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The Office of Thrift Supervision had reason to intervene long before mortgage lenders started dropping like flies. If they did not read Berkshire Hathaway’s annual reports, they could read a report from the St. Louis Federal Reserve Bank. It noted in 2005 that all loans (subprime, Alt-A, and prime) have a higher default rate when the homeowner has little to lose—a low or zero down payment, for example. The report suggested that subprime loans with no down payment are an especially bad idea: “Serious delinquency (60 and 90 days) is especially sensitive to homeowner equity and origination.”43 Loosely translated, that meant that thrifts would have a much harder time getting paid back if they offered risky mortgage loans to people with no down payment and low credit scores. So where was the OTS when no (or low) down payment subprime loans combined with other risky features were being made?

As of 2008, although subprime loans are only $1.3 trillion (over 11-13 percent depending on how you define subprime) of the $11.5 trillion U.S. residential market, they are the most troubled. In May 2008, Standard & Poor’s announced that subprime loans originated in 2005-2007 looked awful, and loans made in 2007 were the worst of the bunch. Where was the OTS? Delinquencies for 2005 vintage subprime loans were 37.1 percent and had increased 2 percent from the previous month; 37.1 percent of 2006 vintage subprime loans were delinquent, a rise of 4 percent from March; 25.9 percent of subprime loans originated in 2007 were delinquent, a 6 percent jump from March to April 2008. The 2007 loans were “unseasoned” or young but were already at least a couple of months late in payments.4445 In the second quarter of 2008, a Mortgage Banking Association survey revealed that 9.2 percent of mortgages for single family to four-family homes were a month or more overdue or in foreclosure.46 It was the worst result in the 39-year history of the survey. In the month of August 2008, foreclosure filings in the U.S. rose to a record high of more than 303,000 properties as the continued drop in home prices, combined with tighter lending standards, made it harder for homeowners to refinance their mortgages, with and an estimated supply of unsold homes of 11 months.47

The direct and indirect costs to the U.S. taxpayer will be difficult to assess because of creative accounting that delays the recognition of the true problem. For example, banks and thrifts announced they were delaying their recognition of losses by allowing delinquencies of up to 180 days before taking a writedown on loans, and Fannie Mae and Freddie Mac said that in the past they wrote down loans when they were 90 days past due, but sometime in 2008 they decided to wait two years.48 On July 16, 2002, Alan Greenspan commented on the corporate shenanigans after the tech-bubble burst saying “infectious greed seemed to grip much of the business community,” and it was a once-in-a-generation frenzy of speculation.” 49 That was after the mini-frenzies of Drexel Burnham Lambert, Long-Term Capital Management, charged-off credit card receivables, manufactured housing loans, and more. Perhaps Alan Greenspan has found a way to accelerate the human lifecycle.

Fortunately for Berkshire Hathaway shareholders, Warren Buffett is the CEO. At year-end 1999, Berkshire Hathaway was Freddie Mac’s largest shareholder; it owned around 8.6 percent.50 Warren Buffett may prefer to hold onto stocks forever but only if he finds an investment that can go the distance with him. In his 2000 shareholder letter he wrote: “we sold nearly all of our Freddie Mac and Fannie Mae shares.”51 Warren later told me that Fannie Mae and Freddie Mac began emphasizing revenue targets of around 15 percent per year. He did not feel this double digit growth was sustainable just based on operating earnings alone. More than that, value investors are not impressed by revenues alone. Anyone can use leverage to inflate revenues.The quality of the revenues is paramount, since that is what will sustain profitability.

Berkshire Hathaway’s Clayton Homes