Hayman Letter 2009

8/3/2019 Hayman Letter 2009

1/26

March2,2009

DearLimitedPartners:

WerecentlyconcludedourthirdyearofoperationsattheHaymanCapitalfundsandarefortunateto

havereturnedaboveaverageresultsforourlimitedpartnersduringaverytumultuoustime. Hayman

CapitalMaster,L.P.(theMasterFund)hasreturned+340%netofallfeesandexpenses*sinceits

inceptioninFebruaryof2006,whiletheS&Phasreturned 42.37%. Forthoseofyouwhohavenotbeen

withussinceinception,theMasterFundsannualreturnsfor2006,2007,2008and2009(yeartodate),

were+20.27%,

+216.64%,

+6.13%

and

+9.03%,

respectively.

These

results

are

the

product

of

many

sleeplessnights,intensegovernmentalaction,andcountlessdiscussionsamongourinvestmentteam

withregardtoourmacroviews. Whileitwouldberepetitivetorevisithowwehavearrivedatthispoint

inworldhistory,laterinthisletterIwilldiscussatlengthoneofthekeyfactorsthatwebelievewill

determineourfuturedirection. Needlesstosay,wehavefocusedonriskmanagementbystructuring

ourpositionswiththemostasymmetricrisk/rewardscenariospossible. Thiscommunicationmaybethe

mostimportantletterwehaveeverwritten.

Asound

banker,

alas!

is

not

one

who

foreseesdanger,andavoidsit,butone

who,whenheisruined,isruinedina

conventionalandorthodoxwayalong

withhisfellows,sothatnoonecanreadily

blamehim.Itisnecessarilypartofthe

businessofabankertomaintain

appearances,andtoconfessa

conventionalrespectability,

which

is

more

thanhuman.Lifelongpracticesofthis

kindmakethemthemostromanticand

theleastrealisticofmen.

John Maynard Keynes Consequences to John Maynard Keynes Does he have it right?


2/26

fiat.[a.Latin'letitbedone';'lettherebemade']

Inshort,

fiat

currency

is

money

that

exists

because

an

authority,

government

or

custom

simply

declares

orforcesittobeassuch. TheAmericanHeritagedictionarydefinesfiatcurrencyas"papermoney

declaredlegaltender,notbackedbygoldorsilver." Ithinkoffiatcurrencyasbeingpapermoneywith

nointrinsicvaluewhichhasbeensimplydeclaredtobelegaltender. Uptothispoint,ithasbeenwidely

acceptedthatcurrencyormoneyisworththegoodsandservicesforwhichitisroutinelyexchanged. I

hopethisremainsthecase,butthinkthattheoddsareagainstit. Inthepast,Ihavestatedmybelief

thatthereisnotenoughmoneyintheworldtosoakupthetensoftrillionsofdollarsofdeleveraging

thatmustoccuroverthenextfewyears. Thiscouldnotbetruerthanitistoday. WhileIdonothavea

solution(and

maybe

it

does

not

exist)

to

the

problems

facing

us

today,

what

Ido

know

is

that

attemptingtoreleveramassivelyoverleveragedsystemisclearlyNOTtheanswer. The

disintermediationofriskisoneoftheprimarycausesofthecurrentproblemanditisNOTthesolution.

AlanGreenspansaiditbestwhenhewroteGoldandEconomicFreedomin1966(beforeheenteredthe

FederalReserveSystem;sincethen,hehasbeensilentonthesubject):

Theabandonmentofthegoldstandardmadeitpossibleforthewelfarestatiststouse

thebankingsystemasameanstoanunlimitedexpansionofcredit. Theyhavecreated

paperreserves

in

the

form

of

government

bonds

which

through

acomplex

series

of

stepsthebanksacceptinplaceoftangibleassetsandtreatasiftheywereanactual

deposit,i.e.,theequivalentofwhatwasformerlyadepositofgold. Theholderofa

governmentbondorofabankdepositcreatedbypaperreservesbelievesthathehasa

validclaimonarealasset. Butthefactisthattherearenowmoreclaimsoutstanding

thanrealassets. Thelawofsupplyanddemandisnottobeconned.Asthesupplyof

money(ofclaims)increasesrelativetothesupplyoftangibleassetsintheeconomy,

pricesmusteventuallyrise.Thustheearningssavedbytheproductivemembersofthe

societylose

value

in

terms

of

goods.

When

the

economys

books

are

finally

balanced,

onefindsthatthislossinvaluerepresentsthegoodspurchasedbythegovernmentfor

welfareorotherpurposeswiththemoneyproceedsofthegovernmentbondsfinanced

bybankcreditexpansion.

Intheabsenceofthegoldstandard,thereisnowaytoprotectsavingsfromconfiscation

throughinflation.Thereisnosafestoreofvalue.Iftherewere,thegovernmentwould

havetomakeitsholdingillegal,aswasdoneinthecasegold. Ifeveryonedecided,for

example,to

convert

all

his

bank

deposits

to

silver

or

copper

or

any

other

good,

and

thereafterdeclinedtoacceptchecksaspaymentforgoods,bankdepositswouldlose

theirpurchasingpowerandgovernmentcreatedbankcreditwouldbeworthlessasa

claimongoods. Thefinancialpolicyofthewelfarestaterequiresthattherebenoway

fortheownersofwealthtoprotectthemselves.


3/26

TheUnitedStatesabandonedthegoldstandardonAugust15,1971,inanexecutiveordersignedby

thenPresidentNixon. Atthatmomentinhistory,theUnitedStatesdecideditwouldnolongerredeem

itspaper

dollars

for

gold.

It

is

an

interesting

point

to

ponder

the

United

States

has

been

operating

in

a

systemoflimitlesscreditcreationforONLY38years. 38yearsisnotanextensiveperiodoftimewhen

reflectingonworldhistory. Intheabsenceofourcurrency'smandatoryconvertibilityintoaprecious

metal(ormoreimportantly,afiniteresource),ourownFederalReserveBankhasbeentaskedwith

preventinginflation(orthedevaluingofourfiatcurrencybyprintingtoomuchofit).Generally,the

UnitedStateshasbeencreatingcreditandexpandingitsGDPandnationaldebtloadforthepast38

years. Interestrateshavecomedowntozeroandtheoldeconomicprincipleofdiminishingmarginal

utilitywasjustappliedtothelastincrementaldollarofcreditmarketdebt. Theproverbialinmateshave

beenrunning

the

asylum.

The

only

institution

in

the

world

that

can

LEGALLY

counterfeit

the

U.S.

Dollar

issupposedtopolicetheunrulydebasementofourcurrency.

Leninwascertainlyright. Thereisnosubtler,nosurermeansofoverturningtheexisting

basisofsocietythantodebauchthecurrency. Theprocessengagesallthehiddenforces

ofeconomiclawonthesideofdestruction,anddoesitinamannerwhichnotoneman

inamillionisabletodiagnose.

John

Maynard

Keynes

Asacountry,wenowfacerunninga$1.5$2.0trillionoperatingdeficitinexcessofroughly$2.1trillion

ofgovernmentrevenue(ifwearelucky). IftheU.S.wereapubliccompany,notevenKenLewiswould

considerpurchasingus(atapremiumnodoubt). Asanattachmenttothisletter,enclosedistheUnited

Statesbalancesheetandincomestatement. Iencourageyoutolookthroughtheminorderto

formulateyourownopinionofentitlementspendingandgovernmentreceipts.Interestinglyenough,

afterquizzingsomeofthegreatassetmanagersintheworld,veryfewcouldevengetclosetoguessing

thegovernment

receipts

number.

Iguess

it

just

does

not

matter

anymore.

Tothebestofourknowledge,therehasonlybeen160,000metrictonsofgoldEVERminedintheworld.

At$950perounce,allofthegoldintheworldwouldbeworth$4.887trilliondollars. Ontheother

hand,weestimatethatthereisroughly$60trillionoffiatmoney(includingcurrencies,deposits,savings,

moneymarketsandCDs)intheworld. Giventhefactthatworldgovernmentsarecaughtwithsomuch

creditmarketleverageandlosses,webelievethattheywillintrueKeynesiancolorattempttoprint

theirwayoutofthismess. Ifthisoccurs,youhavetoaskyourself: Howmanyofpeopledoyouthinkit

willtake

to

begin

to

question

the

value

of

paper

currency

when

it

is

being

debased

in

an

attempt

to

save

worldgovernments? Ifasmallfractionofthemstopbelieving,wherewilltheygotopreservetheir

wealth? MyguessistheU.S.dollarandpreciousmetals.

The Bad News? The Rest of the World Looks Worse


4/26

Ofcourse,anobserverwouldnotbeexpectedtoknowthisbasedontheforecastsandpredictionsmade

byglobal

economic

and

financial

bodies

such

as

the

IMF.

According

to

their

January

World

Economic

OutlookUpdate,theworldeconomywillgrowthisyearbyalmost0.5%despitethreeofthefourtop

economiesintheworldrecordingnegativeseasonallyadjusted,annualizedgrowthinQ42008of

between 6.2%and 12.7%. However,thisisthesamebodythatenteredintobailoutagreementswith

Hungary,UkraineandLatviawithGDPassumptionsvaryingbetween 1%and 2%for2009,onlyto

watchHungaryandLatviapost 12%and 23.6%annualizeddeclines,respectively,inQ42008GDP,

whiletheUkrainescrapedbywithamild 20%GDPcontractionyearoveryearinJanuary2009.

Surprisingly,considering

the

catalyst

for

the

current

crisis

came

from

the

U.S.,

and

the

majority

of

worldwideeconomicopinionhasbeendevotedtotheadmittedlysizeableproblemsfacingtheU.S.

economy,thescorecardsofarreflectsarelativelymilddownturncomparedtotherestoftheworld.

Acomparisonofreported4thquarterannualizedGDPdeclinesisinstructive. Shownbelow,

representativesfromWesternEurope,EastAsiaandEmergingEuropeareallcurrentlycontractingfaster

thantheU.S.

AnnualizedGDPGrowth(Q42008)

25%

20%

15%

10%

5%

0%

Source:Bloomberg,respectiveMinistriesofFinance.

WesternEurope


5/26

repositoryoftheworldsmarginalindustrialcapacityatitlewehavehandedovertothetradesurplus

nationsofEastAsiaandEurope):

UnitedStatesYoYIndustrialProduction(1920Present)

IndustrialproductionacrosstheentireEurozoneisdecliningatitsfastestrateonrecord:

EurozoneYoYIndustrialProduction(exConstruction)(1986Present)


6/26

EastAsia

MeanwhileinEastAsiatheconsumerstrikefromtheU.S.andothernetaggregatedemandeconomies

hashadadevastatingimpactonindustrialproductionandexports. InSouthKorea,industrial

productionandexportsaredecliningmorerapidlythanduringtheAsianfinancialcrisis:

GermanyYoYIndustrialProduction(1992Present)SwedenYoYIndustrialProduction(1991Present)

SouthKoreaYoYExports(1967Present)SouthKoreaYoYIndustrialProduction(1976Present)


7/26

ThestoryisthesameinTaiwan:

Andintheworldssecondlargesteconomy(andcurrentlymostindebtedsovereignnation),azombified

Japanisstartingtoconvulseasindustrialproductiongrowthhitanalltimelowof20.8%yearoveryear

inDecember2008,andexportsarecurrentlyfallingoffacliff:

TaiwanYoYIndustrialProduction(1997Present) TaiwanYoYExports(1994Present)

JapanYoYExports(1986Present)JapanYoYIndustrialProduction(2004Present)


8/26

GDP)toexpanditsdomesticconsumptiontoreplaceanannualized 28%Q4declineinU.S.retail

spending,thereisnosignthatitsevenheadingintherightdirection.

InJanuary,Chinareporteda 17.5%dropinexportsanda 43.1%dropinimportsyearoveryear. By

themselves,thedatapointsindividuallyreflectaremarkabledeclineintradevolumethatisonly

partiallyexplainedbytheseasonalfactors,buttogethertheyreflectthatinternaldemandforexternal

goodsandservicesisdecliningastheimport/exportgapexpandsratherthanshrinks.

ThisbringsustoourdoubtsaboutthequalityofChinascurrentgrowth. Theofficial6.8%yearover

yearQ4growthreleasedbytheChinesegovernmentseemsunsustainablewhenconsideredwiththe

figuresonChinesepoweroutput.

5%

0%

5%

10%

15%

20%

25%

30%

MonthlyChinesePowerOutput YOY%Increase/(Decrease)

ChinaYoYImports(1995Present)ChinaYoYExports(1995Present)


9/26

JustHowBigistheGlobalDebtTidalWave?

Weregonnaneedabiggerboat ChiefBrody,Jaws,1975Wehavespentthegoodpartof6monthscombingthroughtherestoftheworld'ssovereignbalance

sheetsandincomestatementsinordertounderstandjusthowmuchleveragewearereallyworking

with. Theresultsofourstudyarenothingshortofshocking! Itisnowcleartomewhywearewherewe

aretoday. ThecruxoftheproblemwasnotsubprimeorAltAmortgageloans,norwasitthisbankor

thatbank. Itwastheproblematthehighestoftheorder. Governmentsofcountriesaroundtheworld

allowedtheirbankingsystemstogrowunchecked. Thelimitlesscreditcreationaffordedbyfractional

reservebankingandfiatcurrencieshasgrownintoamassiveand,insomecases,untenableliabilityfor

thehostcountry. WhenIcelandfailed,itpromptedustolookdeeperintohowandwhyasovereign

governmentcouldgettothebrinkofdisasterandthenjumpin. OthersdismissedIcelandasasmall

fishingvillageof300,000peopleanda$19billionGDP.WhenwelookedinsideIceland,ithelpedbuild

thebasisforourcurrentunderstandingfortherestoftheworld. Icelandwasbrokenasacountrydue

t th i t ll i h df l f b k t t $200 billi f l R b th

ChinaYoYGDPversusOECD12MonthLeadingIndicatorIndex(1995Present)


10/26

andJapantotal$86trillion(USD). Whilethenameshavebeendisguisedtoprotecttheguilty,the

followingsamplecapturescountriesofEuropeandAsia,aswellastheU.S.:

0%

10%

20%

30%

40%

50%

60%

70%

0x

5x

10x

15x

20x

25x

30x

35x

Cumulative MFIAssets&SovereignDebtasaMultipleofGovernmentRevenuesGovernmentRevenuesas%GDP

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

7.0x

8.0x

9.0x

MFIAssetstoGDPNetSovereignDebttoGDP


11/26

IconsiderProfessorKennethRogoff(ThomasDCabotProfessorofPublicPolicy,Departmentof

Economics,HarvardUniversity)tobeoneoftheworld'sforemostexpertsonsovereignbalancesheets

andthe

history

of

sovereign

defaults.

He

worked

with

Geithner

at

the

IMF,

Ben

Bernanke

at

Princeton,

andevenintroducedLarrySummerstohiswife. Hehaswrittenmanypapersonthesubject,andIfound

ThisTimeisDifferent:APanoramicViewofEightCenturiesofFinancialCrises(April2008)(see

http://www.economics.harvard.edu/faculty/rogoff/files/This_Time_Is_Different.pdf)tobeoneofthe

bestpiecesofworkonthesubjectofgovernmentsgettinginovertheirheadsandtheinevitable

consequencesthatfollow. WhatProfessorRogoffconcludesisthatcapitalmobilityandsubstantial

foreigninvestmentaretwooftheprimarydeterminantstotheconditionsthattypicallyprecede

sovereigndefault. Inpriorworks,suchas"DebtIntolerance"(2003),hetriestounderstandthe

thresholdlevels

of

debt

that

are

"sustainable"

for

many

emerging

economies.

When

we

applied

the

recentresultsofourworktotheconclusionsdrawnbyRogoff,theresultwassomethingthatnoneofus

haveeverimaginedcouldhappen. Ourworksuggestedthattherecouldbea"cluster"ofgovernment

defaultsoverthenextthreeyears(orpossiblysooner). Doyouknowwhatpercentageoftheworld's

sovereigngovernmentsindefaultedintheyear1934? Remember,thebrevityoffinancialmemoryis

remarkable.

PercentofCountriesinDefaultonorRestructuringtheirSovereignExternalDebt(18002006)

ResultoftheGreatDepressionandWorldWarII ResultoftheEmerging

MarketDebtCrisis

Source: CarmenM.ReinhartandKennethS.Rogoff. ThisTimeisDifferent:APanoramicViewofEightCenturiesofFinancialCrises. April16,2008.

Rogoffstatesthat:


12/26

documentsothercrisesthatoftenaccompanydefault: includinginflation,exchangerate

crashes,bankingcrises,andcurrencydebasements.

IrecentlyhadtheopportunityandprivilegetomeetanddiscusswithProfessorRogoffourwork,and

aftercarefulconsiderationandreview,hewasverycomplimentaryofourresearchandintriguedbythe

considerationouranalysisgivestocontingentliabilitiesarisingfromMFIassets.

CompetitiveDevaluation Don'tGetRopeADoped!

Asaresult

of

the

world's

banking

systems

being

multiples

of

the

host

country's

GDP

and

many

multiples

ofgovernmentreceipts,thecountrieshaveonlyafewwaysthroughthis. Whatwehavewitnessedover

thepastfewmonthsisthatgovernmentsaroundtheworldhavedecidedtomaintainthestructural

stabilityoftheirbankingsystemsinordertopreservethetrustoftheirpeople. Basically,governments

aroundtheworldhavetosavetheirbanksevenifitmeansbringingthesovereignintoanuntenable

position. Themostlikelypaththattheworld'sKeynesianswilladoptisthemoneyprintingpress. Even

ourownBenBernankehasexhibitedhisloveforhisprintingpress. Inhisnowinfamous2002

"Helicopter"speech,Mr.Bernankestated:

Indeed,underafiat(thatis,paper)moneysystem,agovernment(inpractice,thecentral

bankincooperationwithotheragencies)shouldalwaysbeabletogenerateincreased

nominalspendingandinflation,evenwhentheshorttermnominalinterestrateisat

zero[.] Whathasthisgottodowithmonetarypolicy? Likegold,U.S.dollarshavevalue

onlytotheextentthattheyarestrictlylimitedinsupply. ButtheU.S.governmenthasa

technology,calledaprintingpress(or,today,itselectronicequivalent),thatallowsittoproduceasmanyU.S.dollarsasitwishesatessentiallynocost. Byincreasingthenumber

of

U.S.

dollars

in

circulation,

or

even

by

credibly

threatening

to

do

so,

the

U.S.

governmentcanalsoreducethevalueofadollarintermsofgoodsandservices,whichis

equivalenttoraisingthepricesindollarsofthosegoodsandservices. Weconcludethat,

underapapermoneysystem,adeterminedgovernmentcanalwaysgeneratehigher

spendingandhencepositiveinflation." (emphasisadded)

Now,thethingthatscaresmethemostaboutthatspeechisthefactthatMr.Bernankesays"at

essentiallynocost." WhenIlookbackintohistory,almosteveryexperimentwithfiatcurrencyhas

endedpoorly.

Actually,

the

thing

that

disturbs

me

the

most

is

Bernanke's

academic

comfort

in

the

fact

thathisprintingpresshasenoughink. HisKeynesianideologyworksbestinavacuumoutsideofthe

realworld. Thefactthathethinksstealingmoneyfromthesaversinhiseconomyandconfiscatingit

throughthehiddentaxofinflation/currencydebasementshouldscareeveryone.

We are about to enter a time in which all of the world's central banks will break out the ink and start


13/26

ApassagefromTheCreaturefromJekyllIslandbyEdwardGriffin:

Indeed,our

founding

fathers

intended

to

prohibit

the

Federal

Government

from

issuing

billsofcredit,considerthis...ThefirstdraftoftheConstitutionwascopiedinlarge

measurefromtheArticlesofConfederation. Whenitwastakenupforconsiderationby

thedelegates,therefore,itcontainedtheoldprovisionthathadcausedsomuchchaos.It

stated:"thelegislatureoftheUnitedStatesshallhavethepowertoborrowmoneyand

emitbillsofcredit." But,afteralivelydiscussiononthematter,theoffendingprovision

wasvotedtoberemovedfromtheConstitutionbyanoverwhelmingmargin. Voicingthe

sentimentofthemajorityofthedelegates,AlexanderHamiltonsaid: "toemitan

unfundedpaper

as

the

sign

of

value

ought

not

to

continue

aformal

part

of

the

Constitution,noreverhereaftertobeemployed;being,initsnature,repugnantwith

abusesandliabletobemadetheengineofimpositionandfraud.

Atthetime,GeorgeWashingtonstated,"Wemaybecomeagreatcommercialandflourishingnation.

But,ifinthepursuitofthemeansweshouldunfortunatelystumbleagainonunfundedpapermoneyor

anysimilarspeciesoffraud,weshallassuredlygiveafatalstabtoournationalcreditinitsinfancy."

Ifthe

Federal

Reserve

begins

to

purchase

large

quantities

of

newly

issued

Treasury

bonds

the

electronicequivalentoftheprintingpresswebetterholdontoourwallets! Thegoodnewsforthe

UnitedStatesisthefactthat,asapercentofGDP,itwillnothavetoprintnearlyasmuchasmanyparts

oftherestoftheworld.

WhatworriesmethemostaboutouranalysisisthefactthattheU.S.willhavetoissue$2.35trillion

newTreasuriesthisyear,andcollectively,Europewillhavetoissueevenmore. Today,ChinaandJapan

own65%oftheforeignownershipofU.S.Treasuries. HaveyouseenwhatishappeningtoChinaand

Japanlately?

It

does

not

seem

possible

that

there

is

anywhere

near

enough

money

in

the

world

to

buy

thatmanyTreasuries.

Tobeclear,webelievethattheU.S.(andinfact,theworld)isinanongoingdebtdeflationaryspiralthat

willlikelycontinueforsometime(possiblyyears). Therampantprintingofcurrenciesaroundtheglobe

isnot,inouropinion,likelytobeimmediatelyinflationary(inthecommonunderstandingoftheterm)

asleveragecomesoutoftheprivatesectorandassetvaluescontinuetodecline. Thegreaterconcernis

thepotentialinflationarytimebombthatgrowsasgovernmentscontinuetoborrow,printand

stimulate.What

happens

to

inflation

when

the

velocity

of

money

goes

from

zero

to

100?

Givenalloftheabove,weareveryconfidentintwopredictions:

1. TheU.S.isinrelativelybettershapethantherestoftheworld,andthedollarwillbeasafercurrency than virtually any other (and yes, that includes the Yen).


14/26

BankDebtStillTooEarly

Wehave

spent

aconsiderable

amount

of

time

analyzing

the

bank

debt

markets

and

looking

for

investmentopportunities. Whilethisassetclasshasperformedwellsinceitslowsinthe4thquarter

2008,webelievethatnowisnotthetimetoenterthisspace. Weareconcernedaboutinvestmentsin

thisarenaforanumberofreasons:

S&Ppredictsthatapproximately23%ofallspeculativegrade,nonfinancialissuerswilldefaultinthiscycle. Webelievethispredictiondrasticallyunderestimatestheseverityoftheproblem

andtheactualnumberwilllikelyapproach50%. ImagineaworldwhereHALFofthese

investmentsfile

bankruptcy.

To

add

insult

to

injury,

we

believe

recoveries

will

be

well

below

historicalnorms,asevidencedbyrecentbankruptcyfilings.

ManyofthemoreliquidnamesarecorepositionsinCollateralizedLoanObligations(CLOs),whichareleveredpoolsofleveredbankloansusedtodisperseriskandgeneratesafe

returnsfromnotsosafeassets(weseenthismoviebefore,haventwe?). Webelievethatthe

ratingagencieswilldowngradeasmuchas40%ofallnoninvestmentgradecreditstoCCC

status. Thispointisextremelyimportant. Suchadowngradewouldtriggerafailureofover

collateralizationtestswhicharekeycovenantsinvirtuallyallCLOsandpotentiallytriggerEvents

ofDefault

in

many

of

these

pools.

The

unintended

and

dangerous

consequence

of

these

defaultswouldbeanevaporationoftheCLObidfromthemarketaccompaniedbyaglutof

supply,thusdrivingdowntheprice.

TherearevirtuallynoreasonablypricedDIPlenders(dependingonwhosesideyouareon),whichisforcingexistingloanstobeimpairedbeyondhistoricnorms(seetheLyondelldiscussion

below).

Mostmarginalborrowerscontinuetoplaychickenwiththeirlenders,andmanyagentbanks(leadlendersinasyndicationprocess)aresimplypuntingthelossesdowntheroadforabetter

day,which

further

weakens

the

collateral.

ThepostureinWashingtonistosaveorcreatefourmillionjobs. Consequently,wethinkmostbankruptcyjudgeswillbeoverlysympathetictoborrowersandpushforgoingconcernsrather

thanliquidations(whichcouldactuallymakemoresenseincertainsituations).

Thesumofthepartsanalysiscommonlyusedinliquidationscenariostendtobeoverlyoptimisticwithregardtocurrentbankdebtpricing. Withnocreditavailabletofinancethese

businessesasgoingconcernsoutofbankruptcy,thebankdebtpricemustultimatelyreflect

whata100%equitypurchaserwouldbewillingtopayanumbermuchlowerthanhistorical

norms(seeTribunediscussionbelow). Thereturnsrequiredbyinvestorswillonlycontinuetoincreaseinthemediumterm.

ThetypicalCLOcanonlyholddefaultedcollateralforaperiodof2to3years. Unfortunately,webelievethisissimplynotenoughtimefortheeconomytofinditswayoutoftheproverbial

woods,andCLOswillbeforcedtosellilliquidreorganizedequityintoachallengingmarket.


15/26

LyondellFrom$21BilliontoBankruptin385Days

LyondellChemical

Company,

amanufacturer

of

intermediate

chemicals,

was

acquired

by

Basell

AF

S.C.A.

onDecember20,2007,for$20.9billionincludingassumeddebt. Thebulkofthepurchasepricewas

financedwiththecombinationof$9.1billioninsyndicatedbankloans,a$7.9billionloanfromBasellAF

S.C.A.,and$800millionofassumedoutstandingunsecuredbonds. Thisimplies85%debt/capital,with

bankloansmakingupnearly44%ofthetotalcapstructure. During2008,Lyondellsoperationssuffered

withtheeconomicdownturn(thedamage,ofcourse,wasamplifiedbyexcessiveleverage)culminating

inbankruptcyfilingonJanuary8,2009. Thinkaboutthatforamoment: ittookonlyayearfora$21

billionleveragedacquisitiontoproceedfrompurchasetobankruptcy. Overthesametimeperiod,the

bidprice

for

the

Lyondell

syndicated

bank

loans

declined

57%

from

$1.00

to

$0.43.

Lyondells

weak

cash

flowoutlookrequiredsignificantDIPfinancingtofacilitatetherestructuringprocess. Thetightcapital

marketconditionsforcedLyondelltoacceptanonerousrollupDIPstructure(LIBOR+1000witha3%

LIBORflooraMINIMUM13%floatingrate)thatwilltransferasubstantialportionoftheeconomics

fromprepetitioncreditors(prebankruptcylenders)totheDIPlenders.Thisputstheprebankruptcy

banklendersinaveryunfavorablepositionunderarollupDIP,originallendersmustthrowgood

moneyafterbadbyputtingadditionalcapitalintothenewDIPfacilitytoprotecttheiroriginalbadloan.

Accordingly,tradingintheseniorsecuredbankloansbifurcatedintotwoclasses: (i)Stub,where

originallenders

did

not

agree

to

re

up;

and

(ii)

Roll

up,

where

original

lenders

threw

good

money

after

bad,desperatelyclawingforanenhancedrecovery. AsofFebruary23,2009,thebidpricesforthe

stubandrollupbankloansare$0.245and$0.570,respectively. Baseduponourexperience,most

WallStreetfirmsassume60%recoveryratestobethenorm.

TribuneBewaretheAllureofTrophyAssets

TribuneCompanyisamediaconglomerateconsistingofnewspapers,televisionstations,andownership

interestsin

the

Chicago

Cubs,

Wrigley

Field,

SportsNet,

and

The

Food

Network.

In

December

2007,

Sam

ZellacquiredTribuneCompanyina$14billionleveragedtransactionfinancedemploying$8.7billionof

seniorsecuredbankloans,$1.6billioninunsecuredbridgeloans,andtheassumptionofunsecured

outstandingbonds. TribuneCompanyintendedtoquicklyrepaydebtwithfreecashflowandproceeds

fromanassetsaleprogram;however,thecompanyfailedtodeliveronitscommitmentsasadvertising

revenuesandthecapitalmarketsevaporatedthroughout2008. InDecember2008,Tribunewasunable

tomeetadebtpaymentandwasforcedtoseekbankruptcyprotection. Overthistimeperiod,theprice

forTribunebankdebtsteadilydeclinedfrom$0.92inApril2008to$0.56inMay2008to$0.42in

December2008

to

$0.26

today.

Investors

in

the

bank

loans

were

enticed

all

the

way

down

by

the

supposedbreakupvalueofcertaintrophyassets.Unfortunatelyforthoseinvestors,themarketvalue

forsuchassetsisshrivelingduetopotentialbuyersinabilitytosecurefinancing,aswellasdeteriorating

assetqualityandcashflows. Inflatedofferprices,asinMarkCubansofferfortheChicagoCubsand

ScrippsofferfortheFoodNetwork,quicklyunraveledasinvestorsrealizedthatpricesforevenhigh

qualityassetsareunderpressureanddealsareincreasinglydifficulttoclose.


16/26

U.S.Mortgages NotQuiteTimeYet

Manyinvestors

have

decided

that

now

is

the

time

to

buy

U.S.

mortgage

whole

loans

as

well

as

mortgage

securities. Whiletherewillbesignificantopportunityinthisspaceoneday,thetimehasnotquite

arrived. Therearelimitedexamplesofbondsthatwehavepurchasedintheportfoliotodate,butthe

circumstancessurroundingtheirpurchaseweremoreofimmediatedistresssales,andthereforethe

pricewasrightregardlessofthetiming. Weuseadraconianmodelonourassumptionsfor

delinquencies,rollratesanddefaults. Peopletendtoforgetthatwhilemanyofthesepoolsare

geographicallydiverse,theytypicallyhaveaparticular"slice"ofthesocioeconomicspectrumthatisnot

reallydiverseineachpool. Historically,joblosseshavebeenthekeyproblemformortgagesand

mortgagebonds.

To

date,

the

majority

of

delinquencies

and

defaults

have

been

caused

by

firms

that

madeloanstopeoplethatcouldnotimmediatelymakeamortgagepayment. Whentheunemployment

ratehits1012%andthejoblessrateapproaches20%intheU.S.,mortgagepriceswilltakeanotherstep

lowerduetothenextwaveofdefaults.

MarktoMarketAccounting Don'tAsk...Don'tTell Really?!?!

Inthepastyear,therehasbeenalotofdebateaboutmarktomarketaccountinganditsaffectonthe

balancesheetsoffinancialinstitutions. Thecriticsofmarktomarket,whowantitsuspendedordoneawaywith,havestatedthatduetothecurrentcreditcrunchandlackofliquidityinthemarketplace,

certainassetsarebeingmarkedatartificiallylowvalues. Thisiscommonlyreferredtoastheliquidity

discount,orsaidanotherway,theportionofthetotaldiscountduetofactorsotherthanprojectedloss

ofprincipalduetocreditriskorthecurrentinterestrateenvironment. Thealternativetomarkto

marketiseithertoletcompanieskeepsecuritiesontheirbooksatcostorusemarktomodelwherethe

companiesthatownthesecuritiesusemanagementsbestestimatesonfuturecashflowstodetermine

thevalueofthesecurities. Trytonameonemanagementteamtodatethathasoverestimatedlosses.

Criticsofmarktomarketseemtooverlookthatthemarketpricesusedtodeterminefairvaluereflect

whereanactualbuyerandsellerhaveagreedtotransactinanorderlyfashion. TheSECandtheFASB

haveissuedguidancestatingthatdistressedassetsalesandilliquidorirrationalmarketsdonothaveto

beusedtodeterminethefairvalueofacompanysassets. Incaseswherealiquidmarketdoesnot

exist,thereisalreadyabuiltinmechanismforcompaniestovaluetheirassetsbasedonsomedegreeof

judgment,butusingasmuchmarketdataaspossibleandwithdisclosureonmanagementsestimates.

Ifanything,weshouldbepushingforamorerobustversionofmarktomarketthateliminatesthe

abilityof

companies

to

shift

assets

that

they

dont

wish

to

mark

to

market

into

the

illiquid

buckets,

or

socalledLevel2and3assets. Level2and3assetsarethoseinwhichcompanieshavetheabilityto

valueassetsatlevelsotherthanmarketbyusingclearlypricesorquotedpricesforsimilarassets. Take

LehmanBrothersforexample,asofMay31,2008,theyhadtotalassetsof$639.4billion,totalliabilities

of$613.2billionandtotalstockholdersequity(includingpreferredstock)equalto$26.3billion.

L h t t l L l 2 d 3 t f thi d t bi d $203 2 billi It


17/26

Ifyoulookatreasonswhythemarketispricingmostassetsbelowpar,itisnotduetoliquidityorthe

creditcrunch. Thesimplefactremainsthatuntilthebroadermacroeconomicconditionsimprove,credit

lossesand

defaults

will

continue

to

increase.

Looking

back

on

the

past

two

years

worth

of

trading

data,

themarkethasnotbeenpunitiveenoughinitsassumptions. Itwasnotlongagothatthesamepeople

blamingmarktomarketaccountingfornotreflectingtrueassetvaluewouldhavesaiditwasimpossible

foraAAAratedbondtohaveprincipallosseventhoughmanyweretradingatsteepdiscounts. Inthe

markettoday,thatoutcomeiswidelydeterminedtobeinevitable. Whilewearecertainthatmarkto

marketaccountingisnotperfectanditwillovervaluesomeassetsandundervalueothers,itisveryclear

thatthemarkethasbeenaheadofthecurvethroughthiscycleandcontinuestobethebestestimateof

ultimatevalue. MoodysclaimsthatnoneoftheirAAAratedbondshaveevertakenacapitalloss. What

theyfail

to

mention

is

that

they

downgrade

AAA

securities

to

lower

ratings

before

capital

losses

occur.

ItisworthpointingoutthatwemarktheMasterFundsinvestmentstomarketeveryday,andwereport

performancebasedonthosemarkstoyou,ourlimitedpartners,everymonth. Wedonotmanipulate

thepricingofourinvestments,nordowehaveanydesiretodoso. Wouldyouinvestwithusifour

returnswerebasedonourownassumptionsofwhatwethoughtsomethingshouldbeworthrather

thanwherethepositionscouldbesoldtoawillingbuyer?

CreditDefaultSwaps TheyareNOTtheVillainintheRoom

WithallofthediscussionlatelyinregardtoCDS,Ithinkitistimetoofferaneasysolutiontofixingthe

problemforgood. Weareanactiveparticipantinthismarketplaceandwouldliketoshareourthoughts

withyouonthesubject. CDSisanenigmatictermusedtobaffleeventhosewhoinvestwiththemin

theirportfolios. Whenanyoneusesthetermswap,Iamsureitturnsoff99%ofthepeoplereadingor

listening. CreditDefaultSwapsaresimplybondoptions.Thereisareferenceobligation(thebond),afinite

time

frame,

and

consideration

exchanged

between

parties

(well

sometimes...and

this

is

the

problemthatneedsfixing). Wedon'thearabouttheequitiesoptionmarketplaceasbeingdisruptive

orsystemic.Wedon'thearaboutthefuturesoptionsmarketplacecausingdepressionsormarket

meltdowns.Whydoyouthinkthatis? TheanswerissoeasythatIcan'tbelieveitisnottalkedabout

more. TheplayersintheCDSmarketplaceplaywithdifferentrules. Ifyouareasellerofopenended

risk(i.e.thepersonsellingtheinsuranceagainstdefault),youhavebeenabletodosowithZERO

INTITIALCOLLATERALREQUIREDifyouwereadealerorsayahugeinsurancecompanywithapristine

creditrating(AIG). So,thereturnsandtheleveragewereinfinitetotheseplayersaslongasthecontract

nevermoved

against

them.

They

would

simply

collect

premiums

without

ever

posting

collateral

or

puttingmoneyupfortherisktheyweretaking. TheWallStreetfirmslikeBearStearns,Lehman,and

AIGalltookcompleteadvantageofthisandleveredthemselvesmorethanever. Ifthereweretobea

ruleinthefuturethatREQUIRINGALLPARTICIPANTStoplaybythesamecollateralrules,themarket

wouldshrinksignificantlyandtherewillnotlikelybeanothersystemicissuesurroundingthem. Ifall

l h d t l b th l thi k t l ld h NEVER t th i it i t d


18/26

IamsureIwillupsetWallStreetfirmsandinsurancecompaniesandalloftheotherparticipantsthat

liketheoldsystemofpostingnocollateralandhavingthemarketplaceopaquesotheycouldfleecethe

unwaryparticipants.

It

is

time

to

have

an

Adult

Skate

only

from

now

on.

EventheSageofOmaha,WarrenBuffet,wroteinhis2008lettertohisshareholders:

Atyearendwehadwritten$4billionofcontractscovering42corporations,forwhichwe

receiveannualpremiumsof$93million. Thisistheonlyderivativesbusinesswewrite

thathasanycounterpartyrisk;thepartythatbuysthecontractfromusmustbegoodforthequarterlypremiumsitwilloweusoverthefiveyears. Weareunlikelytoexpandthis

business

to

any

extent

because

mostbuyersofthisprotectionnowinsistthatthesellerpostcollateral,andwewillnotenterintosuchanarrangement. (emphasis

added).

ToOurInvestorsandFriends:

ManyofyouareawareoftheJointStatementreleasedonFebruary25th(awhole4daysand11%agoin

thefinancials)bytheFDIC,Treasury,FederalReserve,OCC,andtheOTS. Init,theyassuredusthat

currently,the

major

U.S.

banking

institutions

have

capital

in

excess

of

the

amounts

required

to

be

consideredwellcapitalized. Iguessweareallgoodagain. Whatisallofthistalkabout

nationalizationifthebanksarewellcapitalized? WhydidtheFederalReserveandCongressagreeto

backstop,injectorguaranteecloseto$9trillionofsupportiftheyareallwellcapitalized?

Considerthis: iftheTier1riskbasedcapitalrequirementsforU.S.banksis6%,thenthedefacto

amountofbalancesheetleverageisapproximately16x,atbest. Ifyouwereinvestingusing16x

leveragecominginto20072009,howoutofbusinessareyou? TheanswerisCOMPLETELY. The

majorityof

our

banking

system

is

INSOLVENT,

and

that

is

the

problem.

With

the

repeal

of

the

Glass

SteagallAct(whichwasoriginallyputintoplacein1933)in1999,depositoryinstitutionsweregiventhe

abilitytospeculateandinfinitelylevertheirbalancesheetsthroughderivatives. Congressallowedmajor

U.S.moneycenterbankstogettoolevered.WENEEDTOSEPARATECOMMERCIALBANKSFROM

INVESTMENTBANKS. Inthefuture,ourdepositoryinstitutionsshouldnotbeabletospeculateinthe

uberleveredderivativesmarkets.Theyshouldbegoodoldfashionedbanks(backtothebasics). When,

andifthateverhappens,thenextquestionshouldbe:howmuchleverageisprudentatthesebanks? Is

16xleverageprudent? Wethinkthe36pagelistof679nowgovernmentownedcompanies(e.g.banks)

suggestsotherwise.

OnceyouhaveadeepunderstandingofhowtheU.S.andworldbankingsystemswork,itgivesyoua

senseofhowbadthingsreallyareandmaybecome. Sofar,theFederalReserveandtheTreasury's

bestandbrightesthavedecidedthatthebestwaytogetthroughthisistoaddmoreleveragetoan

overlevered economy The TALF program is attempting to restart the securitization market Wait a


19/26

Foryourwealth,youmustthinkabouttheenormityofthisproblemaroundtheworld,andwhatthe

likelygovernmentalresponseswillbe. Ibelievetheyonlyhavetwopathstowalkdowneventually. One

isto

print

money

in

an

attempt

to

paper

over

their

losses

(pardon

the

pun).

This

path

can

only

lead

to

massivedebasementofthefiatcurrencyinourwalletsandbankaccounts,whichisakintothem

stealingitfromsavers. Thesecondpathistomoveallofthebadprivateassetstothegovernmentor

publicbalancesheetsandthendefaultontheirsovereigndebt. Theworldneedsadooverandthis

wouldbethecleanestwaytorebuildingtheworld'sfinancialsystem. AsmuchasIwouldliketothink

thereisanotherpathtosalvationthatdoesnotincludeenormouspain,thereisjustnootherwaywhen

youlookatallofthenumbers.

Assome

of

you

are

aware,

the

Hayman

franchise

expanded

in

2008

to

be

comprehensively

positioned

to

protectandcreatewealthduringtheglobaleconomicmeltdown. Specifically,wecreatedamunicipal

bondfundasarelativelysafeplacetostorecapitalandearnahealthysingledigit,taxfreereturn. We

alsocreatedaresidentialrealestateprivateequityfundfocusingondistressedinvestmentsandDIP

financings. Therewillbeatimetoownrealestate,andwebelievethattherewillbephenomenal

opportunitiestobuyincheaplyasthemarketcontinuestobefloodedwithoverleveredanddistressed

residentialprojects. Wearecarefullyandpatientlycombingthenationalrealestatemarketsoweare

preparedtoactwhentheseopportunitiesarise. Thefundtargetsreturnsinthehighteenstolow

twentieswith

little

to

no

leverage.

To

date,

we

have

executed

one

DIP

financing

and

bid

on

over

$1

billionworthofdistressedtransactions. Giventhedirectioninwhichtheglobaleconomyisheadedand

theloomingworldwidefiatcurrencydebasement,weareconfidentthatatsomepoint,realestatewill

provetobeaveryvaluableassetclass.

Forthoseofyouthathavenotknownmeformorethanacoupleofyears,throughoutmylifeIhave

beenaveryoptimisticperson. Idonothaveanyneedor,forthatmatter,desiretoremainnegative

abouttheworld. Asafiduciary,ImustgatherandassimilatethedatathatIseek. Imustthen(withmy

team)formulate

an

opinion

with

regard

to

that

data

as

well

as

hundreds

of

other

social,

political

and

gametheoryinputsinordertodevelopourthesistofirstprotectandsecond,earngoodriskbased

returnsonyourcapital. Therewillbeatimetogetbullish(myguessismanyyearsfromnow),andat

ourinvestordinneronApril1st,Iwilldescribeonesuchbullishinvestmentwewillbemakingin2009.

Regards,

J.KyleBass

ManagingPartner

HaymanAdvisors,L.P.


20/26

Net results reflect the deduction of operational expenses, management fees and incentive allocations (estimated when

applicable), but do not include side pocket investments (if any). Net results reflect investor returns for an investment

made at the Funds inception without any subsequent contributions or withdrawals. Actual investor results may varydue to, among other things, the timing of contributions or withdrawals and feeder level expenses. Performance

information for 2006 is from the Fund's inception on February 14, 2006 through December 31, 2006.

The information set forth herein is being furnished on a confidential basis to the recipient and does not constitute an

offer, solicitation or recommendation to sell or an offer to buy any securities, investment products or investment

advisory services. Such an offer may only be made to eligible investors by means of delivery of a confidential private

placement memorandum or other similar materials that contain a description of material terms relating to such

investment. The information and opinions expressed herein are provided for informational purposes only. An

investment in the Hayman Fundsis speculative due to a variety of risks and considerations as detailed in theconfidentialprivate placement memorandum of the particular fund andthis letter is qualified in its entirety by the more

complete information contained therein and in the related subscription materials.Nothing contained herein

constitutes financial, legal, tax, or other advice. This may not be reproduced, distributed or used for any other

purpose. Reproduction and distribution of this letter may violate federal or state securities laws.


21/26


22/26

UnitedStatesFederalGovernmentBalanceSheet(NotSeasonallyAdjusted)

Source:FederalReserveLevelsReport2008

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q3 9800Change 0003Change 0308Change 0708Change

%ofTotalFinancialAssets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 0.0% 0.0% 0.0% 0.0%

Gold,SDRsandOfficialForeignExchange 11.4% 7.9% 8.0% 7.1% 8.5% 8.8% 8.9% 5.7% 5.5% 5.5% 4.4% 3.5% 0.8% 4.3% 1.1%

Checkable

Deposits

and

Currency 5.2% 15.7% 4.7% 11.0% 7.9% 8.6% 3.6% 6.0% 5.3% 8.6% 36.2%

0.5% 3.9% 27.6% 27.6%TimeandSavingsDeposits 1.1% 1.0% 1.2% 1.7% 4.6% 0.4% 0.4% 0.2% 0.3% 0.4% 0.3% 0.2% 0.8% 0.1% 0.1%

CreditMarketInstruments 49.7% 46.6% 53.1% 44.6% 46.1% 43.5% 45.3% 44.7% 45.0% 43.6% 29.6% 3.3% 9.6% 13.9% 14.1%

AgencyandGSEBackedSecurities 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

OtherLoans&Advances 31.3% 23.6% 25.1% 20.2% 19.9% 18.7% 18.8% 17.5% 17.3% 16.1% 10.6% 6.2% 6.4% 8.1% 5.5%

Mortgages 10.1% 13.9% 15.0% 12.5% 12.7% 11.7% 12.4% 12.7% 13.0% 12.7% 8.4% 4.9% 3.2% 3.3% 4.3%

ConsumerCredit(StudentLoans) 8.4% 9.1% 13.0% 11.9% 13.4% 13.1% 14.1% 14.6% 14.7% 14.9% 10.6% 4.6% 0.0% 2.5% 4.3%

TradeReceivables 5.0% 4.1% 5.5% 5.8% 5.4% 8.1% 10.1% 11.5% 11.4% 10.8% 7.1% 0.5% 2.7% 1.1% 3.8%

TaxesReceivable 4.8% 6.9% 8.3% 13.1% 10.7% 14.5% 14.9% 15.3% 16.2% 15.4% 10.4% 3.5% 6.3% 4.1% 5.0%

MiscellaneousAssets 22.7% 17.9% 19.3% 16.5% 16.7% 16.2% 16.8% 16.4% 16.3% 15.6% 12.1% 3.5% 3.1% 4.0% 3.5%

%ofTotalLiabilities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 0.0% 0.0% 0.0% 0.0%

SDRCertificates 0.2% 0.1% 0.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

0.2% 0.0% 0.0% 0.0%

TreasuryCurrency 0.4% 0.5% 0.5% 0.6% 0.6% 0.5% 0.5% 0.5% 0.5% 0.4% 0.4% 0.1% 0.0% 0.1% 0.0%

CreditMarketInstruments 82.8% 81.7% 79.4% 78.7% 79.3% 79.1% 79.4% 79.4% 79.2% 78.0% 80.0% 3.5% 0.2% 0.8% 2.0%

SavingsBonds 4.1% 4.1% 4.3% 4.4% 4.3% 4.0% 3.7% 3.5% 3.3% 3.0% 2.7% 0.2% 0.3% 1.3% 0.3%

OtherTreasurySecurities 78.1% 77.0% 74.4% 73.6% 74.5% 74.6% 75.3% 75.6% 75.5% 74.7% 77.0% 3.7% 0.2% 2.3% 2.3%

BudgetAgencySecurities 0.6% 0.6% 0.6% 0.6% 0.6% 0.5% 0.4% 0.4% 0.4% 0.4% 0.3% 0.0% 0.2% 0.2% 0.0%

MultiFamilyResidential Mortgages 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

TradePayables 1.4% 1.6% 1.7% 1.8% 1.7% 3.0% 3.0% 3.4% 3.3% 4.4% 3.4% 0.3% 1.2% 0.5% 1.0%

InsuranceReserves 0.7% 0.8% 0.9% 0.9% 0.9% 0.8% 0.8% 0.7% 0.7% 0.7% 0.6% 0.1% 0.1% 0.2% 0.1%

MiscellaneousLiabilities 14.3% 15.3% 17.4% 18.0% 17.5% 16.6% 16.3% 16.0% 16.3% 16.5% 15.6% 3.1% 0.9% 1.0% 0.9%

Nonmarketable Securities heldbyPensionPlans 14.2% 15.2% 17.3% 17.8% 17.2% 16.0% 15.5% 14.9% 14.9% 14.5% 13.3% 3.1% 1.3% 2.7% 1.2%

Other 0.1% 0 .1% 0 .2% 0 .1% 0 .2% 0 .6% 0 .8% 1 .1% 1 .4% 2 .0% 2 .3% 0.0% 0.4% 1.7% 0.3%


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Documents

Hayman Letter 2009