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

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.

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-

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 Inflation

Source: Robert Shiller; http://i.usatoday.net/news/graphics/housing_prices/home_prices.pdf

T2 Partners LLC -4-

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-

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-

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-

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-

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-

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-

Causes of the Great Mortgage Bubble

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


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

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-

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

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

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

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
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

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


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-

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.


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


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

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

Credit Suisse Predicts More Than Six Million
Foreclosures by the End of 2012

Sources: Credit Suisse; http://calculatedrisk.blogspot.com


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

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-

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
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

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%

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Source: S&P/Case-Shiller index

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.


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.


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;

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

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Source: S&P/Case-Shiller Home Price Index, 20-city data
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But Home Prices Are Always Strong

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February 2000 – September 2008

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-35-

Estimates from John Burns Real Estate Consulting
Also Indicate That We Are About Half Way to a Bottom

Peak

Current

Projected trough


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

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

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


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

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

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.


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

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

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

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