Americans should own their homes, causing them to fall asleep at the switch, not want to take the punch bowl away and/or get bought 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, didn’t ask many questions and took on too much leverage In general, everyone was suffering from irrational exuberance -10-

As Long As Home Prices Rise Rapidly, Even Subprime Mortgages Perform Well – But If Home Prices Fall, Look Out Below! 60%

50%

Cumulative Loss (%)

40%

30%

20%

10%

0% 20%

15%

10%

5%

0%

-5%

-10%

-15%

-20%

-25%

-30%

-35%

-40%

Home Price Appreciation

Source: T2 Partners estimates

-11-

Wall Street’s Demand for Loan “Product” Was a Major Driver of the Decline in Lending Standards •

As discussed later in this presentation, the Asset-Backed Securities (ABSs) and Collateralized Debt Obligation (CDO) businesses were enormously profitable for Wall Street firms –

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

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

Financial Services Wages as a % of U.S. Total 11%

50%

10% 40%

Percent of US Total

Percent of US Total

9% 30%

20%

8%

7%

10%

6%

0% 1975

• • •

•

1980

1985

1990

1995

2000

2005

5% 1975

1980

1985

1990

1995

2000

2005

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 lend at higher loan-to-value ratios, with ultra-low teaser rates, to uncreditworthy borrowers, and don’t bother to verify their income and assets (thereby inviting fraud) There’s only one problem: DON’T EXPECT TO BE REPAID!

Source: Moody’s Economy.com -12-

There Was a Surge of Toxic Mortgages Over the Past 10 Years $4,000 Conforming, FHA/VA Jumbo $3,500

Alt-A Subprime Seconds

$3,000

Originations (Bn)

$2,500

$2,000

$1,500

$1,000

$500

$0 1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Source: Reprinted with permission, Inside Mortgage Finance, published by Inside Mortgage Finance Publications, Inc. Copyright 2009 -13-

Private Label Mortgages (Those Securitized by Wall St.) Are 15% of All Mortgages, But Are 51% of Seriously Delinquent Mortgages Number of Seriously Delinquent Mortgages (000)

Number of Mortgages (million)

Total: 3.5 million

Total: 55.0 million Banks & T hrifts 8

Banks & T hrifts 397

Fannie Mae 444

Fannie Mae 18

Freddie Mac 232

Private Label 8

15% Ginne Mae/FHA 378

Ginne Mae/FHA 6

Private Label 1734

Freddie Mac 13

51%

Approximately two-thirds of homes have mortgages and of these, 56% are owned or guaranteed by the two government-sponsored enterprises (GSEs), Fannie & Freddie Source: Freddie Mac, Q4 08 -14-

Nearly 8% of Mortgages on 1- to 4-Family Homes Were Delinquent or in Foreclosure as of the End of 2008 8.0%

7.0%

Percentage of Home Loans

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

Q 4 1 Q 979 4 19 Q 80 4 19 Q 81 4 19 Q 82 4 19 Q 83 4 19 Q 84 4 19 Q 85 4 19 Q 86 4 19 Q 87 4 19 Q 88 4 19 Q 89 4 1 Q 990 4 19 Q 91 4 19 Q 92 4 19 Q 93 4 19 Q 94 4 19 Q 95 4 19 Q 96 4 19 Q 97 4 19 Q 98 4 19 Q 99 4 20 Q 00 4 20 Q 01 4 2 Q 002 4 20 Q 03 4 20 Q 04 4 20 Q 05 4 20 Q 06 4 20 Q 07 4 20 08

0.0%

Source: National Delinquency Survey, Mortgage Bankers Association. Note: Delinquencies (60+ days) are seasonally adjusted -15-

All Types of Loans, Led by Subprime, Are Seeing a Surge in Delinquencies 45%

40%

Alt A Option ARM Jumbo

35%

Subprime Prime Home Equity Lines of Credit

Percent Noncurrent

30%

25%

20%

15%

10%

5%

20 08

Q

3

20 08

Q 1

20 07

Q 3

20 07

Q

1

20 06

Q 3

20 06

Q

1

20 05

Q 3

20 05

Q 1

20 04

Q 3

20 04

Q 1

20 03

Q

3

20 03

Q 1

20 02

Q

3

20 02

Q 1

20 01

Q 3

20 01

Q

1

20 00

Q 3

20 00

Q

1

19 99

Q 3

Q 1

19 99

0%

Source: Amherst Securities, LoanPerformance; National Delinquency Survey, Mortgage Bankers Association; FDIC Quarterly Banking Profile; T2 Partners estimates. Note: Prime is seasonally adjusted. -16-

Sales of Existing Homes Are Falling and Foreclosures Are Rising, Leading to a Surge in Inventories Months Supply

Existing Home Sales 7.5

12

3.8 million units, equal to 9.7 months as of the end of February

11

7.0 10

6.5 9

Months

Millions

6.0

5.5

8

7

6

5.0 5

4.7 million units as of the end of February 2009

4.5

4

4.0 1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

3 1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: NATIONAL ASSOCIATION OF REALTORS® Existing Home Sales data series -17-

24% of Homeowners With a Mortgage Owe More Than the Home Is Worth, Making Them Far More Likely to Default Among people who bought homes in the past five years, 30%+ are under water In Bubble Markets, Far More Homeowners Are Under Water Price Drop Since Peak -15.2% -32.0% -21.8% -24.8% -36.6% -27.8% -10.4% -34.4% -37.7% -41.8%

% of Last 5 Yrs Purchasers Who Are Under Water 23.0% 56.4% 27.8% 50.3% 25% 65.1% 51.2% 23.2% 20% 63.9% 36.4% 61.4% Percent Underwater

Metro Area New York Los Angeles Boston Washington Miami San Francisco Atlanta San Diego Phoenix Las Vegas

Price Index Is at Lowest Level Since 2004-Q3 2003-Q4 2002-Q2 2004-Q1 2004-Q1 2003-Q3 2004-Q4 2002-Q4 2004-Q3 2003-Q4

There Has Been a Dramatic Rise in Homeowners Who Are Under Water 24%

20%

16%

15%

10%

6% 5%

4%

0% Dec-06

Dec-07

Sep-08

Dec-08

Mar-09

Source: Zillow.com Q4 08 Real Estate Market Report; Moody's Economy.com, First American CoreLogic, T2 Partners estimates; -18-

Certain Types of Loans are Severely Under Water 80% 73% 70%

Percent Underwater

60%

50%

50% 45% 40%

30% 25% 20%

10%

0% Prime

Alt A

Subprime

Option ARM

Source: Amherst Securities, LoanPerformance, Standard & Poor’s -19-

Foreclosure Filings Have Increased Dramatically • 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 Freddie implementing 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. 350,000

300,000

Number of Foreclosures

250,000

200,000

150,000

100,000

50,000

Ju n05 Au g05 O ct -0 5 D ec -0 5 Fe b06 Ap r-0 6 Ju n06 A ug -0 6 O ct -0 6 De c06 Fe b07 A pr -0 7 Ju n07 Au g07 O ct -0 7 D ec -0 7 Fe b08 Ap r-0 8 Ju n08 A ug -0 8 O ct -0 8 De c08 Fe b09

0

Note: Foreclosure filings are defined as default notices, auction sale notices and bank repossessions Sources: RealtyTrac.com U.S. Foreclosure Market Report -20-

In Bubble Markets, Prices Are Way Down Driven By a Surge in the Number of Homes Sold Out of Foreclosure $500

California

70%

60% $400

$300

40%

30%

$200

Foreclosure Resale %

Median Home Price (000s)

50%

20% $100 10%

Ja n09

O ct -0 8

Ju l-0 8

Ap r-0 8

Ja n08

O ct -0 7

Ju l-0 7

pr -0 7 A

Ja n07

O ct -0 6

Ju l-0 6

0% Ap r-0 6

Ja n06

$0

Source: MDA Dataquick. Note: Includes new construction -21-

Home Prices Are in an Unprecedented Freefall 220 S&P/Case-Shiller U.S. National Home Price Index S&P/Case-Shiller 20-City Composite 200

OFHEO Purchase-Only Index NAR Median Sales Price of Existing Homes

180

160

140

120

Q4 2008

Q3 2008

Q2 2008

Q1 2008

Q4 2007

Q3 2007

Q2 2007

Q1 2007

Q4 2006

Q3 2006

Q2 2006

Q1 2006

Q4 2005

Q3 2005

Q2 2005

Q1 2005

Q4 2004

Q3 2004

Q2 2004

Q1 2004

Q4 2003

Q3 2003

Q2 2003

Q1 2003

Q4 2002

Q3 2002

Q2 2002

Q1 2002

Q4 2001

Q3 2001

Q2 2001

Q1 2001

Q4 2000

Q3 2000

Q2 2000

Q1 2000

100

Source: Standard & Poor’s, OFHEO Purchase-Only Index, NATIONAL ASSOCIATION OF REALTORS® Existing Home Sales data series -22-

Home Prices Need to Fall Another 13% to Reach Trend Line 220

Real Home Price Index (1890=100)

200

180

160

-32% from Peak

140

-13% to Trend

Trend Line 120

20 06

20 02

19 98

19 94

19 90

19 86

19 82

19 78

19 74

19 70

19 66

19 62

19 58

19 54

19 50

100

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 -23-

The Housing Affordability Index Shows Houses Are Now Affordable

Mortgage Payment on Median Priced Home as % of Family Income

Before concluding that houses are cheap, however, there are three big caveats: first, low rates are only available to those who qualify for conforming mortgages, which doesn’t help millions of homeowners or potential 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 won’t look 26 so reasonably priced based on these metrics. Finally, in light of the severe economic downturn, average income may fall for quite some time. 24

22

20

18

16

14 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: NATIONAL ASSOCIATION OF REALTORS® Housing Affordability Index -24-

Mortgage Rates Have Fallen Recently 8

7

Jumbo 30 Yr FRM Jumbo 5/1 Hybrid ARM Conforming 30 Yr FRM Conforming 5/1 Hybrid ARM 10-Year Treasury

Rate (%)

6

5

4

3

Fe b09

Fe b08 M ay -0 8 A ug -0 8 No v08

Fe b07 M ay -0 7 Au g07 No v07

Fe b05 M ay -0 5 A ug -0 5 N ov -0 5 Fe b06 M ay -0 6 Au g06 No v06

Fe b04 M ay -0 4 A ug -0 4 N ov -0 4

2

Source: HSH Associates, Yahoo! Finance.com -25-

The Home Price-to-Rent Ratio Has Returned to Normal Levels 27

Median Home Price to Median Gross Rent

25

23

21

19

17

15 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: NATIONAL ASSOCIATION OF REALTORS® Existing Home Sales data series, U.S. Census Bureau, T2 Partners estimates -26-

A Study of Bubbles Shows That All of Them Eventually Return to Trend Line

1.3

Tre nd Line

0.8 0.3

2.0

Relative Return

1.8

2.5 1.5 1.0

Tre nd Line

0.5 0.0

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

46 50 54 58 62 66 70 74 78 82

U.S. Dollar

U.K. Pound

1979-1992

1979-1985

1.6 1.4 1.2 1.0 0.8 79

81

83

85

87

89

1.4 1.3

0.9 0.8 79

80

81

82

83

1992-October 2008

3.0 2.5 2.0 1.5 1.0 0.5 0.0

Tre nd Line

Currencies

1.2 1.1 1.0

91

S&P 500

1981-1999

2.4 2.0 1.6 1.2

92 94 96 98 00 02 04 06 08

Japanese Yen

Japanese Yen

1983-1990

1.4 1.3 1.2 1.1 1.0 0.9 0.8

1992-1998

1.4 1.3 1.2 1.1 1.0 0.9 0.8

83 84 85 86 87 88 89 90

84

Trend Line

0.8

81 83 85 87 89 91 93 95 97 99

Cumulative Return

2.0 1.8

Japan vs. EAFE ex-Japan Detrended Real Price

1946-1984

Stocks

Cumulative Return

1920-1932 Detrended Real Price

2.3

S&P 500

Cumulative Return

Cumulative Return

Detrended Real Price

*

S&P 500

92

93

94

95

96

97

Commodities Gold

Real Price

Real Price

1200 800 400 70

74

78

82

86

90

94

98

250

60 40 20

150 100 50 0

62 66 70 74 78 82 86 90 94 98

1970-1999

600 500

200

0

0

Cocoa

1979-1999

Real Price

80

1600

1962-1999

Real Price

2000

Nickel

Crude Oil

1970-1999

79 81 83 85 87 89 91 93 95 97

400 300 200 100 0 70 74

78 82 86 90

94 98

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.

-27-

The Biggest Danger is That Home Prices Overshoot on the Downside, Which Often Happens When Bubbles Burst S&P 500 1927-1954 2.50

Overrun: 59% Fair Value to Bottom: 1.5 Years Fair Value to Fair Value: 23 Years

2.25

1.75

1.50

1.25

1.00

0.75

0.50

0.00 1927

S&P 500 1955-1986

-59%

0.25

1930

1933

2.25

1936

1939

1942

1945

1948

1951

1954

Overrun: 45% Fair Value to Bottom: 7 Years Fair Value to Fair Value: 12 Years

2.00

Detrended Real S&P 500 Stock Price Index

Detrended Real S&P 500 Stock Price Index

2.00

1.75

1.50

1.25

1.00

0.75

0.50

-45% 0.25

Source: GMO

0.00 1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

1976

1978

1980

1982

1984

1986

-28-

Home Prices Have Already Crashed Through the Trend Line in California – And There Is No Sign of Stabilization $600 Median Sales Price 4% Trend $500

Median Price ($000s)

$400

$300

$200

$100

Ja n09

Ja n07

Ja n05

Ja n03

Ja n01

Ja n99

Ja n97

Ja n95

Ja n93

Ja n91

Ja n89

Ja n87

Ja n85

83 Ja n-

Ja n81

Ja n79

$0

Source: Reprinted with permission of the California Association of REALTORS ® . All rights reserved. www.rebsonline.com, T2 Partners estimates. -29-

Outlook for Housing Prices •

•

We think housing prices will reach fair value/trend line down 40% from the peak based 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. It’s almost certain that prices will reach these levels The key question is whether housing prices will go crashing through the trend line and fall well below fair value? Unfortunately, this is very likely. In the long-term, housing prices will likely settle around fair value, but in the short-term prices will be driven both by psychology as well as supply and demand. The trends in both are very unfavorable – –

• •

Regarding the former, national home prices have declined for 30 consecutive months since their peak in July 2006 through January 2009 and there’s no end in sight, so this makes buyers reluctant – even when the price appears cheap – and sellers desperate. Regarding the latter, there is a huge mismatch between supply and demand, due largely to the tsunami of foreclosures. In January 2009, distressed sales accounted for 45% of all existing home sales nationwide – and more than 60% in California. In addition, the “shadow” inventory of foreclosed homes already likely exceeds one year and there will be millions more foreclosures over the next few years, creating a large overhang of excess supply that will likely 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, bottoming in mid-2010 We are also quite certain that wherever prices bottom, there will be no quick rebound – –

–

There’s 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 can’t sell when they’re under water on their mortgage and in part due to human psychology: people naturally anchor on the price they paid or what something was worth in the past and are reluctant to sell below this level. We suspect that there are millions of homeowners like this who will emerge as sellers at the first sign of a rebound in home prices. Finally, we don’t think the economy is likely to provide a tailwind, as we expect it to contract the rest of 2009, stagnate in 2010, and only then grow tepidly for some time thereafter.

-30-

There Have Been 5 Million Jobs Lost So Far in This Recession, More Than 3 Million in the Past Five Months 600

Change in Nonfarm Payroll Employment (000s)

400

200

0

-200

-400

There have been job losses every month since December 2007

-600

-800

Ja n09

Ja n07 Ja n08

Ja n05 Ja n06

04 Ja n-

Ja n02 Ja n03

Ja n00 Ja n01

Ja n98 Ja n99

Ja n96 Ja n97

Ja n94 Ja n95

Ja n92 Ja n93

Ja n90 Ja n91

-1000

Source: Bureau of Labor Statistics -31-

The Unemployment Rate Jumped to 8.5% in March, the Highest Level Since 1983 12%

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

11%

10%

Unemployment Rate

9%

8%

7%

6%

5%

4%

Ja n09

Ja n06

Ja n03

Ja n00

Ja n97

Ja n94

Ja n91

Ja n88

Ja n85

Ja n82

Ja n79

Ja n76

Ja n73

Ja n70

3%

Source: Bureau of Labor Statistics -32-

The Decline from Peak Employment Now Exceeds the Past Five Recessions 0.0%

1980

1974-76

1990-93

1981-83

2001-05

-0.5%

-1.0%

-1.5%

-2.0%

-2.5%

-3.0%

-3.5%

2007-4.0% 0

6

12

18

24

30

36

42

48

Months after pre-recession peak Source: Bureau of Labor Statistics -33-

Consumer Confidence is at an All-Time Low 160

140

Consumer Confidence Index

120

100

80

60

40

Near all-time low 20

0 1998

Note: 1985=100

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: The Conference Board (www.pollingreport.com/consumer.htm) -34-

Banks are Tightening Consumer Credit and New Household Borrowing Has Plunged Percent of US Banks Tightening Consumer Credit 70% 60% 50% 40% 30% 20% 10% 0% -10%

Credit Cards

Se p08

Ja n08

M ay -0 7

Se p06

Ja n06

M ay -0 5

Se p04

Ja n04

M ay -0 3

Se p02

Ja n02

M ay -0 1

Se p00

Ja n00

-20%

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

Other Consumer Loans $1,200 ($ billions)

$1,000

$800

$600

$400

$200

Source: Federal Reserve

$0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

-35-

The Credit Bubble Led to a Bubble in Financial Profits (& Share of GDP) Low Debt Era

Rising Debt Era

2.5%

350%

300%

2.0% 250%

Total Debt

1.5% 1.0%

Financial Profits

0.5% 0.0% Dec- 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05

200%

150%

Total Debt as Percent of GDP

Financial Profits as Percent of GDP

3.0%

100%

Sources: Federal Reserve, BEA, as of Q2 2007, GMO presentation -36-

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 as well as home equity lines of credit (HELOCs) and second liens (closed-end seconds) Losses outside of the mortgage sector will also continue to rise due to commercial real estate, leveraged loans, junk bonds, etc.

-37-

The Wave of Resets from Subprime Loans Is Mostly Behind Us $35

We are here

$30

Loans with Payment Shock (Bn)

$25

$20

$15

$10

$5

Ju l-1 0 O ct -1 0

Ja n10 A pr -1 0

Ju l-0 9 O ct -0 9

O ct -0 8 Ja n09 Ap r09

Ap r-0 8 Ju l-0 8

Ju l-0 7 O ct -0 7 Ja n08

Ja n07 A pr -0 7

Ju l-0 6 O ct -0 6

Ja n06 A pr -0 6

$0

Sources: LoanPerformance, Deutsche Bank; slide from Pershing Square presentation, How to Save the Bond Insurers, 11/28/07. -38-

But a Wave of Alt-A Resets Is Ahead of Us $300

$10 $9

We are here

$250

$7

Amount (Bn)

$200 $6 $150

$5 $4

$100 $3

Estimated Cumulative Reset Amount (Bn)

$8

$2 $50 $1

Ju l-1 5

Ja n15

-1 4 Ju l

Ja n14

Ju l-1 3

Ja n13

Ju l- 1 2

Ja n12

Ju l- 1 1

Ja n11

$0

Ju l-1 0

Ja n10

$0

Months to 1st reset

Sources: Credit Suisse, LoanPerformance -39-

There Are $2.5 Trillion of Alt-A Loans Outstanding When One Includes Those Held by the GSEs Prime Mortgage Commercial Real Estate Alt-A Other Corporate Commercial & Industrial Subprime High-Yield / Leveraged Loans Jumbo Prime Home Equity Credit Card Auto Option ARM Construction & Development Other Consumer CDO/ CLO $0.0

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

$3.5

$4.0

$4.5

$5.0

Amount Outstanding (Trillion)

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 -40-

Ja nM 99 ay Se 99 p9 Ja 9 nM 00 ay Se 00 p0 Ja 0 nM 01 ay Se 01 p0 Ja 1 nM 02 ay Se 02 p0 Ja 2 nM 03 ay Se 03 p0 Ja 3 nM 04 ay -0 Se 4 p0 Ja 4 nM 05 ay Se 05 p0 Ja 5 nM 06 ay Se 06 p0 Ja 6 nM 07 ay -0 Se 7 pJa 07 nM 08 ay Se 08 p0 Ja 8 n09

Percent Noncurrent (60+ days)

Delinquencies of Securitized Alt-A Mortgages Are Soaring 25%

20%

15%

10%

5%

0%

Sources: Amherst Securities, LoanPerformance -41-

Alt-A Delinquencies By Vintage Show the Collapse in Lending Standards in 2006 and 2007 30%

2007

Percent Noncurrent (60+ days)

25%

2006

20%

15%

2005 10%

2004 5%

2003

0% 0

5

10

15

20

25

30

35

40

45

50

55

60

Months of Seasoning

Sources: Amherst Securities, LoanPerformance -42-

A Primer on Option ARMs •

An Option ARM is an adjustable rate mortgage typically made to a prime borrower –

• •

Banks typically relied on the appraised value of the home and the borrower’s high FICO score, so 83% of Option ARMs written in 2004-2007 were low- or nodoc (liar’s loans) Each month, the borrower can choose to pay: 1) the fully amortizing interest and principal; 2) full interest; or 3) an ultra-low teaser interest-only rate (typically 23%), 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 interest payments

A typical Option ARM is a 30- or 40-year mortgage that resets (“recasts”) after five years, when it becomes fully amortizing –

•

Sold under various names such as “Pick-A-Pay”

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 than subprime borrowers,’ says Kevin Stein, associate director of the California Reinvestment Coalition, which combats predatory lending. ‘They wind up owing more and the resets are more significant.’ -43-

About $750 Billion of Option ARMs Were Written 9%

$300 9%

8% 8%

$250

7%

Originations (Bn)

5%

5% 5%

$150

4%

Percent of Total

6%

$200

3%

$100

2% $50 1%

$0

1%

0% 2004

2005

2006

2007

2008

Source: Reprinted with permission, 2008 Mortgage Market Statistical Annual, published by Inside Mortgage Finance Publications, Inc. Copyright 2008. T2 Partners estimates -44-

Options ARMs Were a Bubble State Phenomenon

Other, 25%

HI, 1% AZ, 3% CA, 58% NV, 3%

FL, 10%

Source: Amherst Securities, LoanPerformance -45-

Beginning in March 2005, High-FICO-Score Borrowers Opted for an Above-Market-Rate Option ARM in Exchange for the Low Teaser Rate 8.5 Fannie Mae 30 Year FRM Index Option ARM Index 8.0

7.5

Interest Rate (%)

7.0

Option ARM borrowers during this period (when nearly all option ARMS were written) were saying they couldn’t afford a fullyamortizing mortgage – otherwise they would have taken one

6.5

6.0

5.5

5.0

4.5

Ja n02 A pr -0 2 Ju l-0 2 O ct -0 2 Ja n03 A pr -0 3 Ju l-0 3 O ct -0 3 Ja n04 Ap r-0 4 Ju l-0 4 O ct -0 4 Ja n05 A pr -0 5 Ju l-0 5 O ct -0 5 Ja n06 A pr -0 6 Ju l-0 6 O ct -0 6 Ja n07 A pr -0 7 Ju l-0 7 O ct -0 7 Ja n08

4.0

Source: Amherst Securities, Bloomberg Finance L.P. -46-

Ja nM 99 ay Se 99 p9 Ja 9 nM 00 ay Se 00 p0 Ja 0 nM 01 ay Se 01 p0 Ja 1 nM 02 ay Se 02 p0 Ja 2 nM 03 ay Se 03 p0 Ja 3 nM 04 ay -0 Se 4 p0 Ja 4 nM 05 ay Se 05 p0 Ja 5 nM 06 ay Se 06 p0 Ja 6 nM 07 ay -0 Se 7 pJa 07 nM 08 ay Se 08 p0 Ja 8 n09

Percent Noncurrent (60+ days)

Delinquencies of Securitized Option ARMs Are Soaring 35%

30%

25%

20%

15%

10%

5%

0%

Sources: Amherst Securities, LoanPerformance -47-

Option ARM Delinquencies By Vintage Show the Collapse in Lending Standards in 2005-2007 45%

2006

40%

Percent Noncurrent (60+ days)

35%

2007

30%

2005

25%

20%

2004

15%

2003

10%

5%

0% 0

5

10

15

20

25

30

35

40

45

50

55

60

Months of Seasoning

Sources: Amherst Securities, LoanPerformance -48-

Ja nM 99 ay Se 99 p9 Ja 9 nM 00 ay Se 00 p0 Ja 0 nM 01 ay Se 01 p0 Ja 1 nM 02 ay Se 02 p0 Ja 2 nM 03 ay Se 03 p0 Ja 3 nM 04 ay -0 Se 4 p0 Ja 4 nM 05 ay Se 05 p0 Ja 5 nM 06 ay Se 06 p0 Ja 6 nM 07 ay -0 Se 7 pJa 07 nM 08 ay Se 08 p0 Ja 8 n09

Percent Noncurrent (60+ days)

Delinquencies of Securitized Jumbo Prime Mortgages Are Soaring 4.0%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

Sources: Amherst Securities, LoanPerformance -49-

Delinquencies of Prime Mortgages Are Soaring 5.0%

4.5%

Percent Noncurrent (60+ days)

4.0%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

20 08

Q

3

20 08

Q 1

20 07

Q 3

20 07

Q 1

20 06

Q

3

20 06

Q 1

20 05

Q 3

20 05

Q

1

20 04

Q 3

20 04

Q 1

20 03

Q 3

20 03

Q

1

20 02

Q 3

20 02

Q 1

Q

3

20 01

20 01

Q 1

20 00

Q 3

20 00

Q 1

19 99 3

Q

Q 1

19 99

0.0%

Sources: Mortgage Bankers Association National Delinquency Survey -50-

HELOCs and Home Equity Loans Soared in Popularity During the Bubble Home Equity & Junior Lien Loans ($ in billions) $1,000 $900 $800 $700 $600 $500 $400 $300 $200 $100

M a Ju r-00 n Se -00 pD 00 ec M -00 a Ju r-01 n Se -01 p D -01 ec M -01 a Ju r-02 n Se -02 pD 02 ec M -02 a Ju r-03 n Se -03 p D -03 ec M -03 ar Ju -04 n Se -04 pD 04 ec M -04 ar Ju -05 n Se -05 p D -05 ec M -05 a Ju r-06 n Se -06 pD 06 ec M -06 a Ju r-07 n Se -07 p D -07 ec M -07 a Ju r-08 n Se -08 p08

$-

Home Equity Loans

Junior Lien Mortgages

Note: Does not include approximately $200 billion of securitized HELOCs and junior liens Source: FDIC Quarterly Banking Profile -51-

Many Borrowers Used HELOCs to Buy New Cars • •

•

As home prices have declined and other funding sources have dried up, millions of consumers have maxed out on home equity debt. In hot markets like California and Florida, a significant percentage of all consumers tapped into the value of their homes to help finance their new cars, according to CNW Marketing Research.

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

Source: New York Times 5/27/2008 -52-

Delinquencies of HELOCs and CESs Are Soaring 3.0% Closed-End Junior Lien Mortgages Home Equity Lines of Credit

Percent Noncurrent (90+ days)

2.5%

2.0%

1.5%

1.0%

0.5%

20 08

Q 4

20 08

Q 3

20 08

Q 2

20 08

Q 1

20 07

Q 4

20 07

Q 3

20 07

Q 2

20 07

Q 1

20 06

Q 4

20 06

Q 3

20 06

Q 2

20 06

Q

1

20 05

Q 4

20 05

Q 3

20 05

Q 2

20 05

Q 1

20 04

Q

4

20 04

Q 3

20 04

Q 2

Q 1

20 04

0.0%

Source: FDIC Quarterly Banking Profile -53-

Pools of HELOCs and CESs Can Suffer Astronomical Losses Due to 100%+ Severities On one second lien deal, Ambac expected losses of 10-12% when it guaranteed the senior tranche. A year ago, Ambac admitted that the pool would likely lose 81.8% of its value – and based on the pool’s performance since then, this will almost certainly prove to be conservative. 3.0%

2.5%

Monthly Loss Rate (3m average)

From Ambac slide, 4/08: • • • • •

2.0%

1.5%

1.0%

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 the transaction having an A+ rating at inception and being structured to withstand 28-30% collateral loss

0.5%

0.0% 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 Ambac Projection April 2008

Actual

Source: Ambac Q1 08 presentation, Amherst Securities; funds managed by T2 Partners are short Ambac -54-

The Timing Indicates That We Are Still in the Middle 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 more defaults It takes an average of 15 months from the date of the first missed payment by a homeowner 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 and auctions in early 2008 Given that lending standards got much worse in late 2005 through 2006 and into the first half of 2007, and the many other types of loans that are now with longer reset dates that are now starting to default at catastrophic rates, there are sobering implications 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 enormous wave of defaults, foreclosures and auctions that is hitting the United States. We predicted in early 2008 that it would get so bad that it would require large-scale federal government intervention – which has occurred, and we’re likely not finished yet. -55-

Total Losses Are Now Estimated at $2.1-$3.8 Trillion – And Less Than Half of This Has Been Realized To Date $3,778 Bn

$4,000

$3,552 Bn $3,500

Corporate Corporate

$3,000

Consumer

Amount (Bn)

$2,500

$2,083 Bn $2,000

$1,500

$2,200 Bn

Consumer

Commercial Real Estate

Commercial Real Estate

Corporate

$1,288 Bn

Consumer Commercial Real Estate

GSEs

$1,000 Residential Mortgages $500

$1,103 Bn

Residential Mortgages

Insurers Banks/ Brokers

Residential Mortgages

$0 Goldman Sachs Jan 2009

IMF Jan 2009

Roubini Jan 2009

T2 Partners March Writedowns to Date 2009

Capital Raised

Sources: Goldman Sachs, International Monetary Fund, RGE Monitor, Bloomberg Finance L.P., T2 Partners estimates -56-

A Breakdown of Our Financial Sector Loss Estimates Amount ( Bn) $0 CDO/ CLO Other Consumer Construction & Development

$100

$200

$300

$400

$500

$600

$700

$800

Total Estimated Financial Sector Losses = $3.8 trillion

Option ARM Auto Credit Card Home Equity Jumbo Prime High-Y ield / Leveraged Loans Subprime Commercial & Industrial Other Corporate Alt-A Commercial Real Estate Prime Mortgage

Sources: T2 Partners estimates -57-

Institutions Have Been Able to Raise Capital to Mostly Keep Up With Writedowns, But This Will Likely Not Continue $1,500 Losses & Writedowns Capital Raised

$1,250

Amount (Bn)

$1,000

$750

$500

$250

$0 Prior

Q3 2007

Q4 2007

Q1 2008

Q2 2008

Q3 2008

Q4 2008

Q1 2009

Q2 2009

Sources: Bloomberg Finance L.P. -58-

Where We Are Finding Opportunities 1.

2.

3.

4.

5. 6.

Blue-chips. The stocks of some of the greatest businesses, with strong balance sheets and dominant competitive positions, are trading at their cheapest levels in years – due primarily to the overall market decline and weak economic conditions rather than any company-specific issues. In this category, we’d put Coca-Cola, McDonald’s, Wal-Mart, Altria, ExxonMobil, Johnson & Johnson, and Microsoft. Out of favor blue-chips. For somewhat more adventurous investors looking to buy great companies in the most out-of-favor sectors such as financials and retailers, we own Berkshire Hathaway, American Express and Target. All are great businesses, but their stocks have suffered mightily thanks to the economic downturn. We think they’re good bets to rebound when things stabilize – but in the meantime, their stocks seem to have no bottom. Balance sheet plays. For investors who are comfortable with lower-quality businesses but want downside protection, there are many companies trading near or even below net cash on the balance sheet. Examples in our portfolio include digital media equipment company EchoStar Corp. and clothing retailer Delia’s. Berkshire is the best of both worlds: a premier company but also a balance sheet play. Turnarounds. There are countless companies that have gotten clobbered by the economic downturn and are reporting dismal results – with stock prices to match. Investors in those that survive and return to anything close to former levels of profitability will be well rewarded – but picking these stocks isn’t easy. Among our holdings in this category are Wendy’s restaurants, Winn-Dixie supermarkets, Huntsman, a specialty chemical maker, Crosstex, a pipeline company, and Resource America, a specialty finance company. Special situations. This is somewhat of a catch-all category that, for us, includes Contango Oil & Gas, a stock that’s declined due to an aborted attempt to sell the company and the sharp drop in the price of natural gas. Mispriced options. Every once in a while we take a tiny position in a highly speculative situation – often where the stock price is below $1 – in which there’s a real chance that the outcome is zero, but also a decent chance, in our opinion, of making many multiples of our money. On an expected value basis, therefore, a small portfolio of such investments is attractive. Our holdings include General Growth Properties, TravelCenters of America, Ambassadors International, Borders Group and PhotoChannel. Do not buy stocks like this unless you really know what you’re doing and have a very strong stomach! -59-

To Learn More…

More Mortgage Meltdown Will Be Available in Mid-May

-61-

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

-62-

Value Investor Insight and SuperInvestor Insight

-63-