8/3/2019 48887451-Kyle-Bass-Feb-14

1/134

February14,2011

TheCognitive

DissonanceofitAll

"Men,ithasbeenwellsaid,

thinkinherds;itwillbeseenthattheygomadinherds,

whiletheyonlyrecovertheirsensesslowly,andonebyone."

-CharlesMackay,ExtraordinaryPopularDelusionsandtheMadnessofCrowds.

DearInvestors:

8/3/2019 48887451-Kyle-Bass-Feb-14

2/134

Wecontinuetobeveryconcerned

aboutsystemicriskintheglobaleconomy.Thusfar,thesystemicrisk

thatwasprevalentintheglobalcreditmarketsin2007and2008has

notsubsided;rather,ithassimplybeentransferredfromtheprivatesectortothepublicsector.Wearecurrentlyinthemidstofacyclical

upswingdrivenby

8/3/2019 48887451-Kyle-Bass-Feb-14

3/134

themostaggressivelypro-cyclicalfiscalandmonetary

policiestheworldhaseverseen.Investorsaroundtheworldareengaging

inanacuteandseverecognitivedissonance.Theyacknowledgethatexcessiveleveragecreated

anassetbubbleofgenerationalproportions,buttheydoeverythingpossibletopreventrationaldeleveraging.Interestingly,equitiescontinuetomarchhigherinthefaceof

Europeansovereignspreads

8/3/2019 48887451-Kyle-Bass-Feb-14

4/134

remainingneartheirwidestlevelssincethe

crisisbegan.ItiseerilysimilartoJuly2007,whenequitiescontinued

higherascreditmarketsbegantocollapse.Thisletteroutlinesthemajorsystemic

faultlineswhichwebelieveallinvestorsshouldconsider.Specifically,weaddressthefollowing:

WhoisMixingtheKool-Aid?(KnowyourCentral

Bankers)The

8/3/2019 48887451-Kyle-Bass-Feb-14

5/134

Zero-Interest-Rate-PolicyTrapTheKeynesianEndpoint

WhereDeficitSpendingandFiscalStimulusBreakDownJapanWhat

OtherMacroPlayershaveMissedandtheComingofX-DayWillGermany

GoAll-In,oristhePriceTooHigh?AnUpdateonIcelandandGreeceDoesDebtMatter?Whilegoodinvestmentopportunitiesstillexist,

investorsneedto

8/3/2019 48887451-Kyle-Bass-Feb-14

6/134

exercisecautionandparticularcarewithrespect

toinvestmentdecisions.Weexpectthat2011willbeyetanothervery

interestingyear.

8/3/2019 48887451-Kyle-Bass-Feb-14

7/134

In2010,ourcoreportfolioof

investmentsinUSmortgages,bankdebt,high-yielddebt,corporatedebt,andequities

generatedourpositivereturnswhileourtailpositionsinEuropecontributednominallyin

thepositivedirectionandourJapaneseinvestmentswerenominallynegative.Webelievethisreboundinequitiesandcommoditiesismostlyaproductofgoosingby

theFedsprinting

8/3/2019 48887451-Kyle-Bass-Feb-14

8/134

pressandarenotenthusiasticaboutinvesting

toofaroutontheriskspectrum.Wecontinuetohavea

portfolioofshortdurationcreditalongwithmoderateequityexposureandlargenotional

tailpositionsintheeventofsovereigndefaults.

WhoisMixingtheKool-Aid?

Unfortunately,academichasbecomeasynonymforcentral

banker.Thesedays

8/3/2019 48887451-Kyle-Bass-Feb-14

9/134

ittakesaparticularpersonalitytypeto

emergeasthehighestfinancialcontrollerinamoderneconomy,andtoo

fewhaverealfinancialmarketorcommercialexperience.RogetsThesaurushasnotyet

adoptedthisuse,butthepracticalrealityissadandtrue.WehaveattachedabriefpersonalworkhistoryoftheUSFedgovernorsto

furtherillustratethis

8/3/2019 48887451-Kyle-Bass-Feb-14

10/134

point.Sofewcentralbankersaroundthe

worldhaveeverrunabusinessyetsomuchfinancialtrust

isvestedwiththem.Indiscussingthesovereigndebtproblemsmanycountriescurrently

face,theacademicelitetendtoarrivequicklyattheproverbialforkintheroad(inflationversusdefault)andchooseinflationbecausetheyperceiveit

tobeless

8/3/2019 48887451-Kyle-Bass-Feb-14

11/134

painfulandlessnoticeablewhilepushingthe

harderdecisionfurtherdowntheroad.Greenspandroppedratesto1%and

tradedthedotcombustforthehousingboom.Heknewthatthe

roadoverthenext10yearswasgoingtobefraughtwithsomuchdangerthathehandedthereinsovertoBernankeandquit.

Centralbankerstend

8/3/2019 48887451-Kyle-Bass-Feb-14

12/134

tobelievethatinflationanddefaultare

mutuallyexclusiveoutcomesandthattheyhavebeenanointedwiththepower

tochooseonepaththatisseparateandexclusiveoftheother.Unfortunately,

whencountriesareasindebtedastheyaretoday,thesechoicesbecomesynonymouswithoneanotheroneactuallycausestheother.

ZIRP

(ZeroInterestRate

8/3/2019 48887451-Kyle-Bass-Feb-14

13/134

Policy)isaTRAP

As

developedWesterneconomiesbouncealongthezerolowerbound(ZLB),fewparticipants

realizeoracknowledgethatZIRPisaninescapabletrap.Whenaheavilyindebted

nationpursuestheZLBtoavoidpainfulrestructuringwithinitsdebtmarkets(household,corporate,and/orgovernmentdebt),theZLBfacilitatesapursuitofaggressiveKeynesianism

thatonlyperpetuates

8/3/2019 48887451-Kyle-Bass-Feb-14

14/134

therelianceonZIRP.Theonlymeaningful

reductionofdebtthroughoutthiscrisishasbeentheforceddeleveragingof

thehouseholdsectorintheUSthroughforeclosure.Totalcreditmarketdebthas

increasedthroughoutthecrisisbythetransferofprivatedebttothepublicbalancesheetwhilerunningdouble-digitfiscaldeficits.Infact,thisisan

explicitpartof

8/3/2019 48887451-Kyle-Bass-Feb-14

15/134

acentralbankersplaybookthatpresupposesthat

netcreditexpansionisanecessarypreconditionforgrowth.However,the

2

HaymanCapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

16/134

problemofoverindebtednessthatis

amelioratedbyZIRPisonlymadeworsethelongerasovereignstays

attheZLBwithevergreaterconsequenceswhenshortrateseventually(and

inevitably)returntoanormalizedlevel.

TotalGlobalDebt(LeftAxis)andGlobalDebt/GDP(RightAxis)

TotalGlobalDebt(Trillionsof

Dollars)

8/3/2019 48887451-Kyle-Bass-Feb-14

17/134

$220350%$200340%$180330%$160

320%$140310%$120300%$100290%$80280%$60270%$40

260%$20250%$240%

2002200320042005200620072008

20092010E

GlobalDebt/GDP

PublicDebtSecurities

PrivateDebtSecurities

BankAssets

Debt/GDP(RightAxis)

8/3/2019 48887451-Kyle-Bass-Feb-14

18/134

Source:IMFGlobalFinancialStability

Report;IMFWorldEconomicOutlook;MoodysCountryCreditStatisticalHandbook;BIS;CIA

WorldFactbook;Haymanestimates.

ConsidertheUnitedStatesbalancesheet.The

UnitedStatesisrapidlyapproachingtheCongressionally-mandateddebtceiling,whichwasmostrecentlyraisedinFebruary2010to$14.2trilliondollars(including$4.6trillion

heldbySocial

8/3/2019 48887451-Kyle-Bass-Feb-14

19/134

Securityandothergovernmenttrustfunds).Every

onepercentagepointmoveintheweighted-averagecostofcapitalwillend

upcosting$142billionannuallyininterestalone.Assuminganythingbutaninverted

curve,amovebackto5%shortrateswillincreaseannualUSinterestexpensebyalmost$700billionannuallyagainstcurrentUSgovernmentrevenuesof

$2.228trillion(CBO

8/3/2019 48887451-Kyle-Bass-Feb-14

20/134

FY2011forecast).EvenifUSgovernment

revenuesweretoreachtheirpriorpeakof$2.568trillion(FY2007),

theimpactofariseininterestratesisstillstaggering.Itis

plainandsimple;theUScannotaffordtoleavetheZLBcertainlynotonceitaccumulatesafurther$9trillionindebtoverthenext

10years(which

8/3/2019 48887451-Kyle-Bass-Feb-14

21/134

willincreasetheannualinterestbillby

anadditional$90billionper1%).IfUSratesdostartmoving,

itwillmostlikelybeforthewrong(andmostdire)reasons.Academic

researchonthissubjectisbestdefinedasalchemymasqueradingashardscience.Theonlyhistoricalobservationofadebt-drivenZIRPhasbeenJapan,and

thetrueconsequences

8/3/2019 48887451-Kyle-Bass-Feb-14

22/134

haveyettobefelt.Neverbefore

havesomanydevelopedwesterneconomiesbeeninthesameZLBboat

atthesametime.Bernanke,ourcurrentWizardofOz,offeredthislittle

tidbitofconjectureinapieceheco-authoredin2004whichwasappropriatelytitledMonetaryPolicyAlternativesattheZeroBound:AnEmpiricalAssessment.He

clearlydidnot

8/3/2019 48887451-Kyle-Bass-Feb-14

23/134

wanttocallthispaperaHypothetical

Assessment(asitreallywas).

3

Hayman

CapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

24/134

Despiteourrelativelyencouragingfindingsconcerning

thepotentialefficacyofnon-standardpoliciesatthezerobound,cautionremains

appropriateinmakingpolicyprescriptions.Althoughitappearsthatnon-standardpolicymeasuresmay

affectassetpricesandyieldsand,consequently,aggregatedemand,considerableuncertaintyremainsaboutthesizeandreliabilityoftheseeffectsunderthecircumstancesprevailingnear

thezerobound.

8/3/2019 48887451-Kyle-Bass-Feb-14

25/134

Theconservativeapproachmaintainingasufficientinflationbuffer

andapplyingpreemptiveeasingasnecessarytominimizetheriskofhitting

thezeroboundstillseemstoustobesensible.However,suchpolicies

cannotensurethatthezeroboundwillneverbemet,sothatadditionalrefiningofourunderstandingofthepotentialusefulnessofnonstandardpoliciesfor

escapingthezero

8/3/2019 48887451-Kyle-Bass-Feb-14

26/134

boundshouldremainahighpriorityfor

macroeconomists.

-Bernanke,Reinhart,andSack,2004.(EmphasisAdded)Itis

tellingthatheusestheverbescapinginthatfinalsentenceinstinctively

heknowstheZLBisdangerous.

TheKeynesianEndpointThingsBecomeNon-Linear

AsProfessorKenRogoff(HarvardSchoolofPublic

PolicyResearch)describes

8/3/2019 48887451-Kyle-Bass-Feb-14

27/134

inhisnewbook,ThisTimeis

Different:EightCenturiesofFinancialFolly,sovereigndefaultstendtofollowbanking

crisesbyafewshortyears.Hisworkshowsthathistorically,theaverage

breakingpointforcountriesthatfinancethemselvesexternallyoccursatapproximately4.2xdebt/revenue.Ofcourse,thisisnotahardandfastruleandeach

countryisdifferent,

8/3/2019 48887451-Kyle-Bass-Feb-14

28/134

butitdoesprovideausefulframe

ofreference.Webelievethatthetwocriticalratiosforunderstandingand

explainingsovereignsituationsare:(1)sovereigndebttocentralgovernmentrevenueand

(2)interestexpenseasapercentageofcentralgovernmentrevenue.Webelievethattheseratiosarebetterincrementalbarometersoffinancialhealththanthe

oftenreferenceddebt/GDP

8/3/2019 48887451-Kyle-Bass-Feb-14

29/134

GDPcalculationscanbeverymisleading.

Webelievethatcentralgovernmentrevenueisamoreprecisemeasureof

agovernmentssubstantiveabilitytopaycreditors.EconomistsuseGDPasahomogenizing

denominatortoillustratebroadpointswithoutparticularattentiontotheidiosyncrasiesofeachnation.Usingourpreferreddebtyardsticks,wefindthatwhendebtgrows

tosuchlevels

8/3/2019 48887451-Kyle-Bass-Feb-14

30/134

thatiteclipsesrevenuemultipletimesover,

(everycountryisuniqueandthemaximumsustainablelevelofdebtfor

anygivencountryisgovernedbyamultitudeoffactors),thereisa

non-linearrelationshipbetweenrevenuesandexpensesinthattotalexpendituresincreasefasterthanrevenuesduetotheriseininterestexpensefromahigherdebt

loadcoupledwith

8/3/2019 48887451-Kyle-Bass-Feb-14

31/134

ahigherweighted-averagecostofcapitaland

thenaturalinflationofdiscretionaryexpenditureincreases.Themeansbywhichsovereigns

fallintothisinescapabledebttrapisthecriticalpointwhichmustbe

understood.Insomecases,on-balancesheetgovernmentdebts(excludingpensionshort-fallsandunfundedholesinsocialwelfareprograms)exceed3xrevenue,andcurrentfiscalpolicies

pointtoa

8/3/2019 48887451-Kyle-Bass-Feb-14

32/134

continuingupwardtrend.4

HaymanCapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

33/134

TheBankofInternationalSettlementsreleased

apaperinMarch2010thatisparticularlysobering.Thepaper,entitled

TheFutureofPublicDebt:ProspectsandImplications(Cecchetti,MohantyandZampolli)paints

ashockingpictureofthetrajectoryofsovereignindebtedness.WhiletheauthorsfocusonGDP-basedratiosasopposedtoourpreferredmetrics,theforecastis

neverthelessalarming.The

8/3/2019 48887451-Kyle-Bass-Feb-14

34/134

studyfocusesontwelvemajordevelopedeconomies

andfindsthatdebt/GDPratiosriserapidlyinthenextdecade,exceeding

300%ofGDPinJapan;200%intheUnitedKingdom;and150%in

Belgium,France,Ireland,Greece,ItalyandtheUnitedStates.Additionally,theauthorsfindthatgovernmentinterestexpenseasapercentofGDPwillrisefrom

around5%[on

8/3/2019 48887451-Kyle-Bass-Feb-14

35/134

average]todaytoover10%inall

cases,andashighas27%intheUnitedKingdom.Theauthors

pointoutthatwithoutaclearchangeinpolicy,thepathisunstable.1

Whencentralbankersengageinnon-standardpoliciesinanattempttogrowrevenues,theresultingincreaseininterestexpensemaybemanymultiples

ofthechange

8/3/2019 48887451-Kyle-Bass-Feb-14

36/134

incentralgovernmentrevenue.Forinstance,Japan

currentlymaintainscentralgovernmentdebtapproachingonequadrillion(onethousandtrillion)Yen

andcentralgovernmentrevenuesareroughly48trillion.Theirratioofcentralgovernment

debttorevenueisafatal20x.Aswediscusslater,Japansailedthroughtheirsolvencyzonemanyyearsago.Minuteincreasesintheweighted-average

costofcapital

8/3/2019 48887451-Kyle-Bass-Feb-14

37/134

forthesegovernmentswillforcetheminto

whatwehavetermedtheKeynesianendpoint -wheredebtservicealoneexceedsrevenue.

InJapan,somethoughtfulmembersoftheDiet(Japansparliament)decided

thattheymusttargetamoreaggressivehardinflationtargetof2-3%.Forthepast10+years,theinstitutionalinvestorbaseinJapanhasagreed

tobuy10-year

8/3/2019 48887451-Kyle-Bass-Feb-14

38/134

bondsandreceivelessthan1.5%in

nominalyield,aspersistentdeflationbetween1-3%peryearprovidesthebuyer

witharealyieldsomewherebetween2.5%-4.5%(nominalyieldplusdeflation).(Webelieve

thatJapaneseinstitutionalinvestorsmaybasesomeoftheirinvestmentdecisionsonrealyieldswhereasexternalJGBinvestorsdonot.)IftheBankofJapan

(BOJ)wereto

8/3/2019 48887451-Kyle-Bass-Feb-14

39/134

targetinflationofjust1%to2%,

whatratewouldinvestorshavetochargeinordertohavea

positiverealyield?Inordertoachieveevena2.5%realyield,the

nominal(orstated)yieldsonthebondswouldhavetobeinexcessof3.5%.Hereinliestherealproblem.IftheBOJchoosesan

inflationtarget,the

8/3/2019 48887451-Kyle-Bass-Feb-14

40/134

Japanesecentralgovernmentscostofcapitalwill

increasebymorethan200basispoints(overtime)andincreasetheir

interestexpensebymorethan20trillion(every100basispointchangein

theweighted-averagecostofcapitalisroughlyequalto25%ofthecentralgovernmentstaxrevenue).Forcontext,ifJapanhadtoborrowatFrances

rates(aAAA-rated

8/3/2019 48887451-Kyle-Bass-Feb-14

41/134

memberofthe

U.N.Security

Council),theinterestburdenalonewouldbankruptthegovernment.Theirdebtservice

alonecouldeasilyexceedtheirentirecentralgovernmentrevenue -checkmate.TheZIRPtrapsnaps

shut.Thebond1http://www.bis.org/publ/work300.pdf(p.9)

5

HaymanCapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

42/134

marketstendtoanticipateeventslong

beforetheyhappen,andwebelieveaJapanesebondcrisisislurking

rightaroundthecornerinthenextfewyears.

Below,please

findapieceofourworkdetailingsomeimportantcountriesandthesekeyrelationships:

GovernmentDebt/Revenue(2010E)

2000%1900%

400%300%200%

8/3/2019 48887451-Kyle-Bass-Feb-14

43/134

100%0%

Note:Iceland

dataincludesgrossIcesaveliabilities.Source:MoodysCountryCreditStatisticalHandbook.Japan

datasourcedfromJapaneseMinistryofFinance.

GovernmentInterestExpense/

Revenue(2010E)

35%

30%25%20%15%10%5%0%

Note:IcelanddataincludesgrossIcesaveliabilities.

Source:Moodys

8/3/2019 48887451-Kyle-Bass-Feb-14

44/134

CountryCreditStatisticalHandbook;Haymanestimates;Japan

datasourcedfromJapaneseMinistryofFinanceFY2011budget.

6

HaymanCapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

45/134

WhatotherMacroParticipantsHaveMissed

andtheComingofX-Day

Japanhasbeenakey

focusofourfirmforthelastfewyears.Whileitrepresentsa

smallamountofcapitalatriskintheHaymanCapitalMasterFundL.P.,itremainstheplacewherewebelievethemostasymmetryandoutsized

returnswillbe

8/3/2019 48887451-Kyle-Bass-Feb-14

46/134

generatedinthecomingyears.Wecould

spendanother10pagesdoingadeepdiveintoourentirethesis,

butwewillsavethatforourinvestordinnerscheduledforApril26th.

Fornow,WearegoingtostickwiththecatalystsfortheupcomingJapanesebondcrisis.

Investingwiththeexpectationsofrisingrates

inJapanhas

8/3/2019 48887451-Kyle-Bass-Feb-14

47/134

beendubbedthewidowmakerbysome

oftheworldsmosttalentedmacroinvestorsoverthepast15-20years.

Itisourbeliefthattheseinvestorsmissedacrucialpiecetothe

puzzlethatmighthavesavedthemuntoldmillions(andmaybebillions).TheyoperatedundertheassumptionthatJapaneseinvestorswouldsimplygrowtiredoffinancing

thegovernment

8/3/2019 48887451-Kyle-Bass-Feb-14

48/134

directlyorindirectlywithsucha

lowreturnoncapital.However,webelievethattheabsenceofattractive

domesticinvestmentalternativesandthepreponderanceofnewdomesticsavingsgeneratedeachyear

enabledtheJapanesegovernmenttoself-financebysellinggovernmentbonds(JGBs)toitshouseholdsandcorporations.Thisisdonedespitetheirpreferenceforcashand

timedepositsvia

8/3/2019 48887451-Kyle-Bass-Feb-14

49/134

financialinstitutions(suchastheGovernmentPension

InvestmentFund,otherpensionfunds,lifeinsurancecompanies,andbankslikeJapan

Post)thathavelittleappetiteformorevolatilealternativesandlittleopportunityto

investinnewprivatesectorfixed-incomeassets.Essentially,theytakeinthesavingsasdepositsandrecyclethemintogovernmentdebt.Thus,itisnecessary

tounderstandhow

8/3/2019 48887451-Kyle-Bass-Feb-14

50/134

largethepoolofcapitalforthe

saleofnewgovernmentbonds.

Wefocusonincrementalsales

orflowversusthestockofaggregateddebt.Tosimplify,theavailablepools

ofcapitalarecomprisedoftwoaccountshouseholdandcorporatesector.TheformeristheincrementalpersonalsavingsoftheJapanesepopulation,andthe

latteristhe

8/3/2019 48887451-Kyle-Bass-Feb-14

51/134

after-taxcorporateprofitsofJapanesecorporations.These

twopiecesofthepuzzlearetheincrementalpoolsofcapitalto

whichthegovernmentcansellbonds.Asreflectedinthechartbelow,as

longasthesumofthesetwonumbersexceedstherunninggovernmentfiscaldeficit,theJapanesegovernment(intheory)hastheabilitytoself-financeor

selladditionalgovernment

8/3/2019 48887451-Kyle-Bass-Feb-14

52/134

bondsintothedomesticpoolofcapital.

Aslongasthebluelinestaysabovetheredline,the

Japanesegovernmentcancontinuetoself-finance.Thisisthekeyrelationshipthemacro

investorshavemissedforthelastdecadeitisnotaquestionofwillingness,butoneofcapacity.AstheJapanesegovernmentsstructuraldeficit

growswider(driven

8/3/2019 48887451-Kyle-Bass-Feb-14

53/134

bytheincreasingcostofanageing

population,higherdebtservice,andsecularlydecliningrevenues)thedivergencebetweensavings

andthedeficitwillincrease.Interestinglyenough,AlanStanfordandBernieMadoffhave

recentlyshownuswhattendstohappenwhenthisself-financingrelationshipinverts.Whentheavailableincrementalpoolofcapitalbecomessmallerthantheincremental

7

8/3/2019 48887451-Kyle-Bass-Feb-14

54/134

HaymanCapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

55/134

financingneedsofthegovernmentor

aPonzischeme,therubberfinallymeetstheroad.Theseveredecline

inthepopulationinadditiontoJapaneseresistancetolargescaleimmigrationcombine

toformavolatilecatalystforatoxicbondcrisisthatcouldverylikelybethelargesttheworldhaseverwitnessed.Belowischart

depictingthisrelationship:

8/3/2019 48887451-Kyle-Bass-Feb-14

56/134

JapaneseNetDomesticSavingsvs.

GeneralGovernmentDeficit

(%ofGDP)

18%

16%

14%

12%

10%

8%

6%

4%

2%

0%

-2%

-4%

Excessdomesticsavingsprovidedsignificant

roomforprivateand

8/3/2019 48887451-Kyle-Bass-Feb-14

57/134

publiccreditexpansionatlowinterestratesThe

deficit/savingsgapneedstobefilledfromexternalcapital

NetSavings/GDPDeficit/GDPSource:IMF

WorldEconomicOutlook;JapanNationalAccounts;Haymanestimates.

Personalsavingsin

Japan,whilehistoricallyhigherthanalmostanyothernation,isnowapproachingzeroandwillfallbelowzerointhecomingyears(asrecentlypointed

outbythe

8/3/2019 48887451-Kyle-Bass-Feb-14

58/134

BankofTokyoMitsubishi)asmorepeople

leavetheworkforcethanenter.Foratleastthenext20years,

webelievethatJapanwillhaveoneofthelargestnaturalpopulationdeclines

inadevelopedcountry.

JapaneseHouseholdSavingsRateand60+PopulationRatio

(%)

BTMUbelievesJapanesehouseholdsavingswillcrossintonegativeterritoryin2015thedownwardtrendisirreversiblewithoutasignificantchangeindemographicprofile.Source:BankofTokyo

Mitsubishi.

8/3/2019 48887451-Kyle-Bass-Feb-14

59/134

8

HaymanCapitalManagement,

L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

60/134

OnelastpointaboutJapanthat

ismorepsychologicalthanquantitative:thereisaninterestingpsychologicalparallelbetween

JGBsandUShousing.Inthelast20years,Japanesestockshavedropped

75%,Japaneserealestatehasdeclined70%(withhigh-endrealestatedropping50%inthelasttwoyears),andnominalGDPisexactlywhereit

was20years

8/3/2019 48887451-Kyle-Bass-Feb-14

61/134

ago.Whatoneassethasneverhurt

thebuyer?Whatoneassethasearneda20yearpro-cyclical,Pavlovianresponse

associatedwithsafetyandevenmoresafety?ThebuyersandownersofJGBs

haveneverlostmoneyinthepurchaseoftheseinstrumentsastheirinterestrateshavedonenothingbutfallforthebetterpartofthe

last2decades.

8/3/2019 48887451-Kyle-Bass-Feb-14

62/134

Itisfascinatingtoseeaninstrument/asset

beviewedasoneofthesafestintheworld(10-yrJGB

cashratesarecurrently1.21%)ataperiodoftimeinwhichthe

creditfundamentalshaveneverbeenriskier.WithoutrevealingtheMasterFundspositioninghere,wecertainlyintendtoexploittheinefficienciesofoptionpricingmodelsover

thenextfew

8/3/2019 48887451-Kyle-Bass-Feb-14

63/134

years.Theprimaryflawinpricingthe

riskofrisingJGByieldsistherelianceonhistoricalvolatilitywhich,

tothispointintime,hasremainedverylow.Webelievethatvolatility

willrisesignificantlyandthatcurrentmodelsundervaluethepotentialmagnitudeoffuturemovesinJGByields.

Withalloftheevidenceliterally

stackingupagainst

8/3/2019 48887451-Kyle-Bass-Feb-14

64/134

Japan,afewmembersofsomeof

themajorpoliticalpartiesarebeginningtodiscussandplanforthe

ominouslynamedX-Day.AccordingtoTheWallStreetJournalandBusinessWeek,X-Dayisthe

daythemarketwillnolongerwillinglypurchaseJGBs.Planningisintheveryearlystages,butcentersaroundhavingasetofseriousfiscal

changesthatcould

8/3/2019 48887451-Kyle-Bass-Feb-14

65/134

beannouncedimmediatelywiththeintentionof

givingtheBankofJapanthecovertheywillneedtopurchase

massiveamountsofJGBswithmoneyprintedoutofthinair.Ifthe

BOJweretoengageinthistypeofbehavior,webelievetheYenwouldplummetagainstthebasketofkeyworldcurrencieswhichwouldin

turndriveJapanese

8/3/2019 48887451-Kyle-Bass-Feb-14

66/134

interestrateshigherandfurtheraggravatetheir

bondcrisis.NeithertheFed,theBankofEnglandnortheEuropean

CentralBankhavebeenabletoconsistentlysuppressbondyieldsthroughpurchaseswith

printedmoneythebiggerthepurchase,thegreatertheriskofacollapseinconfidenceinthecurrencyandcapitalflight.Nomatterhow

theyattemptto

8/3/2019 48887451-Kyle-Bass-Feb-14

67/134

quellthecrisis,nomatterwherethey

turn,theywillrealizethattheyareincheckmate.

Will

GermanyGoAll-InoristhePriceTooHigh?

Webelieve

thatanappreciationoftheextentandlimitsofGermancommitmenttofullfiscalanddebtintegrationwiththerestoftheEurozoneiscrucial

tounderstandingthe

8/3/2019 48887451-Kyle-Bass-Feb-14

68/134

pathforwardforEuropeansovereigncreditissues.

DespiteconsistentattemptsbytheEuropeanCommissionandothermembers

oftheEurozonebureaucraticvanguardtopubliclypromoteasdonedealsvariousproposals

toextenddebtmaturities,engageindebtbuybacksanddramaticallyextendboththescopeandsizeoftheEFSFtheoutcomehasremainedin

doubt.In

8/3/2019 48887451-Kyle-Bass-Feb-14

69/134

9

HaymanCapital

Management,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

70/134

theend,thenationalgovernmentsof

thememberstateswilldeterminethesepoliciesregardlessofwhatunnamedEuropean

officialsleak

tothenewswires.

WebelievethatAngelaMerkelhas

heededthediscordintheGermandomesticpoliticalsphere(whereconsistentpollingshowsadeclineinsupportfortheEuroandanincreaseinbelief

thatGermanywould

8/3/2019 48887451-Kyle-Bass-Feb-14

71/134

havebeenbetteroffnotjoining)and,

asaresult,setaseriesofsubstantialcriteriaforanyGerman

approvaloffurtherreformandextensionoftheEFSFstructure.Theareascanvassed

balancedbudgetamendments,corporatetaxrateequalization,eliminationofwageindexationandpensionageharmonizationreadlikeawishlistforremakingthe

entireEurozoneinto

8/3/2019 48887451-Kyle-Bass-Feb-14

72/134

aresponsibleandconservativefiscalactorin

themoldofmodern-dayBerlin.However,webelieve(absentadramaticchange

inthepoliticalmood)thatseveralmemberstateswillneverallowtheserequests

tobecomebindingprerequisitesforfurtherfiscalintegration -theIrishandSlovaksontax,theFrenchonpensionage,theBelgiansandPortugueseonindexationand

almosteverybodyon

8/3/2019 48887451-Kyle-Bass-Feb-14

73/134

thebalancedbudgetamendment.

So

theEurozoneseemstobeatanimpassetheGermansare

reluctanttostepfurtherintothequagmireofperipheralsovereigndebtwithoutassurances

thatallnationswillbecompelledtobringtheirhousesinorder,andtherestoftheEurozonerejectstheburdenofaGermanfiscal

straightjacket.Wecontinue

8/3/2019 48887451-Kyle-Bass-Feb-14

74/134

tobelievethat,intheend,the

Germanpeoplewillnotgoall-intobackstoptheprofligacyandexpediency

oftherestoftheEurozonewithoutacredibleplantorestructureexisting

debtsandensurethattheycanneverreachsuchdangerouslevelsagain.

Avarietyofsolutionshavebeenproposedtoallowthede-facto

restructuringofGreek

8/3/2019 48887451-Kyle-Bass-Feb-14

75/134

debtwithoutengaginginformaldefault.The

ECBandECcontinuetobeobsessedwithpreventingwhattheyhave

deemedtobespeculatorsfrombenefitingviathetriggeringofCDSonGreek

sovereigndebt.Notonlyisthispointlesslystatistinitsoppositiontomarketparticipants,butitisalsocounterproductivetotheirotherstatedaimsof

maintainingfinancialstability

8/3/2019 48887451-Kyle-Bass-Feb-14

76/134

andbanksolvency,asmuchofthe

notionalCDSoutstandingagainstGreeksovereigndebtisheldasabona

fidehedge.DatafromtheDepositoryTrustandClearingCorporation(DTCC)clearlyinvalidates

theassertionthataroguearmyofspeculatorsisinstigatingaGreekbondcrisisforaprofit.AccordingtotheDTCC,thereisonly$5.7

billionnetnotional

8/3/2019 48887451-Kyle-Bass-Feb-14

77/134

CDSoutstandingonsovereignobligationsofthe

HellenicRepublic,versusapproximately$489billionoftotalsovereigndebtoutstanding(as

ofSeptember30,2010).NetCDSonGreeksovereigndebtisequalto

1.2%ofdebtoutstanding.2

AnyrevaluationofdebtthatreducestherealornominalvalueofGreecesdebtoutstandingeitherthroughmaturity

extensionsorthrough

8/3/2019 48887451-Kyle-Bass-Feb-14

78/134

discounteddebtbuybacksnecessarilycreatesaloss

forexistingholders.The

2http://www.dtcc.com/products/derivserv/data_table_i.php?tbid=5.

10

HaymanCapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

79/134

Europeanstresstestsshowedthatup

to90%ofsovereigndebtisheldtomaturitybyinstitutionalplayers,

andthusisstillatriskoffuturewritedowns.Thereisno

incentivetovoluntarilysubmittoanextensionorabuybackthatreducesthenominalorrealvalueofthesebonds,andcoercionwillsimply

forcethelosses.

8/3/2019 48887451-Kyle-Bass-Feb-14

80/134

Intheendthemathematics

ofthedebtsituationinGreeceareinescapablethereismore

than350bnofGreeksovereigndebtandatleast200billionofit

needstobeforgiventoallowthedebttobeserviceablegivencurrentyieldsandthegrowthprospectsoftheGreekgovernmentsrevenues.Thisloss

hastobe

8/3/2019 48887451-Kyle-Bass-Feb-14

81/134

bornebysomeoneeitherbondholdersor

non-Greektaxpayers.ThecurrentpolicyprescriptionthathasGreeceborrowingitsway

outofdebtispurefolly.Thatistherealityofasolvency

crisisasopposedtotheliquiditycrisisthattheEurozonehasassumedtobetheproblemsincelate2008.

Untilaworkableplan

iscreatedthat

8/3/2019 48887451-Kyle-Bass-Feb-14

82/134

sharestheburdenoftheselossesand

thenformalizesarecapitalizationplan,itwillcontinuetofesterandspread

discordintherestoftheEurozone.Infact,itisclearfrom

thepriceandvolumeactioninperipheralbondsthatthereisaneffectiveinstitutionalbuyerstrike,anditisonlythemoneyprintingbythe

ECBthatis

8/3/2019 48887451-Kyle-Bass-Feb-14

83/134

keepingtheseyieldsfromenteringstratosphericlevels

yetstilltheygrindhigher.Someofthismoveinperipheral

Europeanbondyieldshasbeendrivenbybroadermoveshigherinrates,but

puttingthesespreadsaside,itistheabsoluteyieldlevelsthatgovernserviceabilityforthesestatesandbothSpainandPortugalarecurrentfinancingat

unsustainablyhighlevels.

8/3/2019 48887451-Kyle-Bass-Feb-14

84/134

Absentaseriousrestructuringplan,

theEurozonewillcontinuetoreelfromoneminicrisistothe

nexthopingtoputoutspotfiresuntilthebankingedificefinallycomes

crashingdownunderitsownweight.Inourview,itwillseverelyaffectafewstatesconsideredtobeinthecoreofEuropeas

well.

8/3/2019 48887451-Kyle-Bass-Feb-14

85/134

OfIcelandandGreece

We

recentlytraveledtoGreeceandIcelandinordertobetterunderstandthe

situationsineachofthesefinancialwastelands.Wemetwithcurrentandformer

governmentofficialsaswellaslargebanksandothersystemicallyimportantcompaniesandwealthyfamilies.Thistripconfirmedourquantitativeanalysisandultimatelywasa

lessoninpsychology.

8/3/2019 48887451-Kyle-Bass-Feb-14

86/134

Wemetmanyinterestingpeopleinboth

placesbutvirtuallyallofthemlivedinsomestateofdenial

withregardtoeachcountrysfinances.AsMarkTwainoncesaid,Denialaint

justariverinEgypt.

InGreece,theycurrentlyspend14%ofgovernmentrevenuesoninterestaloneandarefranticallyattemptingtoget

toaprimary

8/3/2019 48887451-Kyle-Bass-Feb-14

87/134

surplus.Thisisanalogoustoaheavily

indebtedcompanytryingtogettopositiveEBITDAwhilestillbeingcash

flownegativeduetointerestexpense.TheGreekgovernmentsrevenueisamonstrous

40%ofGDP(only15%intheUS)andGreecehasraisedtheirVATtaxto23%fromjust17%thispastsummer.Wedont

11

8/3/2019 48887451-Kyle-Bass-Feb-14

88/134

HaymanCapitalManagement,L.P.

2011

8/3/2019 48887451-Kyle-Bass-Feb-14

89/134

thinktheycanpossiblyburdentheir

tax-payingpopulationmuchmoreeventhoughtheprevalentthoughtinGreeceis

thattheyneedtotaxthepopulacemoretomakeupforthose

whopaynotax.Greeceskeyproblemstodayareallofthesmallandmediumenterprise(SME)loansthatarebeginningtodefault.Asthe

governmentbeginsto

8/3/2019 48887451-Kyle-Bass-Feb-14

90/134

increasetaxesontheGreeks,businessesare

movingoutofGreecetoplaceslikeCyprus,Romania,andBulgaria(analogous

toCalifornians,Illinoisans,andNewYorkersmovingtoTexas)wheretaxratesare

muchlower.GiventhefiscalsituationinGreece,arestructuringoftheirdebts(i.e.default)seemsthemostprobableoutcome.Atnearly140%sovereigndebt

toGDPand

8/3/2019 48887451-Kyle-Bass-Feb-14

91/134

3.4xdebttogovernmentrevenues,Greeceput

itselfintocheckmatelongago.

Inoneofthemore

comicalmeetingswehaveeverattended,onechiefeconomistatoneofthe

largestbanksinGreecesurmisedthatifthesovereigncouldtransfer100billionofgovernmentdebttothepersonalbalancesheetsofthepopulationthat

itwouldbe

8/3/2019 48887451-Kyle-Bass-Feb-14

92/134

apotentialmagicalfixforthestates

finances(andsubsequentlypointedoutthatGreecewouldnotbesuchanoutlier

as

aresult).WhenaskedhowtheGreekstatecouldaccomplishsuch

afeat,hesaidhedidnotknowandthatmaybeHarryPottercouldfindaway.Itishardtobelieve,buthewas

completelyserious.For

8/3/2019 48887451-Kyle-Bass-Feb-14

93/134

him,itwasntimportanthoworif

itcouldhappenaslongasthepotentialoutcomemadethe

situationlookbetterforprospectivebondinvestors.Greekbankshavebetween33.5xtheir

entireequityinvestedinGreekgovernmentbonds.Considerthatifthesebondstooka70%haircut(Haymansestimateofthenecessarywrite-down),Greekbankswould

losemorethan

8/3/2019 48887451-Kyle-Bass-Feb-14

94/134

twicetheirequity.

Shortlyafter

thismeeting,myhostinformedmeofanauditrecentlydoneon

oneofthelargesthospitalsinAthens.ThishospitalwashemorrhagingEuros,and

theGreekgovernmentisrequiredtomakeupthedeficitwithcapitalinjections.Officialsbegananinquiryintotheselossesandfound45gardenerson

staffatthe

8/3/2019 48887451-Kyle-Bass-Feb-14

95/134

hospital.Themostinterestingfactaboutthe

hospitalwasthatitdidnothaveagarden.Thecorruptionis

endemicinthesociety,anditisnowonderthatGreecehasbeen

aserialdefaulterthroughouthistory(91aggregateyearsinthelast182orapproximatelyhalfthetime).Itisunfortunatethatitisabout

tohappenonce

8/3/2019 48887451-Kyle-Bass-Feb-14

96/134

again.Althoughaswehavepreviously

stated,restructuringisactuallythegatewaytorenewedgrowthandprosperityover

timewehaveidentifiedatleasttwoassetsthatwewouldlike

toowninGreeceinapost-restructuringenvironment.

Iceland,ontheotherhand,hasasimilarbalancesheetanddifferentculture.Icelands

abruptdeclineinto

8/3/2019 48887451-Kyle-Bass-Feb-14

97/134

financialobscuritywasthedrivingforceat

Haymanthatpromptedustolookattheworldthroughadifferent

lens.IfirstencounteredIcelandshistoryandcultureinabookIhad

readseveralyearsagotitledCollapse:HowSocietiesChoosetoFailorSucceedwrittenbyPulitzerPrizewinnerJaredDiamond.Diamondisaprofessorof

geographyatUCLA

8/3/2019 48887451-Kyle-Bass-Feb-14

98/134

andadeterminedenvironmentalist.Hisanalysisis

basedonenvironmentaldamagethat

12

Hayman

CapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

99/134

societiesinflictonthemselvesandthat

thereareothercontributingfactorstoacollapse.Onecommentmadeearly

inthisbookcaughtmyeyemanyyearsago:

Somesocieties

thatIshalldiscuss,suchastheIcelandersandtheTikopians,succeededinsolvingextremelydifficultenvironmentalproblems,havetherebybeenabletopersistfor

alongtime,

8/3/2019 48887451-Kyle-Bass-Feb-14

100/134

andarestillgoingstrongtoday.

-JaredDiamond,Collapse:HowSocietiesChoosetoFailorSucceed.

WhatcaughtmyattentionwasthefactthatDiamondusesIcelandas

acountrythathasbeenabletogetitrightasasocietyforaverylongtime.Whatbroughtthemtotheirkneesin

thelastfew

8/3/2019 48887451-Kyle-Bass-Feb-14

101/134

yearswasacompletedisregardforthe

risksinherentinallowingtheirbankingsystemtogrowunchecked(dueto

theoverwhelminglypositivecontributiontoGDPandjobgrowth).Inanationof

318,000peopleandapproximately$20billionUSDofGDP(2008),Icelandhadover$200billionUSDinassetsinjustthreebanks.Moreimportantly,Iceland

hadover34x

8/3/2019 48887451-Kyle-Bass-Feb-14

102/134

itscentralgovernmentrevenueinbankingassets.

Toputthisintocontext,a3%lossratiointhebanking

systemwouldcompletelywipeoutthebanksandthecountrysabilitytodeal

withtheproblem.Ofcourse,thisispreciselywhathappenedandIcelandfindsitselftodayinastateofsuspendedanimation.Thegovernmentimmediatelyimposed

capitalcontrols(money

8/3/2019 48887451-Kyle-Bass-Feb-14

103/134

wasallowedin,butnomoneywas

allowedout)andbeganaprocessofdeterminingwhichdebtstheycould

payandfromwhichmultilaterallendinginstitutionstheywouldhavetobeg.Conventional

wisdomsuggeststhatIcelandhasturnedthecorneranddealtwithitsdemonsandwillemergestrongerandsmartergoingforward.Unfortunately,wedontbelieve

thattobe

8/3/2019 48887451-Kyle-Bass-Feb-14

104/134

thecaseyet.

Icelandcurrently

spendsanestimated118billionIcelandickroneroninterestexpense(includinggross

interestonIcesaveliabilities)aloneagainstapproximately600billionkronerofrevenuesat

aweighted-averagecostofcapitalofroughly4.7%(evenwithheavilysubsidizedloansfromtheIMFandotherNordiccountries).Withgrossdebtsasa

percentofGDP

8/3/2019 48887451-Kyle-Bass-Feb-14

105/134

(includingIcesave)thatexceedGreece(whose10-yr

bondsyieldover11%),wecouldntfindarealpublicmarketfor

Icelandsdebt.

Today,theirstatedexchangerateofkronertotheUSDhovers

around117andtheblackmarketoroffshorerateforthekroneris176(a33.5%devaluationfromtheonshorerate).Pre-crisis,theofficialexchange

ratewas60

8/3/2019 48887451-Kyle-Bass-Feb-14

106/134

kronertothedollareventhe

onshoreofficialrateshavedevaluedbynearly50%totoday.Governmentrevenue

declinedinnominaltermsthroughoutthecrisisevenwhilethecurrencydepreciatedby

50%!Imaginesufferinga50%devaluationinpurchasingpowerandaconcomitantincreaseinexportcompetitiveness,yetthegovernmentcannotmaintainnominalrevenue,whichis

akeypart

8/3/2019 48887451-Kyle-Bass-Feb-14

107/134

oftherecoveryplantoavoideventual

restructuring.WhileIcelandishardlyanoasisoffiscalreform,weexpect

overtimethatitwillrecognizethatrestructuringwillaffordthebestopportunity

tosharefinancialpainevenlyandrestartalongthepathofgrowth.LikeGreece,wehaveidentifiedattractiveassetsand

13

HaymanCapital

8/3/2019 48887451-Kyle-Bass-Feb-14

108/134

Management,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

109/134

investmentopportunitiesinIcelandoncethe

restructuringoccursandcapitalcontrolsarelifted,allowingthecurrencytodepreciate

furthertowardsarealmarketrate.

Icelandisamicrocosmof

whatwentwrongwiththeworld,butaftertheIMFandNordicloans,attentionwasdivertedawayfromtheproblem.IcelandandIrelandsharesimilar

rootswhenit

8/3/2019 48887451-Kyle-Bass-Feb-14

110/134

comestotheiracuteproblems.Withthe

developmentoftheEuropeanUnionandthecreationofaEuropeanfree-trade

zone,inefficiencies

wereexploitedbetweencountrieswhohaddifferingtaxanddepositstructures.

SmallcountrieslikeIrelandandIcelandcouldactuallycompetewithmuchlargercounterpartsbyofferingslightlyhigherdepositrateswithprogramslikeIcesaveaccounts.The

keyproblemwas

8/3/2019 48887451-Kyle-Bass-Feb-14

111/134

thatnoprovincialregulatorpaidanyattention

tothesizeandleverageineachcountrysbankingsystemsoreven

crossbordercapitalflows.Inmeetingswithkeypoliticians,academics,andregulatorsin

early2009,itbecameclearthatabsolutelynobodywaspayingattentiontothegrosssizeofeachcountrysbankingsystemsortheabilitytodeal

withtheproblems

8/3/2019 48887451-Kyle-Bass-Feb-14

112/134

emanatingfromthecrisis.

Both

IcelandandGreecewillhavetorestructuretheirdebtsbeforetheyare

toattractsustainedforeigndirectinvestmentagain.Webelievelossesontheirgovernment

andgovernmentguaranteedbondswillexceed50%andnewchaptersinfinancialhistorywillbewritten.Untilthen,weaskallofourreadersto

rememberaquote

8/3/2019 48887451-Kyle-Bass-Feb-14

113/134

fromC.NorthcoteParkinson:Delayisthe

deadliestformofdenial.

InflationAnImmediateConcern

Wewillkeepourthoughtsonthissubjectbriefandstraightforward.While

theinflation/deflationdebateisvigorouslydefendedonbothsides,andwecertainlyrecognizetheongoingneedfordeleveragingwhichshouldapplydeflationarypressures,itis

difficulttoignore

8/3/2019 48887451-Kyle-Bass-Feb-14

114/134

simpledatawhichpointstothecontrary.

Infact,wefindveryfewassetsaroundtheworldoutsideof

UShousingthatareactuallydeflatinginvalue.Hardandsoftcommoditiesacross

virtuallyallclassificationscontinuetoclimbinvalue(innominalterms)andmanyareatornearall-timehighs.

14

HaymanCapitalManagement,

8/3/2019 48887451-Kyle-Bass-Feb-14

115/134

L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

116/134

CommodityPriceIndiciesfromJanuary2009

White=FrontmonthWTICrudeFutureRed=

BloombergSpotPreciousMetalsIndexYellow=BloombergSpotBaseMetalsIndexGreen

=UBSBloombergCMCIAgricultureIndexSource:Bloomberg.

AveryinterestingchartfromarecentGoldmanSachsresearchpublicationcaughtourattention.The

authorshighlightedthe

8/3/2019 48887451-Kyle-Bass-Feb-14

117/134

severeriskstoheadlineinflationstemmingprimarily

fromglobalfoodprices.Morespecifically,theyassesstherisktoheadline

inflationonacountry-by-countrybasisinascenariowherelocalfoodpricescatch

uptointernationalfoodpricesinlocalcurrency(aswasthepatterninthe2007-2008foodinflationspike).

Theresultsarealarming:

PhilippinesDec-10

8/3/2019 48887451-Kyle-Bass-Feb-14

118/134

2.99HeadlineifInternationalFoodPricesRemain

atCurrentLevelsQ22011Change10.067.07SwitzerlandDec-100.52Headline

ifInternationalFoodPricesRemainatCurrentLevelsQ22011Change1.581.06

Russia8.7315.006.27Japan0.000.920.92China4.769.064.30Mexico4.435.090.66Chile2.996.593.60Poland2.903.550.65Korea

3.506.252.75

8/3/2019 48887451-Kyle-Bass-Feb-14

119/134

Euroland2.192.710.52Israel2.575.24

2.67Indonesia7.007.340.34Turkey6.409.062.66Hungary4.614.83

0.22Singapore4.586.632.05Sweden2.112.200.09HongKong3.084.77

1.69UK4.774.55(0.22)Brazil5.787.441.66Taiwan0.640.30(0.34)SouthAfrica3.484.871.39India8.297.53(0.76)USA1.392.54

1.15Norway2.72

8/3/2019 48887451-Kyle-Bass-Feb-14

120/134

1.75(0.97)CzechRepublic2.333.401.07

Source:GoldmanSachsGlobalEconomics,CommoditiesandStrategyResearch,Global

Viewpoints,February9,2011.15

HaymanCapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

121/134

Webelievethatthatcommodityprice

inflationhasprimarilybeendrivenbydemandcoupledwith(insomecases)

supply-sideshocksin2010.Interestingly,UnitedStatescoreinflationwillnotmovematerially

untiltheUShousingmarketturns,whichwebelievecouldbeupto3yearsaway.Thereasonforthisphenomenonisthathousing(excluding

theenergycomponent)

8/3/2019 48887451-Kyle-Bass-Feb-14

122/134

comprisesroughly37%oftheheadlineCPI

calculationand49%ofthecoreCPIcalculation3.Therestisjust

details,especiallywhenfoodandenergyareremoved.Unfortunately,ifyoueator

driveeveryday,youarealreadyfeelingtheimpactofinflation.

UnweightedCPIComponents(December2008=100)

95100105110115120125130Dec-08Jan-09

Feb-09Mar-09Apr-09

8/3/2019 48887451-Kyle-Bass-Feb-14

123/134

May-09Jun-09Jul-09Aug-09Sep-09Oct-09Nov-09

Dec-09Jan-10Feb-10Mar-10Apr-10May-10Jun-10Jul-10Aug-10Sep-10Oct-10Nov-10

Dec-10

HeadlineCPICoreCPIFoodEnergyHousingMedicalCareOther

Goods&ServicesRecreationTransportationApparelEducation&Communication

Note:HousingandTransportationcomponentsshownaboveeachincludetheirrespectiveenergycomponents(approximately

10%and29%

8/3/2019 48887451-Kyle-Bass-Feb-14

124/134

ofHousingandTransportation,respectively).Forillustrative

purposes,Energyisalsoshownasaseparateitem.Source:FederalReserve

BankofSt.Louis.

Justremember:

Hyperinflationsarealways

causedbypublicbudgetdeficitswhicharelargelyfinancedbymoneycreation.Ifinflationacceleratesthesebudgetdeficitstendtoincrease(TanzisLaw).

-PeterBernholz,Monetary

8/3/2019 48887451-Kyle-Bass-Feb-14

125/134

RegimesandInflation.(EmphasisAdded)

WithHelicopterBenprinting$3.3billionperday($2.3millioneveryminute),

theconsequencesofthisfinancialexperimentcouldbestaggering.

3http://www.bls.gov/cpi/cpiri2010.pdf.

16

HaymanCapitalManagement,L.P.2011

8/3/2019 48887451-Kyle-Bass-Feb-14

126/134

DoesDebtMatter?

We

spendalotoftimethinkingaboutanddiscussingsystemicrisk.This

isnotbecausewearenaturalpessimists;rather,webelievethatmanyinvestors

cannotseetheforestforthetreesastheygetcaughtupintheshort-livedeuphoriaofthemarkets.

Weaskourselves,and

urgeyouto

8/3/2019 48887451-Kyle-Bass-Feb-14

127/134

askyourselfonesimplequestion:Doesdebt

matter?Itwasexcessleverageandcreditgrowththatbroughttheglobal

economytoitsknees.Since2002,globalcredithasgrownatanannualized

rateofapproximately11%,whilerealGDPhasgrownapproximately4%overthesametimeframecreditgrowthhasoutstrippedrealGDPgrowthbyan

astounding275%.We

8/3/2019 48887451-Kyle-Bass-Feb-14

128/134

believethatdebtwillmatterlikeit

haseverytimesincethedawnoffinancialhistory.Withoutaresolution

ofthisglobaldebtburden,systemicriskwillfesterandgrow.

Whilewepositionourselvesdefensivelyagainsttheriskswehaveidentified,weareopportunisticinotherareasoftheportfolioandareconstantlyseekingunique

situationsacrossmultiple

8/3/2019 48887451-Kyle-Bass-Feb-14

129/134

assetclasses,longandshort.Weare

enthusiasticaboutsharingmoredetailonsomeofourkeypositionsat

ourupcominginvestordinneronApril26thinDallas.Atthedinner,the

investmentteamwilldiscussindetailsomeofthewaysinwhichweintendtoopportunisticallycapitalizeonourmacroviewsdiscussedherein.

BestRegards,

8/3/2019 48887451-Kyle-Bass-Feb-14

130/134

J.KyleBassManagingPartner

Theinformationsetforthhereinisbeingfurnishedonaconfidentialbasis

totherecipientanddoesnotconstituteanoffer,solicitationorrecommendationto

selloranoffertobuyanysecurities,investmentproductsorinvestmentadvisoryservices.Suchanoffermayonlybemadetoeligibleinvestorsby

meansofdelivery

8/3/2019 48887451-Kyle-Bass-Feb-14

131/134

ofaconfidentialprivateplacementmemorandumor

othersimilarmaterialsthatcontainadescriptionofmaterialtermsrelatingto

suchinvestment.Theinformationandopinionsexpressedhereinareprovidedforinformationalpurposes

only.AninvestmentintheHaymanFundsisspeculativeduetoavarietyofrisksandconsiderationsasdetailedintheconfidentialprivateplacementmemorandum

oftheparticular

8/3/2019 48887451-Kyle-Bass-Feb-14

132/134

fundandthissummaryisqualifiedin

itsentiretybythemorecompleteinformationcontainedthereinandinthe

relatedsubscriptionmaterials.Thismaynotbereproduced,distributedorusedforany

otherpurpose.Reproductionanddistributionofthissummarymayconstituteaviolationoffederalorstatesecuritieslaws.

17

Hayman

CapitalManagement,L.P.

8/3/2019 48887451-Kyle-Bass-Feb-14

133/134

2011

8/3/2019 48887451-Kyle-Bass-Feb-14

134/134