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					Foreseeing the Recession of ‟08: An Evaluation of the Paper Trail
                                   August 7, 2009


Summary

        In order to understand and evaluate my historical projections on the U.S.
economy, I have recreated a „paper trail‟ of my communications dating back to early
2006. On the whole, my early and more pessimistic forecasts of key economic trends
proved quite accurate, in contrast to those of the consensus economists. I called
attention to notable institutions in danger and thus far, have accurately pinpointed
the bottom of the housing market. However, I failed to identify all the mechanisms
that would lead to the current recession by underestimating the swift pull-back
response of the American consumer and overestimating the impact of rising
inflation. Any true demand shifts in driving and vehicle demand, as well as the
permanence of changes in consumer behavior, remain unknown. Overall Grade: B


The „Paper Trail‟

       Sifting through blog posts, emails, and presentations, I have pieced together
my thoughts on the economic environment. I now have the luxury of evaluating this
„paper trail‟. The evaluation includes the following.

      Date and nature of communication
      Table of economic metrics relevant to time period (see below). Though some
       communications came several times in a single month, the economic
       indicators are listed only once.

       Indicator               Description
       GDP Growth              Annualized YOY growth, previous quarterly reading
       Unemployment Rate       Seasonalized unemployment rate, previous month
       Inflation               CPI for all items, YOY rate, previous month
       Savings Rate            Personal savings rate, previous month
       Interest Rate           3-month Treasury bill, average for previous month
       Stock Market            S&P 500 YOY returns, previous month
       Vehicle Market          Total vehicle unit YOY growth, previous month
       Housing Market          Existing home sales YOY growth, previous quarter

      Text of communication. Please note: Comments proprietary to former
       Employer have been deleted and noted in blue font.
      Interspersed post-hoc commentary, indicated by red font
      Evaluation and qualitative grade of communication, indicated by red font


The paper trail begins on the next page, on April 2, 2006.
April 2, 2006 (Source: Personal blog: http://kevinmabe.blogspot.com)


                                                                                 Today
Indicator           Mar 2006    Jul 2006 Dec 2007 Apr 2008 Jun 2008 Aug 2008    Jul 2009
GDP Growth               5.4%        1.5%     2.1%    -0.7%     1.5%    -2.7%       -1.0%
Unemployment Rate        4.7%        4.7%     5.0%     5.0%     5.6%     6.2%        9.5%
Inflation                3.4%        2.4%     4.1%     3.9%     5.0%     5.4%       -1.4%
Savings Rate             1.0%        0.3%     0.4%     0.0%     2.5%     0.8%        6.9%
Interest Rate            4.5%        4.8%     3.0%     1.3%     1.9%     1.7%        0.2%
Stock Market             8.3%       20.7%     4.4%    -5.3%   -16.7%   -11.8%      -27.0%
Vehicle Market          -2.4%      -13.1%    -4.2%    -6.8%   -18.1%   -15.4%      -33.9%
Housing Market          -0.7%       -6.1%   -23.2%   -15.7%   -16.7%   -15.0%        3.8%



“... [But] wasn't the economic boom of the 1990's a good thing? Yes, but the source of
the growth was consumption and government spending, not saving and associated
investment. Indeed, our investments were sent abroad and funded a trade deficit for
our consumption.

Post-hoc Note: The blanket statement of investments sent abroad does not tell the
more complete story. Progress in domestic investment did occur.

So where are we today? We are the largest economic superpower in the world. We
also have a government deficit and a trade deficit to show for it, and we just posted a
negative savings rate for last year, the first time since the Great Depression. This
means that the average American spent every last cent of his paycheck, and then
some. Sure, we're growing, but at the expense of tomorrow…”

Post-hoc Note: The Bureau of Economic Analysis restated the NIPA accounts,
including the historical savings rate. The BEA now shows negative rates only for
October, 2001 and August, 2005, stemming from capital write-downs associated with
the 9/11 terrorist attacks and Hurricane Katrina. Suffice to say, however, savings
rates remained close to zero since 2006.

“Furthermore, our economic boom of the 1980's and 1990's has created a negative
side effect. We are accustomed to easy money and feel entitled to immediate
satisfaction. Enjoy good times now, and forget the future. No need to sacrifice, we
can have it all. The negative savings rate is testament to these delusions and the
increased credit debt shows our lack of concern for the future…”

“Can it be fixed? Again, my short answer is yes.

First, we must save. Saving creates funds for entrepreneurs and college education.
Second, we use these savings for domestic investment in … capital goods,
infrastructure, and education, not for additional consumption. Over time, this
increased investment leads to economic growth stemming from durable investment
rather than short-lived consumption goods like iced lattes and designer jeans.
Post-hoc Note: Consumption still drives two-thirds of the American economy. Not
all monies can and should go away from nondurable goods. I still do enjoy a good
cup of coffee, after all.

So why isn't this being done? It would require a change of thinking, and would
actually lead to a short-term economic decline because of immediate scaled-back
consumption. Americans would have to find it desirable to give up consumption (not
just postpone it) and save a portion of their salaries. They would have to endure the
inevitable six- to twenty-four- month duration of economic decline, as these funds
are lent out for domestic investment and education. What politician would advocate
poor growth? However, the growth rate obtained by this mode of thinking
eventually exceeds that driven by consumption and positively contributes to the
future viability of this country. Let the manufacturing jobs be shipped overseas, but
let us instead innovate to control the manufacturing processes [emphasis added].
Knowledge is power. Flexing our muscle has worked in the past, but if we don't start
using our brain, we will have to settle a position in the top ten, rather than number
one.”

Post-hoc Note: After the fact, it appears that the recession incited the stark rise in
the savings rate, rather than the American consumer proactively saving for the
rainy day. The storm had already brewed. Time will tell as to whether the upper
bound of the above economic decline („twenty-four months‟) will be reached.


Evaluation: The communication provided the set-up of what I still believe to be the
root of the current recession – entitlement and excess. This blog post was the
warning shot, though very light on some of the impending circumstances.

Grade: B+
August 14, 2007 (Source: Presentation to Management)


                                                                                 Today
Indicator           Mar 2006    Jul 2006 Dec 2007 Apr 2008 Jun 2008 Aug 2008    Jul 2009
GDP Growth               5.4%        1.5%     2.1%    -0.7%     1.5%    -2.7%       -1.0%
Unemployment Rate        4.7%        4.7%     5.0%     5.0%     5.6%     6.2%        9.5%
Inflation                3.4%        2.4%     4.1%     3.9%     5.0%     5.4%       -1.4%
Savings Rate             1.0%        0.3%     0.4%     0.0%     2.5%     0.8%        6.9%
Interest Rate            4.5%        4.8%     3.0%     1.3%     1.9%     1.7%        0.2%
Stock Market             8.3%       20.7%     4.4%    -5.3%   -16.7%   -11.8%      -27.0%
Vehicle Market          -2.4%      -13.1%    -4.2%    -6.8%   -18.1%   -15.4%      -33.9%
Housing Market          -0.7%       -6.1%   -23.2%   -15.7%   -16.7%   -15.0%        3.8%



The Problem
 Since the 1980s, economic growth has been fueled by consumption
      o Economy transitioned from an industrial- to service-based structure
      o Consumption grew significantly in nondurable goods…
      o Investment in durable good and infrastructure has declined in relativity
 Consumption has been fueled by economic and social factors
      o Easy credit, stock market, and housing boom has created more disposable
          wealth
      o Baby boomers saw their incomes and wealth grow since the 1980s
      o Gen-X and Y are instilled with a weaker sense of thrift
      o Media sells the social mantra: You can have it all and you deserve it
 The problem: Today‟s generation sacrifices tomorrow for today

 The question: What happens when money runs out and spending declines?


The Result
 Credit problems have emerged
      o Questionable lending practices in subprime sector of home loans
      o Scandal in student loan industry…
      o American Express delinquencies spiked in 2Q2007
      o Rise in foreclosures
      o FTC and Federal Reserve studies of use of credit in insurance
      o Next anticipated congressional outcry: Credit card companies
 When the money and credit runs out, the spending stops
 The U.S. economy will be sluggish to return to an economic growth structure not
   overwhelmingly dependent on consumption
 A generation must be re-trained to value saving and investment in capital

 The answer: The economy slows down

Post-hoc Note: The presentation identified credit issues slightly ahead of the
general consensus, but the projection that credit card companies would serve as the
next punching bag has still not proven quite accurate.
Mitigating Factors
 More options than in the 1970s to shift money and funds
       o Global markets more liquid than ever before
       o Under-the-radar hedge funds provide an alternative investment vehicle
 Economic oversight more sophisticated than in years past
       o Federal Reserve more hands-on and knowledgeable
       o Bernanke currently holding course to balance inflation with economic
          stagnation
 The Election of 2008
       o Removal of an unpopular President should boost confidence in the U.S.
       o The euphoria doesn‟t last long

 The severity of the slowdown will be tempered

Post-hoc Note: One may easily argue that hedge funds created more problems than
they solved. Debate currently surrounds the efficacy of the regulators and watch-
dogs of the overall system. Confidence has generally increased since Obama‟s
election, and euphoria did wane. Overall, though, I overestimated the extent of
these mitigating factors as the severity of this current recession continues.


Evaluation: Once again, this presentation sets the stage and identifies the source of
some problems (i.e. credit), but placed too much confidence on regulatory oversight.

Grade: B-
January 4, 2008 (Source: Email to Management)


                                                                                  Today
Indicator            Mar 2006    Jul 2006 Dec 2007 Apr 2008 Jun 2008 Aug 2008    Jul 2009
GDP Growth                5.4%        1.5%     2.1%    -0.7%     1.5%    -2.7%       -1.0%
Unemployment Rate         4.7%        4.7%     5.0%     5.0%     5.6%     6.2%        9.5%
Inflation                 3.4%        2.4%     4.1%     3.9%     5.0%     5.4%       -1.4%
Savings Rate              1.0%        0.3%     0.4%     0.0%     2.5%     0.8%        6.9%
Interest Rate             4.5%        4.8%     3.0%     1.3%     1.9%     1.7%        0.2%
Stock Market              8.3%       20.7%     4.4%    -5.3%   -16.7%   -11.8%      -27.0%
Vehicle Market           -2.4%      -13.1%    -4.2%    -6.8%   -18.1%   -15.4%      -33.9%
Housing Market           -0.7%       -6.1%   -23.2%   -15.7%   -16.7%   -15.0%        3.8%



The Bureau of Labor Statistics released the unemployment rate for December --
5.0%, slightly higher than economists' projections. Economists projected a 4.8% rate
and were surprised by the posting.

I am concerned for a different reason. In following unemployment trends since the
Second World War, I believe this figure represents the start of a sharp turning point
toward markedly higher unemployment this year, well into 2009 and perhaps part of
2010. Considering other factors I've been following, I believe the risk of sluggish
economic growth is now perhaps unstoppable.

THE DETAILS:

Unemployment rates are fairly stable measurements, and aside from
monthly/quarterly seasonality, they follow regular patterns. The cause of this
stability stems from stickiness in wages to difficulty in hiring/firing employees to lag
times in finding work. Below is a quick-n-dirty chart of monthly unemployment
rates since 1948 (thick black line is the 12-month moving average, thin gray line is
the unadjusted data).
                                                   Unemployment Rates

                            12.0%


                            10.0%
  U ne m plo ym e nt Rate




                            8.0%


                            6.0%


                            4.0%


                            2.0%


                            0.0%
                                    1948




                                           1956




                                                  1964




                                                         1972




                                                                      1980




                                                                              1988




                                                                                     1996




                                                                                            2004
                                                                Month/ Year



Because of this stability, one must wonder at any point in the line when the next
'turning point' will occur. These jumps in unemployment can be several percentage
points lasting for one to three years before peaking and then declining once again.
There have been a few 'false turning points', most notable in 1995, when
unemployment ticked up then continued a downward path.

Based on some analysis I completed a few months ago, when unemployment of
month X is higher than unemployment two years' prior (24 months ago), the turning
point has been reached and unemployment climbs. With exceptions in the mid-
1960's, this 'pattern' appears to have stood for 60 years. December's reading is
higher than that of December, 2005, indicating a high probability that we've reached
a turning point.

Post-hoc Note: I fully admit that this pattern appears quite simplistic and includes
no cause-effect. However, I am truly surprised that even this simplistic
unemployment rate projection remained far more prophetic, far sooner, than
consensus forecasts. The U.S. labor market appears to act like an aircraft carrier –
slow to turn, and prone to past behavior. I still do not understand why in January,
2008, I saw consensus forecasts painting a rosy employment situation.

It is my belief that unemployment's rise is nearly inevitable this year. I had said
several times last year that 2008 was going to be a rough year, and we have another
piece of evidence. We're already seeing indications that banks will be writing off
billions more for 4Q2007 earnings. Saving rate has once again dipped in the
negative territory and credit card delinquencies are on the rise. If oil and food prices
continue their upward climb, Bernanke will have a difficult time in cutting rates
drastically because of inflation fears. Surprising to me is that Bernanke has
*already said* more rate cuts will follow, even despite the rising prices. Either is he
is not worried about the impact on inflation (doubtful) or he is seeing much more
weakness than anyone would truly be comfortable with (more likely). If Bernanke is
unable to use interest rate cuts to combat the slowing economy, we might be in for
*stagflation*, where unemployment and inflation both rise at the same time. This
has not happened in the U.S. since the 1970s, sparked by the oil crises during
Nixon's administration. It is a frustrating time for both government and the Fed
because they have few tools to combat it, except for time. Stagflation is not unlike
the flu where no medicine really cures except for time, rest, and rebalance.

Post-hoc Note: Banks did in fact wrote off billions more for 4Q2007, well into 2008.
Fears of stagflation, however, appear unfoundedly alarmist.

Why do we care?

Aside from personal investment and financial choices and mere curiosity, rising
unemployment has implications for the insurance industry. [proprietary text
deleted]. More concerning, though, is that should this rise in unemployment occur
this year, there are too many indicators to [sic, should read “that”] suggest that the
economy will slow down… [proprietary text deleted]



January 17, 2008 (Source: Email to Management)


This week, we are hearing of the billions of dollars of write-offs for 4Q2007 earnings
from the large banks and investment houses. This news is not good. After 3Q2007
write-offs, I cautioned that if we see any write-offs for the 4th quarter in similar
magnitude, then we are in serious trouble. Well, the write-offs announced this week
are of the order of tens of billions. Other factors have come into play in the past few
weeks:

-- Retail spending for the 2007 holiday season was at the lowest growth pace in years
-- Bernanke and crew have announced several times that a rate cut is coming
-- Bernanke is calling for *fiscal* policy to help stave off slow growth
-- Housing starts are at the lowest level since 1991
-- Inflation in 2007 is at an abnormally high level overall

Post-hoc Note: The game-theory evaluation of the implication of 4Q2007 bank write-
offs appeared correct.

Fiscal policy tends to have a quick effect, but it takes a long time to implement.
(This is in contrast to Bernanke monetary policy which is quick to implement, but
slow to take effect.) The hidden message here is not for the call of fiscal boost, but
for the call of such a boost from BERNANKE himself. Read between the lines and
this is a quiet admission that monetary policy alone will not save 2008 from
slowdown. Bernanke can't cut rates too low or he'll have to worry about higher
inflation, which we are already in the midst of dealing with.

Post-hoc Note: Bernanke and others have indicated that indeed, fiscal stimulus
must accompany his monetary policy. In 2008 and 2009, massive fiscal policy
included tax refunds and bailout packages.

As a final point, whether we are/will be in a 'recession' ultimately doesn't matter. A
'recession' is a legalistic definition, much like whether a murder is first-degree,
second-degree, or manslaughter. The end result, though, is a fatally wounded
person. Thus, whether we have 'slow growth' or a 'recession', all will view the
economy as being 'poor'.

Dealing with the economy this year will be like the flu. The only real cure will be
time -- time for unbalanced forces to come back into line. Savings. Investment.
Spending. Unproductive workers in the wrong jobs. Bernanke and Congress can
help some of the symptoms, but they cannot cure the flu.

I'm projecting a real GDP growth for 2008 around 0.75% for the year, the lowest rate
since 2001. I hope I'm wrong. [Proprietary text deleted]


Evaluation: These two emails defined my career as Farmers‟ economist. They
represent a watershed event in my drawing a line in the sand that did not agree
with most economists. Aside from comments relating to stagflation, these emails
foretold the economic storm.

Grade: A
May 1, 2008 (Source: Email to Management)


                                                                                 Today
Indicator           Mar 2006    Jul 2006 Dec 2007 Apr 2008 Jun 2008 Aug 2008    Jul 2009
GDP Growth               5.4%        1.5%     2.1%    -0.7%     1.5%    -2.7%       -1.0%
Unemployment Rate        4.7%        4.7%     5.0%     5.0%     5.6%     6.2%        9.5%
Inflation                3.4%        2.4%     4.1%     3.9%     5.0%     5.4%       -1.4%
Savings Rate             1.0%        0.3%     0.4%     0.0%     2.5%     0.8%        6.9%
Interest Rate            4.5%        4.8%     3.0%     1.3%     1.9%     1.7%        0.2%
Stock Market             8.3%       20.7%     4.4%    -5.3%   -16.7%   -11.8%      -27.0%
Vehicle Market          -2.4%      -13.1%    -4.2%    -6.8%   -18.1%   -15.4%      -33.9%
Housing Market          -0.7%       -6.1%   -23.2%   -15.7%   -16.7%   -15.0%        3.8%



As you may have heard, the Fed lowered key interest rates by a quarter-point, as
expected by Wall Street. Because of the continued strong pace of gas and food
inflation, it is my opinion that the Fed has already overplayed its hand, and the
interest rate cuts will most likely stop. Bernanke's speech yesterday indicates this
may be true. This morning, consumer spending showed continued growth, despite
the slowing economy. The savings rate is still essentially zero.

Post-hoc Note: Bernanke eventually brought the interest rates even lower, as again,
fears of rampant inflation appeared overblown.

What surprised most surveyed economists was the large rise in jobless claims (+35K
actual vs. +18K expected). [Proprietary text deleted]. For the past five months, I've
forecasted a turning point in unemployment from about 4.6% in 2007 to 5.5% or
higher in 2008. Preliminary estimates show it gained 0.1 points and now stands at
5.2%. I expect neither the recent rate cut nor the fiscal stimulus checks to curtail
the increase in unemployment. [Proprietary text deleted].

Post-hoc Note: Judging the trend, it appears that in fact, neither the rate cuts nor
stimulus check greatly influenced the onward creeping rise of unemployment.


May 19, 2008 (Source: Email to Management)


This morning I read an article on CNN.com that states that the credit crisis might
be nearing an end, though lower GDP growth and higher unemployment will remain
in its wake. (link --> [Link defunct])

The National Association of Business Economics has revised their forecast for both
GDP growth (general economic well being) and unemployment for the remainder of
2009. I wanted to give you a somewhat historical perspective on what has been
forecasted for 2008 for both indicators. Doing so highlights two main points.

1) Forecasts are forecasts and thus they can be volatile. But...
2) ... even in the economic community, you will not find extraordinary ownership
and responsibility of the performance of forecasts made in the past. …[My manager]
and I have been adamant about measuring the accuracy of my forecasts so that we
can all learn about changing assumptions, employing better methodology, and
frankly, building credibility. It's simply good business practice to be held
responsible for what you say might happen.

Post-hoc Note: I concede that ownership of forecast performance may exist, but it
nevertheless often remains internal to the entity. I rarely see the entities publicly
evaluate their forecasts.

Here is a summary of the two indicators, including forecasts from both the
community as well as my own.

YOY Real Growth in Gross Domestic Product (general economic health) for 2008

Forecast Date        Owner                         Projection
Fall, 2007           Fed Reserve                   2.5% to 3.0%
December, 2007       Mabe, Farmers Inc.                0.8%
December, 2007       Fed Reserve                   1.8% to 2.5%
February, 2008       Fed Reserve                   1.3% to 2.0%
February, 2008       NABE                             1.8%
May, 2008            NABE                             1.4%

Unemployment for 2008

Forecast Date        Owner                         Projection
Fall, 2007           Fed Reserve                      4.5%
December, 2007       Economic Consensus               4.8%
December, 2007       Mabe, Farmers Inc.            5.5% to 6.0%
December, 2007       Fed Reserve                   4.8% to 4.9%
February, 2008       Fed Reserve                   5.2% to 5.3%
February, 2008       NABE                             5.2%
May, 2008            NABE                             5.3%

Note that the other forecasts for GDP have been continually ratcheted downward
while those for unemployment have been creeping upwards. If I am truly correct on
my unemployment figure, then unless the behavior of that indicator has changed
from that established in the past 60 years, we are headed for a spike in the next
three to six months. We have already passed the "turning point" a few months ago.
It is my expectation that we will see some "surprise" unemployment rise this
summer.

Post-hoc Note: The email forecasts a spike in the unemployment rate and surmised
it would surprise most economists. Both occurred.

How will this happen?
Inflation (yes, even excluding food and gas) has been running hot lately. My
opinion: The Fed overplayed its hand in cutting interest rates. As the pressure
builds to stop cutting rates or even raise them to combat inflation, the economy will
respond by slowing down even more. I believe this slowing will push unemployment
higher. Yes, the rebate checks have been sent, however only a third of consumers
will blow them on new TVs and vacations. The rest will pay down debt, use them for
mortgage payments, or save them. While it may be true that the credit crisis is over,
there is enough evidence to suggest that credit is still tight. Even owners of
traditionally good credit scores are having a more difficult time getting a loan. After
billion-dollar write-downs, banks are wary.

Post-hoc Note: The credit crisis continued in the form of tight credit, but this
portion of the email remains wholly incorrect. Inflation, and associated interest rate
increases, did not serve as a major factor in the worsening economy.

Are we in a recession? Will we enter one?

Aside from investment advice, this is the #1 question I am asked. My answer is this:
It doesn't matter. The term 'recession' is academic…. Whether we end up with a
plus 1.0% or negative 1.0% growth, it's still far lower growth than average. We all
KNOW the economy is slowing down. Thus, our customers and our business will
both be impacted. We must continue to strive to understand the impact and plan
accordingly…[Proprietary text deleted].



May 20, 2008 (Source: Email to Management)


[In response to a request regarding the impact of subprime meltdown]

I'd like to first give a very brief history of the subprime disaster. Doing so will
uncover the underlying reasons as well as address [your questions]. [Proprietary
text deleted]. The subprime mess is a symptom of a greater problem.

The U.S. economy in the 1990's, fueled by consumption, was strong. Interest rates
(and thus, mortgage rates) were low, beginning to fuel the housing run-up. After the
stock market burst in 1999 and 2000, the investing public began to search for the
next best "thing". Speculators and euphoria ensued, pushing up demand for
housing. With the seemingly unstoppable increase in housing prices, a portion of
consumers used their houses like ATMs, using second and third mortgages to do so.
Credit practices ran unchecked, and a combination of shifty lenders that preyed on
subprime risks, speculators in bubble markets (such as CA, AZ, and FL), and
consumers with entitlement mindsets living far beyond their means all created the
perfect storm. Add in the packaging and repackaging of these loans to sell on Wall
Street, and this storm was buried under the financial rug of banks and investment
houses.
This all works in an ever-increasing housing market. It doesn't when the economy
turns south.

Post-hoc Note: Whether speculation per se added to the issues with the housing
market, this simplification proved more accurate than not, though did not tell the
whole story.

As the first of the adjustable rate mortgages began to adjust in 2005, the bubble
began to burst. Consumers were no longer able to pay the much-higher mortgage
payments and began to cut back on other spending. Keep in mind that these type
mortgages were written rampantly until around 2006, which means the canary has
not finished singing. In fact, many of these loans will begin to adjust this fall, and
that is one reason why there is such a rushed push in Congress to remedy the
situation through bailouts and rate-freezes. Because consumption drives 70% of the
U.S. economy, and because consumers now can't tap into their house to borrow
against equity, they turned to short-term credit, thinking that this problem was
short-lived. Unfortunately, it's not.

Post-hoc Note: This impact appears more accurate.

So where are we today?

-- Housing prices must fall significantly in order to clear out the excess inventory
(now around 10 months supply). [Proprietary text deleted].
-- The U.S. savings rate is essentially zero, implying that the average U.S.
consumer spends all of his after-tax disposable income. The rate was 4% ten years
ago and 7% twenty years ago. The last time that the savings rate was zero? The
Great Depression.
-- Foreclosures have increased 58% in 1Q2008, particularly in southern CA,
Phoenix, Las Vegas, Denver, Detroit, and Florida's coasts.
-- Delinquency rates on all real estate loans are now 3.4%, the highest in 17 years
(subprime delinquency rates are far higher). Delinquency rates on credit cards are
4.7%, the highest in six years, and are increasing.
-- Banks have written off tens of billions in the past year. Countrywide went under.
Bear Sterns went under. Consensus among most economists is that another major
bank will fail this year.
-- The economy has slowed. Unemployment is rising, and the Fed's ability to
combat the problem through monetary policy is tight, particularly because inflation
is rising out of their comfort zone.

And so with that history, I answer [your questions]:

1) Liquidity issues: The increase in delinquencies, coupled with tighter reforms in
bankruptcy code in 2004, has made banks more wary in issuing credit.
2) Mortgage interest rate impacts: Though interest rates you hear about in the
news have been cut by the Fed, the mortgage rates have not followed suit,
illustrating the effects of increased risk of lending. (Incidentally, one reason why the
mortgage rates did not track the lowering of interest rates from 2001 to 2005 was
because the demand for mortgages was so strong in the ever-booming housing
market. To optimize revenue and profit, banks had the incentive to keep rates
high).




3) [Proprietary text deleted].

4) [Proprietary text deleted].



May 21, 2008 (Source: Email to Management)
All:

A few days ago I sent out an email regarding an updated forecast by the NABE. The
Federal Reserve has just revised its own estimate for 2008…. These new projections
now corroborate my expectations I forecasted five months ago…. The equity
markets have reacted to the news today, as the magnitude of these downward
adjustments are not insignificant. The Fed's expectation on inflation has also
increased a full percentage point, which is certain to affect their decision to stop
cutting rates and discuss raising them, further exacerbating the economic slowdown.

In order for the Fed's forecast to "come true", the Fed must see the economy contract
for a few quarters this year and unemployment spike in the next 6 months. My
comments a few days ago regarding unemployment were similar. While I'm
reluctant to revise my GDP forecast, I fear that unemployment might hit the higher
end of my range by year end.

Post-hoc Note: The upward march of unemployment, and the Fed‟s fears, came to
pass.

Link to related article: [Link defunct]

YOY Real Growth in Gross Domestic Product (general economic health) for 2008

Forecast Date        Owner                       Projection
Fall, 2007           Federal Reserve             2.5% to 3.0%
December, 2007       Mabe, Farmers Inc.             0.8%
December, 2007       Federal Reserve             1.8% to 2.5%
January, 2008        Federal Reserve             1.3% to 2.0%
February, 2008       NABE                           1.8%
May, 2008            NABE                           1.4%
May, 2008            Federal Reserve             0.3% to 1.2%

Unemployment for 2008

Forecast Date        Owner                       Projection
Fall, 2007           Federal Reserve                4.5%
December, 2007       Economic Consensus             4.8%
December, 2007       Mabe, Farmers Inc.          5.5% to 6.0%
December, 2007       Federal Reserve             4.8% to 4.9%
February, 2008       Federal Reserve             5.2% to 5.3%
February, 2008       NABE                           5.2%
May, 2008            NABE                           5.3%
May, 2008            Federal Reserve             5.5% to 5.7%



May 30, 2008 (Source: Email to Management)
A few notes and commentary on recent economic news:

GDP in 1Q2008 grew 0.9%. This is a revised figure from the preliminary +0.6%.
This figure falls within the Fed's expectation of +0.3% to +1.2% for the year and
nearly matches my forecast of +0.8% made in December. Economic growth came
especially from robust exports benefitting from a weaker dollar.

Fiscal stimulus checks show no sign of significant economic boost, as many
consumers chose to either save the money or apply them to mortgages. Indeed, the
savings rate is now positive, near 1%. This is a reversal from the zero or negative
savings rate we've seen during much of 2005 through 2007. [Proprietary text
deleted].

Post-hoc Note: Most economists agree that the 2008 tax refunds boosted the
economy for a month or two, but provided no long-term relief.

Domestic automakers just can't get a break. A full quarter of GM's (remaining) U.S.
blue-collar workforce opted to take a buyout package and leave the company. Ford
has announced white-collar layoffs. New truck sales are down 14% YOY and had
their worst 1Q sales level in seven years (interestingly in 2001, the year of the last
recession). Sales of foreign autos, on the other hand, fell 5% during the same time
period, demonstrating the increasingly worse competitive environment for domestic
manufactures. With fewer vehicles purchased, auto insurance is taking somewhat of
a hit. Per capita expenditures have fallen 0.2%. [Proprietary text deleted].

The news about the housing market is that there is no new news. That is, sales are
continuing to fall and prices are plummeting. I still forecast a bottoming of the
housing market in late 2009. Any talk you hear in the media (or real estate
agencies) that the market will bottom this year is, in my opinion, overly optimistic.

Post-hoc Note: This paragraph summarized some internal analysis I had done
regarding when the housing market would „bottom‟. As it stands now, in mid-2009,
the market appears to have bottomed in the West (actually growing, because of the
rise of foreclosure sales). Time will tell whether the national level of housing sales
will reach its bottom in the next few months.


Evaluation: In this series of emails, I projected GDP growth and the unemployment
rate quite accurately, and far sooner than other entities. My projection of a late-
2009 turnaround of the housing market proves correct so far. However, I incorrectly
overemphasized the role of inflation and underestimated Bernanke‟s toolbox.

Grade: A (projections), C (underlying mechanisms)
July 15, 2008 (Source: Email to Management)


                                                                                 Today
Indicator           Mar 2006    Jul 2006 Dec 2007 Apr 2008 Jun 2008 Aug 2008    Jul 2009
GDP Growth               5.4%        1.5%     2.1%    -0.7%     1.5%    -2.7%       -1.0%
Unemployment Rate        4.7%        4.7%     5.0%     5.0%     5.6%     6.2%        9.5%
Inflation                3.4%        2.4%     4.1%     3.9%     5.0%     5.4%       -1.4%
Savings Rate             1.0%        0.3%     0.4%     0.0%     2.5%     0.8%        6.9%
Interest Rate            4.5%        4.8%     3.0%     1.3%     1.9%     1.7%        0.2%
Stock Market             8.3%       20.7%     4.4%    -5.3%   -16.7%   -11.8%      -27.0%
Vehicle Market          -2.4%      -13.1%    -4.2%    -6.8%   -18.1%   -15.4%      -33.9%
Housing Market          -0.7%       -6.1%   -23.2%   -15.7%   -16.7%   -15.0%        3.8%



Plenty of economic news out there.

Banking has been hit hard, with the FDIC's seizure of IndyMac and the impending
"bailout" of Freddie Mac and Fannie Mae by the government. International
consensus is demonstrating lukewarm response to the possibility of the U.S.
government overseeing up to $5.5 trillion (with a "T") worth of mortgages. Keep
your ears tuned to news regarding Washington Mutual, Wachovia, Lehman
Brothers, and Merill Lynch. Vultures are circulating.

Post-hoc Note: Lehman Brothers went under in September, 2008, while Bank of
America bought Merill Lynch. Washington Mutual became the largest bank failure
in U.S. history and fell under J.P. Morgan‟s control. Wells Fargo purchased
Wachovia in December, 2008. Notably missing from my list above is the utter
collapse of AIG.

Inflation has come in both on the producer and consumer sides, and the story is
continued upward pressure. The average consumer does not see his basket of goods
net of food and gas increases. That is, the average consumer cares little of core
inflation and more about headline inflation reported in the news and hitting his
pocketbook. We are hitting growth rates in inflation that haven't been seen since
1981. I threw out the nasty word of stagflation last December as a possibility and
I'm afraid that the word has been popping up recently. Stagflation is the painful
combination of higher unemployment, higher inflation, and low growth.

Post-hoc Note: Once again, inflation fears proved premature.

The auto and housing markets continue to struggle. I send out separate summaries
for these entities and you are all recipients.

Below is a summary of GDP and Unemployment Rate projections I've been
following…. Overall, there has been a slight uptick in optimism for the latter half of
2008, driven by the stimulus package. I don't quite buy the optimism quite yet. Yes,
the stimulus package made a huge difference in May, but June showed worse results
vs. expected regarding consumer spending. As a result, I'm cautiously standing by
my 0.8% but will now allow some positive wiggle room up to 1.1% …. On the
unemployment side, I have no reason to change my original projection made nearly
eight months ago. We saw the unemployment rate spike two months ago, and I'm
betting on continued increase through the rest of the year.

Post-hoc Note: My temperance of optimism showed to be correct.

[Proprietary text deleted].

YOY Real Growth in Gross Domestic Product (general economic health) for 2008

Forecast Date         Owner                    Projection
Fall, 2007            Federal Reserve          2.5% to 3.0%
October, 2007         Swiss Re                    2.3%
December, 2007        Mabe, Farmers Inc.          0.8%
December, 2007        Federal Reserve          1.8% to 2.5%
December, 2007        Swiss Re                    1.9%
January, 2008         Federal Reserve          1.3% to 2.0%
February, 2008        NABE                        1.8%
March, 2008           Swiss Re                    0.9%
May, 2008             NABE                        1.4%
May, 2008             Federal Reserve          0.3% to 1.2%
May, 2008             Macro Advisors              1.6%
July, 2008            Federal Reserve          1.0% to 1.6%
July, 2008            Conning                     0.9%
July, 2008            Mabe, Farmers Inc.       0.8% to 1.1%


YOY Real Growth in Gross Domestic Product (general economic health) for 2009

Forecast Date         Owner                    Projection
December, 2007        Swiss Re                    3.0%
March, 2008           Swiss Re                    2.0%
May, 2008             Macro Advisors              3.3%
July, 2008            Conning                     2.0%


Unemployment for 2008

Forecast Date         Owner                    Projection
Fall, 2007            Federal Reserve             4.5%
December, 2007        Economic Consensus          4.8%
December, 2007        Mabe, Farmers Inc.       5.5% to 6.0%
December, 2007        Federal Reserve          4.8% to 4.9%
February, 2008        Federal Reserve          5.2% to 5.3%
February, 2008        NABE                        5.2%
May, 2008             NABE                        5.3%
May, 2008             Federal Reserve          5.5% to 5.7%
May, 2008             Macro Advisors              5.0%
Unemployment for 2009

Forecast Date        Owner                        Projection
May, 2008            Macro Advisors                  5.3%




July 21, 2008 (Source: Email to Management)


[In response to the state of health of the Californian economy]

Overall California Economy Risk: Moderately High

The good, the bad, the ugly

California is the world's eighth largest economy. Compared to the rest of the United
States, CA's economy is well-balanced, though it's slightly biased toward financial
and professional services. Because the service sector tends to be more resilient and
less volatile as the manufacturing and agriculture sectors, CA weathers economic
downturns better than other more specialized states.

That said, the housing market has taken quite a toll in recent years. CA saw an
explosion of the housing market coincident with the internet bubble of the 1990's
and after the 2001 countrywide recession. Driven particularly by speculation and
the positive migration, the CA bubble began to burst in early 2005, somewhat before
the rest of the nation. CA's sales are now at the lowest levels in 16 years. There is a
possibility (note, a possibility) that we are seeing a slowdown in the cliff-dive. Next
year we might see the reaching of a bottom for CA's housing market.

Post-hoc Note: The California housing market, measured by existing home sales
and admittedly boosted by rampant foreclosure sales, did bottom out in late 2008.
                                                   Existing Home Sales

                                            rest of US                                  CA

                   7000                                                                                     650

                                                                                                            600
                   6000
                                                                                                            550

                   5000                                                                                     500
   United States




                                                                                                                  California
                                                                                                            450
                   4000
                                                                                                            400

                   3000                                                                                     350

                                                                                                            300
                   2000
                                                                                                            250

                   1000                                                                                     200

                          '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08



CA's unemployment rate has been higher than the rest of the United States for
nearly two decades, in part because of cost of living as well as immigration. For the
1991 and 2001 recessions, CA's unemployment pattern actually followed the pattern
expressed by the nation as a whole, mainly because the service sector responds
sluggishly to economic trends. That is, it's usually the last major sector to feel the
effects of the downturn. In contrast, CA's unemployment reached a turning point
nearly a year before the rest of the nation, driven by the burst of the CA housing
market. It's quite probable that CA will see markedly higher unemployment in
2009. If we believe my expectation for unemployment to hit up to 6.0% this year,
then it's not unrealistic to expect that CA will hit 7.5% or even 8.0% this year, and
perhaps worse next year. The failure of Indymac and Countrywide are both
significant, and I expect that we'll see continued degradation of employment in the
financial and construction subsectors. Agriculture and mining should both mitigate
some of the losses.

Post-hoc Note: California unemployment ended 2008 with a rate of 9.1% in
December (not seasonally adjusted), and just over 7% for the entire year. As of
June, 2009, California has one of the highest unemployment rates in the U.S.
                                          Unemployment Rate

                                     US                                    CA

              12


              10


              8
  Pe rce nt




              6


              4


              2


              0


                   '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08



Two areas of further concern will be both the budget deficit and immigration. CA's
budget deficit will hamstring economic flexibility precisely at a time when we need
it. Revenue from property taxes has been decimated because of the housing market.
Immigration is a wildcard for 2009 and highly depends on who's elected to the White
House. Chances are, however, that any legislation will have minimal impact in
2009.

Post-hoc Note: California‟s budget crisis continues, and resolution will involve
severe cuts and notable tax hikes. Immigration did not pan out to be a hot topic
during 2009, so far.

[Proprietary text deleted].



August 1, 2008 (Source: Email to Management)


Plenty of economic news out there lately.

The good news is that GDP for 2Q2008 has a preliminary growth rate of +1.9%,
though this growth includes the fiscal stimulus package. The not-so-good news is
that GDP growth for 4Q2007 has been revised downward by over a half-point, to a
negative 0.2% rate. The last contraction was in the 3rd quarter of 2001. Many folks
agree that the economic growth for the rest of the year does not look as sunny as the
2nd quarter. Indeed, the 1st quarter came in at +0.9%, a figure within the range of
my initial expectations.

The unemployment rate ticked even higher to 5.7%, surprising the consensus of
5.6%. I'm actually surprised that it did not tick much higher. The 5.7% is now right
in the middle of my original projection for 2008 unemployment.

I'm watching both the GDP and unemployment carefully as they both have
implications for my GWP and loss forecasts.

-------------------------------------------

YOY Real Growth in Gross Domestic Product (general economic health) for 2008

Forecast Date                Owner                Projection
Fall, 2007                   Federal Reserve      2.5% to 3.0%
October, 2007                Swiss Re                2.3%
December, 2007               Mabe, Farmers Inc.      0.8%
December, 2007               Federal Reserve      1.8% to 2.5%
December, 2007               Swiss Re                1.9%
January, 2008                Federal Reserve      1.3% to 2.0%
February, 2008               NABE                    1.8%
March, 2008                  Swiss Re                0.9%
May, 2008                    NABE                    1.4%
May, 2008                    Federal Reserve      0.3% to 1.2%
May, 2008                    Macro Advisors          1.6%
July, 2008                   Federal Reserve      1.0% to 1.6%
July, 2008                   Conning                 0.9%
July, 2008                   Mabe, Farmers Inc.   0.8% to 1.1%


YOY Real Growth in Gross Domestic Product (general economic health) for 2009

Forecast Date                Owner                Projection
December, 2007               Swiss Re                3.0%
March, 2008                  Swiss Re                2.0%
May, 2008                    Macro Advisors          3.3%
July, 2008                   Conning                 2.0%


Unemployment for 2008

Forecast Date                Owner                Projection
Fall, 2007                   Federal Reserve         4.5%
December, 2007               Economic Consensus      4.8%
December, 2007               Mabe, Farmers Inc.   5.5% to 6.0%
December, 2007               Federal Reserve      4.8% to 4.9%
February, 2008               Federal Reserve      5.2% to 5.3%
February, 2008       NABE                           5.2%
May, 2008            NABE                           5.3%
May, 2008            Federal Reserve             5.5% to 5.7%
May, 2008            Macro Advisors                  5.0%


Unemployment for 2009

Forecast Date        Owner                       Projection
May, 2008            Macro Advisors                 5.3%


Evaluation: Forecasts of GDP, unemployment, bank and financial service failures,
and the situation of California proved accurate. I continued to overestimate the role
of inflation. I did not have enough foresight regarding AIG.

Grade: B
September 5, 2008 (Source: Email to Management)


                                                                                 Today
Indicator           Mar 2006    Jul 2006 Dec 2007 Apr 2008 Jun 2008 Aug 2008    Jul 2009
GDP Growth               5.4%        1.5%     2.1%    -0.7%     1.5%    -2.7%       -1.0%
Unemployment Rate        4.7%        4.7%     5.0%     5.0%     5.6%     6.2%        9.5%
Inflation                3.4%        2.4%     4.1%     3.9%     5.0%     5.4%       -1.4%
Savings Rate             1.0%        0.3%     0.4%     0.0%     2.5%     0.8%        6.9%
Interest Rate            4.5%        4.8%     3.0%     1.3%     1.9%     1.7%        0.2%
Stock Market             8.3%       20.7%     4.4%    -5.3%   -16.7%   -11.8%      -27.0%
Vehicle Market          -2.4%      -13.1%    -4.2%    -6.8%   -18.1%   -15.4%      -33.9%
Housing Market          -0.7%       -6.1%   -23.2%   -15.7%   -16.7%   -15.0%        3.8%



The latest unemployment figure came out today and rose far above consensus. It
measured 6.1% against expectations of 5.7%. Job losses were broad and
encompassed more than just the troubled manufacturing sector. Regions affected
were especially in the West as well as the Rust Belt. I believe this is the second of
the two summer unemployment spikes I had foreseen earlier this year. I do not
expect the upward climb to slow down over the rest of the year, but I do expect the
increase to occur at a decreasing rate. By year end, I stand by my original projection
of 5.5% to 6.0% for the whole of 2008, though I suspect we may see figures in the
6.4% to 6.7% range on a monthly basis. The key now is to determine when it will
peak and subside. We're a bit in uncharted territory with some other economic
indicators.

Post-hoc Note: The average unemployment rate for 2008 measured around 5.7%,
completely within my original estimate. Monthly estimates toward the end of the
year, however, measured slightly worse – 6.8% for November and 7.2% for
December. The second derivative of the unemployment rate appears to have tipped
negative by January, 2009.

Vehicle sales plummeted far below expectations for July, as Ford, Toyota, and GM
missed their already-depressed forecasts. Gas prices have of course played a key
role, but the diminished access to credit and downturned economy are both
exacerbating the problem. What I wonder is how much of the quantity decline is due
to an actual demand shift, stemming perhaps from underlying growing preferences
for public transportation above and beyond the price issue. Time will tell.

Post-hoc Note: I have not shown yet whether a true shift in driving demand has
occurred.

On a brighter note, there continues to be growing evidence that the housing market
is finding a bottom in the West. I do not see a bottoming for the rest of the nation,
but the news in the West is (hopefully) a harbinger of things to come. A new region-
level "Pending Sales Index" will give us an [sic, should read “a”] directional one-
month indicator of sales activity and for now shows the trend in the West should
continue.
More detail will be given in the Auto and Home Market Updates in the next week or
so.

[Proprietary text deleted].

Post-hoc Note: The housing market in the West has bottomed and rebounded,
driven by foreclosure sales in California, Nevada, and Arizona. Overall for the
nation, the market remains stagnant.


Evaluation: Final unemployment rate projection fell in the middle of my range.
Actual GDP growth, not noted above, came in below my projection range of 0.8% to
1.1%. Directionally, however, my original target proved more accurate than
consensus economists.

Grade: B+

				
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