Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [38]
Chapter 5
MAD Mortgages—The “Great” Against the Powerless
The manufactured housing industry’s business model centered on the ability . . . to unload terrible loans on naïve lenders . . . The consequence has been huge numbers of repossessions and pitifully low recoverie[s].
—Warren Buffett,
Berkshire Hathaway 2003 Annual Report
Berkshire Hathaway’s 2003 annual report arrived in my mailbox in April 2004. Reading it, I learned that Berkshire Hathaway had acquired Clayton Homes, the largest U.S. manufacturer and marketer of manufactured homes. Unlike Oakwood Homes, a Berkshire Hathaway investment that lost money in 2002, Clayton Homes is well managed and practices sound lending through its Vanderbilt Mortgage and Finance Inc. affiliate. Clayton Homes is noted for the good character of its management in an industry rife with corrupt practices where buyers who could not afford homes were steered into fee-bloated loans created by lenders who should not have lent to them.Warren had learned about those practices the hard way after purchasing the distressed debt of Oakwood Homes, another manufactured housing company, which went bankrupt in 2002. Warren wrote: “Oakwood participated fully in the insanity.”1
Oakwood Homes (Oakwood) designed and manufactured modular homes and sold them either directly to home buyers or to independent retailers. Oakwood provided loans to buyers of its homes. On its own, Oakwood did not have money to lend. Oakwood got money through a line of credit from Credit Suisse First Boston (Credit Suisse). The credit line was similar to a credit card except that Oakwood had to put up the home loans as collateral. Credit Suisse earned fees for the loans and further fees when it packaged (securitized) Oakwood’s loans. Credit Suisse (the “old investor”) bought the securitized loans and then sold them to so-called sophisticated private and institutional investors (the “new” investors).
Many of Oakwood’s “home buyers” had not actually bought a home; they had assumed a mortgage loan they could not pay back. Sales declined. Loan delinquencies (late payments) and repossessions rose. Oakwood Homes had crushing debt and falling income for at least three years before it filed for bankruptcy in November 2002.
Oakwood and Credit Suisse sued each other.These nice kids found each other in a dangerous playground; and they courted each other for years, long after the affection had gone. The court issued an opinion in June 2008.The documents said Oakwood’s aggressive lending practices led to the high number of repossessions and a debt load that Oakwood could not support; Oakwood’s liquidator called the transactions it did with Credit Suisse “value destroying.”2 The court said that Oakwood’s own alleged wrongful conduct prevented it from recovering any money from Credit Suisse; there was equal fault. Basically, the court shrugged at the liquidator’s claim: lay down with dogs, wake up with fleas. An exception to this would have been if Credit Suisse were a corporate insider (say, if Credit Suisse had an officer on Oakwood’s board—which it did not), but Oakwood’s board and management made its own decisions.
Warren Buffett learned that the manufactured housing industry’s consumer financing practices were “atrocious,” and securitization made the situation much worse. Investors in the securitizations supplied money to investment banks who lent to manufacturers and retailers, who then lent money to home “buyers” in the form of mortgage loans or real estate investment contracts. Since the ultimate so-called sophisticated investors, the buyers of the securitized loans,