An Overview of the Housing/Credit Crisis
      And Why There Is More Pain to Come

                                       ...
Overview

           1.  Overview of the Great Mortgage Bubble                             Page 3
           2.  Causes of...
Overview of the Great Mortgage Bubble
Prior to This Decade, Housing Had Been a Stable Investment,
           Increasing at Less Than ½ of 1% Per Year After Infl...
From 2000-2006, the Borrowing Power of a Typical
            Home Purchaser More Than Tripled
             $400,000       ...
Americans Have Borrowed Heavily Against Their Homes
       Such That the Percentage of Equity in Their Homes Has
       Fa...
There Was a Dramatic Decline in Mortgage
         Lending Standards from 2001 through 2006
                               ...
The Decline in Lending Standards Led to a
           Surge in Subprime Mortgage Origination

                             ...
But Subprime Mortgages Are Only a
            Tiny Part of the Problem
                                              CDO  ...
The Surge in Borrowing Power and Decline in Lending Standards
            Led to Home Prices Soaring Far Above Trend Line
...
Causes of the Great Mortgage Bubble
Among the Many Causes of The Great
           Mortgage Bubble, Two Stand Out
           •      The companies making crazy ...
Lenders Cared Little Who They Lent To Because
           They Assumed Perpetually Rising Home Prices
      When home price...
Losses in Bubble-Era Subprime Mortgage Pools
           Become Catastrophic if Home Prices Decline

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

           •   ...
A Case Study of Wall Street Compensation Run Amok:
           Stan O’Neal, Dow Kim & the Mortgage Team at Merrill Lynch


...
The Housing Bubble Helped Many People Achieve the Dream
           of Home Ownership – Which is Now Turning Into a Nightma...
Consequences of the Bursting
of the Great Mortgage Bubble
10% of Mortgages on 1- to 4-Family Homes Are
           Delinquent or in Foreclosure as of the End of Q3
                 ...
Sales of Existing Homes Are Falling and Foreclosures
           Are Rising, Leading to a Surge in Inventories
            ...
Home Vacancies Are at an All-Time High




                                                                               ...
16% of Homeowners Owe More on Their Mortgage Than the
           Home Is Worth, Making Them Far More Likely to Default
   ...
Certain Types of Loans are Severely Under Water

                          Percentage of Borrowers Who Had Negative Equity...
Foreclosure Filings Have Increased Dramatically
          • Foreclosures in November rose 28% year-over-year, but declined...
Credit Suisse Predicts More Than Six Million
           Foreclosures by the End of 2012




        Sources: Credit Suisse...
So Far, Few Loan Modifications Are Working



     % In
    Default




        Sources: Office of the Comptroller of the ...
In Bubble Markets, Sales and Prices Are Way Down, While
        the Number of Homes Sold in Foreclosure Has Skyrocketed
  ...
The Outlook for Home Prices is Grim

 We Estimate That Home Prices Are Only a
Little More Than Half Way Finished Declining
Home Prices Are in an Unprecedented Freefall

                        Through September, home prices had fallen an average...
Home Prices Have Fallen, But Are Still Well Above
              Levels at the Start of the Decade in Almost All Cities
   ...
The Surge in Borrowing Power and Decline in Lending
 Standards Led to Home Prices Soaring Far Above Trend Line




       ...
Borrowing Power of a Typical Home Purchaser Has
           Tumbled By Approximately 32%

    $400,000                     ...
Home Prices Would Have to Fall 41.6%
           to Return to 2002 Levels




                                             ...
Sequential (month-to-month) Home Price Declines
    Improved Dramatically in April, May and June of This Year
            ...
Fe
                                                                                                                       ...
Estimates from John Burns Real Estate Consulting
         Also Indicate That We Are About Half Way to a Bottom




       ...
A Comparison to the Last Cycle Indicates a 30-40%
           Decline in Home Prices from the Peak




      Sources: Zellm...
The Home Price-to-Income and Price-to-Rent Ratios
           Show That Home Prices Have Further to Fall
                  ...
Another Look at the Home Price to Income Ratio

                                               Median House Price / Median...
In Summary, Home Prices Need to Decline
           Another 17-24% to Reach Fair Value




      Sources: USA Today analysi...
A Study of Bubbles Shows That All of Them
                                          Eventually Return to Trend Line
      ...
The Biggest Danger is That Home Prices Overshoot on the
                                Downside, Which Often Happens When...
Economic Weakness Creates an
Additional Headwind for Home Prices
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
Overview Of Housing/Credit Crisis And Why There Is More Pain To Come
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Overview Of Housing/Credit Crisis And Why There Is More Pain To Come

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Overview Of Housing/Credit Crisis And Why There Is More Pain To Come

  1. 1. An Overview of the Housing/Credit Crisis And Why There Is More Pain to Come T2 Partners LLC T2 Accredited Fund, LP Tilson Offshore Fund, Ltd. T2 Qualified Fund, LP December 18, 2008 T2 Partners Management L.P. is a Registered Investment Advisor 145 E. 57th Street ˚ 10th Floor New York, NY 10022 (212) 386-7160 Info@T2PartnersLLC.com ˚ www.T2PartnersLLC.com This presentation is available at www.valueinvestingcongress.com. We would like to thank Amherst Securities Group L.P. (www.asglp.com) for generously providing data used in this presentation. 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.
  2. 2. Overview 1. Overview of the Great Mortgage Bubble Page 3 2. Causes of the Great Mortgage Bubble Page 11 3. Consequences of the Bursting of the Great Mortgage Bubble Page 18 4. The Outlook for Home Prices is Grim Page 28 5. Economic Weakness Creates an Additional Headwind for Home PricesPage 43 6. There Are Only a Few Bits of Good News Page 51 7. What Does the Future Hold? Page 57 8. A Primer on Option ARMs Page 61 9. A Primer on HELOCs and Closed-End Seconds Page 68 10. A Closer Look at Mortgage Loans That Were Securitized: Quantity and Quality Page 73 11. A Closer Look at Mortgage Loans That Were Securitized: Defaults Page 86 12. Where Did the Securitized Mortgages End Up? A Primer on ABSs and CDOs Page 106 13. The Opportunity in Distressed Debt Page 115 T2 Partners LLC -2-
  3. 3. Overview of the Great Mortgage Bubble
  4. 4. Prior to This Decade, Housing Had Been a Stable Investment, Increasing at Less Than ½ of 1% Per Year After Inflation Source: Robert Shiller; http://i.usatoday.net/news/graphics/housing_prices/home_prices.pdf T2 Partners LLC -4-
  5. 5. From 2000-2006, the Borrowing Power of a Typical Home Purchaser More Than Tripled $400,000 1/1/95 1/1/00 1/1/04 1/1/05 1/1/06 1/1/07 6/1/07 1. Pre-Tax Income $ 30,000 $ 33,693 $ 36,966 $ 38,064 $ 39,581 $ 40,403 $ 40,403 2. Debt-to-Income Ratio 33% 33% 40% 45% 55% 55% 60% 3. Non-Agency Mortgage Rate 10.50% 9.50% 7.50% 6.25% 6.00% 6.50% 6.75% 4. Mortgage Type Full Am. Full Am. Full Am. Int Only Int Only Int Only Int Only 5. Borrowing Power $ 90,190 $ 110,191 $176,227 $274,060 $ 362,824 $341,873 $359,139 $300,000 Equity Required 15% 15% 10% 0% 0% 0% 0% Cash Required $ 15,916 $ 19,445 $ 19,581 $ - $ - $ - $ - Leverage 3.0 3.3 4.8 7.2 9.2 8.5 8.9 $200,000 $100,000 $- 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05 1/06 1/07 Pre-Tax Income Borrowing Power 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 T2 Partners LLC Source: Amherst Securities Group, L.P. -5-
  6. 6. 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 90% 80% 70% 60% Mortgage Debt: $18.6 billion 50% Equity: $97.5 billion 40% 30% Q3 2008 Mortgage Debt: $10.6 trillion 20% Equity: $8.5 trillion 10% 0% 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Source: Federal Reserve Flow of Funds Accounts of the United States; www.federalreserve.gov/releases/z1/Current/z1.pdf T2 Partners LLC -5-
  7. 7. There Was a Dramatic Decline in Mortgage Lending Standards from 2001 through 2006 • In 2005, 29% of new mortgages were interest only — or less, in the case of Option ARMs — vs. 1% in 2001 • In 1989, the average down payment all home buyers was 20%; in 2007, it was 10%; for first-time home buyers, the figures were 10% and 2%, respectively (aka “Liar’s Loans”) • 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 T2 Partners LLC Source: LoanPerformance, Paulson presentation; USA Today (www.usatoday.com/money/economy/housing/2008-12-12-homeprices_N.htm) -7-
  8. 8. The Decline in Lending Standards Led to a Surge in Subprime Mortgage Origination 13.6% of all mortgages originated during the year $B 0.9% of all mortgages originated during the year Source: Lehman Brothers, Paulson presentation T2 Partners LLC -8-
  9. 9. But Subprime Mortgages Are Only a Tiny Part of the Problem CDO $ 0 .4 Other Consu m er $ 0.4 Constru ction & Developm ent $0 .6 Subprime $ 0.7 Com m erical & Indu strial $1 .0 Alt-A $ 1.0 Au to $ 1.0 High-Yield Corporate Bonds $ 1.1 Credit Card $ 1.1 Hom e Equ ity $2 .1 Ju m bo $ 2.4 Leveraged Loans $ 2.6 Com m ercial Real Estate $3 .5 Agency MBS $4 .6 Sources: Flow of funds data and Prim e Mortgage $4 .7 Paulson estimates 0 1 2 3 4 5 T2 Partners LLC Market Size ($ trillion) -9-
  10. 10. The Surge in Borrowing Power and Decline in Lending Standards Led to Home Prices Soaring Far Above Trend Line Sources: OFHEO, Bureau of Economic Analysis, Paulson presentation T2 Partners LLC -10-
  11. 11. Causes of the Great Mortgage Bubble
  12. 12. 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 interests 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 T2 Partners LLC -12-
  13. 13. Lenders Cared Little Who They Lent To Because They Assumed Perpetually Rising Home Prices When home price appreciation slows, loss severity skyrockets when mortgages default. What will loss severities look like when home prices are declining more than 10% annually?! No-one knows because there is no precedent for this. The assumption of perpetually high HPA led lenders to give virtually anyone a loan because even if they defaulted, the home could simply be resold with little or no loss. Sources: LoanPerformance; OFHEO; Deutsche Bank; “Who's Holding the Bag?”, Pershing Square presentation, 5/23/07 T2 Partners LLC -13-
  14. 14. Losses in Bubble-Era Subprime Mortgage Pools Become Catastrophic if Home Prices Decline Cumulative Loss for Various HPA Scenarios Loss (Month 60) 30.0% 25.0% 20.0% 17.5% 15.0% 10.0% 7.1% 5.0% June '06: 83 bps 0.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% Home Price Appreciation (quot;HPAquot;) T2 Partners LLC Source: Merrill Lynch; Paulson estimates -14-
  15. 15. 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: • 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, NY Times, 12/18/08 T2 Partners LLC -15-
  16. 16. A Case Study of Wall Street Compensation Run Amok: Stan O’Neal, Dow Kim & the Mortgage Team at Merrill Lynch Source: On Wall Street, Bonuses, Not Profits, Were Real, NY Times, 12/18/08 T2 Partners LLC -16-
  17. 17. The Housing Bubble Helped Many People Achieve the Dream of Home Ownership – Which is Now Turning Into a Nightmare Percentage of Households Owning Homes Source: Census Bureau; http://i.usatoday.net/news/graphics/housing_prices/home_prices.pdf T2 Partners LLC -17-
  18. 18. Consequences of the Bursting of the Great Mortgage Bubble
  19. 19. 10% of Mortgages on 1- to 4-Family Homes Are Delinquent or in Foreclosure as of the End of Q3 Total Delinquencies and Foreclosures Mortgage Delinquency Rate, By Product Type Foreclosure Inventory, By Product Type Note: Delinquencies (defined as at least 30 days past due) are seasonally adjusted; foreclosures are not. • Issued by federally qualified lenders and insured by the Federal Housing Administration; 2. A mortgage guaranteed by the U.S. Department of Veterans Affairs. Source: Mortgage Bankers Association, WSJ, 12/6/08; http://i.usatoday.net/news/graphics/housing_prices/home_prices.pdf T2 Partners LLC -19-
  20. 20. Sales of Existing Homes Are Falling and Foreclosures Are Rising, Leading to a Surge in Inventories Monthly Supply of Homes for Sale (Seasonally adjusted annual rate, millions) 4.23 million units, equal to 10.2 months as of the end of 10/08 5.0 million units as of the end of 10/08 The recent stabilization in home sales is driven by a surge of foreclosed homes, which now account for 35-40% of all sales. This puts tremendous pressure on home prices. Source: National Association of Realtors, Paulson presentation; http://i.usatoday.net/news/graphics/housing_prices/home_prices.pdf T2 Partners LLC -20-
  21. 21. Home Vacancies Are at an All-Time High More than 10% of all homes built this decade are vacant today T2 Partners LLC Note: In Q2, the overall rate dropped slightly to 2.8% and stayed at that level in Q3 -21-
  22. 22. 16% of Homeowners Owe More on Their Mortgage Than the Home Is Worth, Making Them Far More Likely to Default Among people who bought homes in the past five years, 29% are under water. There Has Been a Dramatic Rise in In Bubble Markets, Far More Homeowners Who Are Under Water Homeowners Are Under Water 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 2006 2007 Sept '08 Source: WSJ, 10/8/08, http://online.wsj.com/article/SB122341352084512611.html. T2 Partners LLC -22-
  23. 23. Certain Types of Loans are Severely Under Water Percentage of Borrowers Who Had Negative Equity (as of Sept. 2008) 70% 60% 50% 40% 30% 20% 10% 0% Prime Jumbo Alt-A Subprime Option ARM Source: Credit Suisse, WSJ 12/8/08 T2 Partners LLC -23-
  24. 24. Foreclosure Filings Have Increased Dramatically • Foreclosures in November rose 28% year-over-year, but declined 7% sequentially – “Foreclosure activity in November hit the lowest level we’ve seen since June thanks in part to recently enacted laws that have extended the foreclosure process in some states, along with more aggressive loan modification programs and self-imposed holiday foreclosure moratoriums introduced by some lenders,” said James J. Saccacio, chief executive officer of RealtyTrac. “There are several indications, however, that this lower activity is simply a temporary lull before another foreclosure storm hits in the coming months.” • By the end of the year, RealtyTrac expects more than a million bank-owned properties on the market, representing around a third of all properties for sale in the U.S. 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 05 06 07 08 5 6 5 6 7 7 8 8 06 07 08 5 6 6 7 7 8 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 n- n- n- n- b- b- b- ug ug ug ug ct ct ct ct pr pr pr ec ec ec Ju Ju Ju Ju Fe Fe Fe O O O O A A A A A A A D D D Note: Foreclosure filings are defined as default notices, auction sale notices and bank repossessions Sources: RealtyTrac T2 Partners LLC -24-
  25. 25. Credit Suisse Predicts More Than Six Million Foreclosures by the End of 2012 Sources: Credit Suisse; http://calculatedrisk.blogspot.com T2 Partners LLC -25-
  26. 26. So Far, Few Loan Modifications Are Working % In Default Sources: Office of the Comptroller of the Currency and the Office of Thrift Supervision Mortgage Metrics; http://calculatedrisk.blogspot.com T2 Partners LLC -26-
  27. 27. In Bubble Markets, Sales and Prices Are Way Down, While the Number of Homes Sold in Foreclosure Has Skyrocketed Case Study: Resale House Sales in San Diego Home prices in San Diego fell 16.7% year over year 1,600 in January – and this accelerated to -26.3% in Sept. 1,400 1,200 -34% Resale Homes 1,000 Sold Normal 800 1,417 -54% 657 Foreclosure 600 400 200 +328% 338 79 (5% of total) (34% of total) 0 January '07 January '08 More than half of homes sold in September in CA had been in foreclosure. This contributed to home sales jumping 65% year over year, but the statewide median home price fell 34% (MDA DataQuick). T2 Partners LLC Note: Excludes condos and new construction. Source: San Diego Union-Tribune article, 2/13/08. -27-
  28. 28. The Outlook for Home Prices is Grim We Estimate That Home Prices Are Only a Little More Than Half Way Finished Declining
  29. 29. Home Prices Are in an Unprecedented Freefall Through September, home prices had fallen an average of 21.8% from their peak in 20 major metropolitan areas 220 200 S&P/ -21.8% Case- 180 Shiller Home 160 Price Index (20 140 city) 120 100 Feb-00 Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08 Source: S&P/Case-Shiller index T2 Partners LLC -29-
  30. 30. Home Prices Have Fallen, But Are Still Well Above Levels at the Start of the Decade in Almost All Cities 200% Jan. 2000-July 2006 Jan. 2000-Sept. 2008 150% 100% 50% 0% is . ge d s ta o as i tte x o . go r as t .C n tle pa k m re ele ve oi an ol ieg ni sc sto n or all ra eg lo ia D ica O m at etr ap tla oe en ci el ng Y e D Bo ar M Se sV Ta D n, d, an ev av ne Ch A D Ph D sA ew Ch n to an Fr Cl in Sa La ity ng N rtl Lo M n -c hi Po Sa 20 as W -50% Source: S&P/Case-Shiller index T2 Partners LLC -30-
  31. 31. The Surge in Borrowing Power and Decline in Lending Standards Led to Home Prices Soaring Far Above Trend Line A 34% decline to return to trend line Sources: OFHEO, Bureau of Economic Analysis. T2 Partners LLC -31-
  32. 32. Borrowing Power of a Typical Home Purchaser Has Tumbled By Approximately 32% $400,000 1/1/1995 1/1/2000 1/1/2004 1/1/2005 1/1/2006 1/1/2007 6/1/2007 1/1/2008 12/1/2008 1. Pre-Tax Income $ 30,000 $ 33,693 $ 36,966 $ 38,064 $ 39,581 $ 40,403 $ 40,403 $ 41,963 42,173 2. Debt-to-Income Ratio 33% 33% 40% 45% 55% 55% 60% 35% 35% 3. Non-Agency Mortgage Rate 10.50% 9.50% 7.50% 6.25% 6.00% 6.50% 6.75% 6.75% 6.00% 4. Mortgage Type Full Am. Full Am. Full Am. Int Only Int Only Int Only Int Only Int Only Int Only 5. Borrowing Power $ 90,190 $110,191 $176,227 $274,060 $362,824 $341,873 $359,139 $217,585 246,008 Equity Required 15% 15% 10% 0% 0% 0% 0% 0% 0% Cash Required $ 15,916 $ 19,445 $ 19,581 $300,000 Leverage 3.0 3.3 4.8 7.2 9.2 8.5 8.9 5.2 5.8 $200,000 Even with average homeowners able to borrow nearly 6x their income, nearly $100,000 double historical averages, borrowing power is still down 32% from its peak $- 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05 1/06 1/07 1/08 Pre-Tax Income Borrowing Power Source: Amherst Securities Group, L.P. T2 Partners LLC -32-
  33. 33. Home Prices Would Have to Fall 41.6% to Return to 2002 Levels A 17.8% decline plus a 29.0% decline equals a total decline of a 41.6% Note: Based on the S&P/Case-Shiller Index thru April 2008 Source: Wall St. Journal, 7/14/08; Mark Zandi, chief economist at Moody's Economy.com and author of quot;Financial Shockquot; T2 Partners LLC -33-
  34. 34. Sequential (month-to-month) Home Price Declines Improved Dramatically in April, May and June of This Year March 2005 – September 2008 2.0% 1.5% 1.0% 0.5% 0.0% M a r- Apr- M a y- J un- J ul- Aug- S e p- Oc t- No v- De c - J a n- F e b- M a r- Apr- M a y- J un- J ul- Aug- S e p- Oc t- No v- De c - J a n- F e b- M a r- Apr- M a y- J un- J ul- Aug- S e p- Oc t- No v- De c - J a n- F e b- M a r- Apr- M a y- J un- J ul- Aug- S e p- 05 05 05 05 05 05 05 05 05 05 06 06 06 06 06 06 06 06 06 06 06 06 07 07 07 07 07 07 07 07 07 07 07 07 08 08 08 08 08 08 08 08 08 -0.5% -1.0% -1.5% -2.0% -2.5% -3.0% Source: S&P/Case-Shiller Home Price Index, 20-city data T2 Partners LLC -34-
  35. 35. Fe b -3.0% -2.5% -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% -0 A 0 pr -0 0 Ju n- 0 A 0 ug -0 O 0 T2 Partners LLC ct -0 D 0 ec -0 0 Fe b- 01 A pr -0 1 Ju n- 01 A ug -0 1 O ct -0 D 1 ec -0 1 Fe b- 02 A pr -0 2 Ju n- 02 A ug -0 O 2 ct -0 2 D ec Source: S&P/Case-Shiller Home Price Index, 20-city data -0 2 Fe b- 03 A pr -0 3 Ju n- 03 A ug -0 O 3 in April, May and June ct -0 D 3 ec -0 3 Fe b- 04 A pr -0 4 Ju n- 04 A ug -0 4 O ct -0 D 4 ec -0 4 Fe b- 05 A pr -0 5 Ju n- 05 A ug -0 O 5 ct But Home Prices Are Always Strong -0 D 5 ec -0 5 February 2000 – September 2008 Fe b- 06 A pr -0 6 Ju n- 06 A ug -0 O 6 ct -0 D 6 ec -0 6 Fe b- 07 A pr -0 7 Ju n- 07 A ug -0 O 7 ct -0 7 D ec -0 7 Fe b- 08 A pr -0 8 Ju n- 08 A ug -0 8 -35-
  36. 36. Estimates from John Burns Real Estate Consulting Also Indicate That We Are About Half Way to a Bottom Peak Current Projected trough T2 Partners LLC -36-
  37. 37. A Comparison to the Last Cycle Indicates a 30-40% Decline in Home Prices from the Peak Sources: Zellman and Associates, 9/08; Carlyle presentation, 10/15/08 T2 Partners LLC -37-
  38. 38. The Home Price-to-Income and Price-to-Rent Ratios Show That Home Prices Have Further to Fall Price-to-Income Ratio Price-to-Rent Ratio Sources: Census Bureau; S&P/Case-Shiller index; economist Morris Davis, Univ. of Wisconsin; http://i.usatoday.net/news/graphics/housing_prices/home_prices.pdf T2 Partners LLC -38-
  39. 39. Another Look at the Home Price to Income Ratio Median House Price / Median Family Income 4.4 GMO: Home prices need to fall 8% to reach fair value… GMO: Home prices need to fall 8% to reach fair value… 4.2 but likely will fall 20% to reach a bottom but likely will fall 20% to reach a bottom 4.0 3 std dev 3.8 3.6 2 std dev 3.4 1 std dev 3.2 3.0 2.8 2.6 2.4 1976 1980 1984 1988 1992 1996 2000 2004 Source: National Association of Realtors, U.S. Census Bureau, GMO As of 8/31/08 T2 Partners LLC -39-
  40. 40. In Summary, Home Prices Need to Decline Another 17-24% to Reach Fair Value Sources: USA Today analysis; http://i.usatoday.net/news/graphics/housing_prices/home_prices.pdf T2 Partners LLC -40-
  41. 41. A Study of Bubbles Shows That All of Them Eventually Return to Trend Line Stocks S&P 500 S&P 500 Japan vs. EAFE ex-Japan S&P 500 1920-1932 1946-1984 1981-1999 1992-October 2008 * 2.3 2.5 3.0 2.4 Detrended Real Price Detrended Real Price Detrended Real Price 2.0 2.5 Relative Return 1.8 2.0 2.0 1.5 1.3 1.5 1.6 Tre nd Line 1.0 Tre nd Line 1.0 0.8 0.5 1.2 0.5 Tre nd Line Trend Line 0.3 0.0 0.0 0.8 20 21 22 23 24 25 26 27 28 29 30 31 46 50 54 58 62 66 70 74 78 82 81 83 85 87 89 91 93 95 97 99 92 94 96 98 00 02 04 06 08 Currencies U.S. Dollar U.K. Pound Japanese Yen Japanese Yen 1979-1992 1979-1985 1983-1990 1992-1998 2.0 1.4 1.4 1.4 Cumulative Return Cumulative Return Cumulative Return Cumulative Return 1.8 1.3 1.3 1.3 1.6 1.2 1.2 1.2 1.4 1.1 1.1 1.1 1.2 1.0 1.0 1.0 1.0 0.9 0.9 0.9 0.8 0.8 0.8 0.8 79 81 83 85 87 89 91 79 80 81 82 83 84 83 84 85 86 87 88 89 90 92 93 94 95 96 97 Commodities Gold Crude Oil Nickel Cocoa 1970-1999 1962-1999 1979-1999 1970-1999 2000 250 80 600 1600 200 500 60 Real Price Real Price Real Price 400 Real Price 1200 150 40 300 800 100 200 400 20 50 100 0 0 0 0 70 74 78 82 86 90 94 98 62 66 70 74 78 82 86 90 94 98 79 81 83 85 87 89 91 93 95 97 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. T2 Partners LLC -41-
  42. 42. The Biggest Danger is That Home Prices Overshoot on the Downside, Which Often Happens When Bubbles Burst S&P 500 1926-1954 S&P 500 1954-1986 2.5 2.00 Overrun: 63% Overrun: 51% 2.3 Fair Value to Bottom: 1.5 Years Fair Value to Bottom: 7 Years 1.75 2.0 Fair Value to Fair Value: 23 Years Fair Value to Fair Value: 12 Detrended Real Price Detrended Real Price 1.50 Years 1.8 1.5 1.25 1.3 1.00 1.0 0.75 0.8 0.5 0.50 -51% -63% 0.3 0.25 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 Japan vs. EAFE ex-Japan 3.75 Overrun: 53%? 3.25 Fair Value to Bottom: Cumulative Relative Return 5 Years? 2.75 Fair Value to Fair Value: >6 Years 2.25 1.75 1.25 0.75 0.25 -53% 79 81 83 85 87 89 91 93 95 97 99 01 Source: GMO, as of 9/30/02 T2 Partners LLC -42-
  43. 43. Economic Weakness Creates an Additional Headwind for Home Prices

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