tt HAYMAN ADVISORS LP October 2, 2009 “You cannot spend your way out of recession or borrow your way out of debt.” - Daniel Hannan, Member of the European Parliament Dear Investors: There have been many significant global developments since our March letter. Governments around the world are running fiscal deficits at levels never before seen, while central banks have loosened monetary policy and are printing money at a record pace. While the US appears to have avoided a systemic implosion, the question becomes at what cost~now and in the future? In this letter, we address: The “good” news and bad news of the current economic situation; Areas of opportunity; The implications of global and US monetary policy; The current state of the US housing market and expectations for the future; The International Monetary Fund's policy prescription for dealing with troubled economies; The boom and potential bust in China; The looming debt crisis in Japan; and How the fund is positioned to capitalize on these issues. The purpose of this letter is not simply to communicate how the fund is positioned, but also ~ and possibly more importantly — to stimulate thought and discussion about the “big picture” implications of these issues. We believe that we are in the midst of a once-in-a-lifetime (literally) economic shift that has affected or will affect everyone. While there are certainly hardships and challenges ahead, we also see opportunities 2101 CEDAR SPRINGS ROAD, SUITE 1400 DALLAS, TX 75201 TEL. 214-347-8050 FAX 214-347-8051The “Good” News? The “good” news is the recession Is officially over. Real GDP dropped only 4% peak-to-trough, S&P 500 revenues dropped only 18%, and home prices dropped only 31.3% nationwide. Broad-based unemployment (including the underemployed) reached 17.0%, which translates into 17.4 million Americans out of work and another 9.2, million working part-time jobs that are insufficient to pay their bills.’ After losing an average of 578,346 jobs every week since October 2008, the headline unemployment figure improved in July from 9.5% to 9.4%, Never mind that in August the Bureau of Labor Statistics ("BLS") revised their prior estimates, and a portion of the “improvement” in July was achieved by adjusting the total size of the labor force (think increasing the denominator to reduce the percentage) and unemployment continued its upward trajectory to 9.7% in August and 9.8% in September. We are left wondering how broad based unemployment went from its most recent trough of 7.9% in December 2006 to 17.0% currently, while total retail sales declined only 3.6% over the same time period? Source: Mike Keefe, Denver Past. Reprinted wth permission. Bernanke and crew have done a masterful job of pulling out all of the stops (and then some) to save the US and world banking system from collapse. Having gone from potential collapse to valuations well above the 10-year averages, the S&P 500 now trades at 2x book value and 20x EPS and credit spreads relative to Treasuries are back to pre-Lehman levels, Where We are Bullish There are great businesses which have too much leverage, which are being or will be recapitalized through consensual restructurings or Chapter 11 bankruptcies. These “capital transformation investments” usually involve buying senior debt and working with the company’s stakeholders and management to craft a plausible * According to the latest data available from the BLS, 15.142 million Americans are included in the labor force and are classified as “unemployed.” Another 2.219 million would like to work, but have not searched for ajob in the last four weeks. An additional 9.179 million are classified as “part-time for economic reasons,” meaning currently employed part- time as an alternative to not working at all ? average Initial Jobless Claims since the first week of October, as published by the Department of Labor. » Source: Bloomberg, © 2009 Hayman Advisors LP.capital structure to return the entity to health and growth. As the capital markets have recovered, money is flowing and many private equity players are prepared to invest in their existing portfolio companies after or in conjunction with a debt restructuring. It is in these types of situations that we see great opportunity. Our investments are focused on asset-heavy businesses where we can buy into the right portion of the capital structure in advance of the restructuring. On the back end, we will Iikely end up owning some amount of senior debt with attractive current pay characteristics and in certain circumstances end up holding equity in the company for little, if any, real cost. This is one area where we are acutely focused and we believe presents the most asymmetric returns for being invested on the long side. If the story could just finish here with such a happy ending ~ unfortunately, here is where the really bad news begins, Never Before and Hopefully Never Agai Western democracies, communistic capitalists, and Japanese deflationists are concurrently engaging in what may be the largest, global financial experiment in history. Everywhere you turn, governments are running enormous fiscal deficits financed by printing money. The greatest risk of these policies is that the quantitative easing will persist until the value of the currency equals the actual cost of printing the currency (which is just, slightly above zero). There have been 28 episodes of hyperinflation of national economies in the 20th century, with 20 occurring after 1980. Peter Bernholz (Professor Emeritus of Economics in the Center for Economics and Business (WWZ) at the University of Basel, Switzerland) has spent his career examining the intertwined worlds of politics and economics with special attention given to money. In his most recent book, Monetary Regimes and Inflation: History, Economic and Political Relationships, Bernholz analyzes the 12 largest episodes of hyperinflation ~ all of which were caused by financing huge public budget deficits through money creation. His conclusion: the tipping point for hyperinflation occurs when the government's deficit exceed 40% of its expenditures. According to the current Office of Management and Budget (“OMB”) projections, US federal expenditures are projected to be $3,653 trillion in FY 2009 and $3,766 trillion in FY 2010 with unified deficits of $1.580 trillion and $1,502 trillion, respectively. These projections imply that the US will run deficits equal to 43.3% and 39.9% of expenditures in 2009 and 2010, respectively. To put it simply, roughly 40% of what our government is spending has to be borrowed. One has to ask whether the US reached the eritical tipping point? Beyond the quantitative measurements associated with government deficits and money creation, there exists a qualitative aspect to such a scenario that may be far more important. The qualitative perceptions of fiscal and monetary policies are impossible to control once confidence is lost. In fact, recent price action in metals, the dollar and commodities suggests that the market is already anticipating the future. M1 money supply is the most liquid measure of money outside of tangible currency. The chart below illustrates M1 growth of the world’s major currencies since 2007, © 2009 Hayman Advisors LP.