Warren Buffet, aka the Oracle of Omaha, is revered on Wall Street as one of the all time most savvy down to earth investors of the 20th century. What did he have to say today about another severe leg down in the global equity markets? Something akin to… no one noticing that the canary in the coal miner’s cage was dead.
Pre-fabricated home collapse should have made the Fed, Congress and SEC sit up and scream for legislative action. The republicans tried but were shot down by the likes of Senators Barney “Rubble” Franks and Chris “Head in the sand” Dodd.
WARREN BUFFET TODAY — Market Watch
BOSTON (MarketWatch) — Warren Buffett’s ruminations on the battered economy grabbed most of the financial headlines to start the week, but in his annual letter to Berkshire Hathaway shareholders, the folksy investor also offered some thoughts on the public-policy debate raging over how to fix the housing and mortgage markets.
Buffett devoted a section of his highly anticipated missive to the experience and lessons of Clayton Homes — the family-run, manufactured home builder that Berkshire Hathaway acquired in 2003 — during a mortgage crisis that shook the industry in the late 1990s. The debacle “should have served as a canary-in-the-coal-mine warning for the far-larger conventional housing market,” he said.
Manufactured homes — also known as prefabricated, or modular homes — are dwellings that are constructed at a factory and then delivered. Maryville, Tenn.-based Clayton has been building manufactured homes since the 1930s; about a third of its borrowers have subprime credit scores. The builder delivered about 27,500 units last year and has the largest market share, but overall sales in the industry have fallen since they peaked in 1998.
“At that time, much of the industry employed sales practices that were atrocious,” Buffett wrote in his letter to shareholders, released over the weekend.
“To begin with, the need for meaningful down payments was frequently ignored. Sometimes fakery was involved,” he said, pointing to lucrative commissions for salespersons if the loans were approved. “Moreover, impossible-to-meet monthly payments were being agreed to by borrowers who signed up because they had nothing to lose.”
The fallout from this earlier lending spree doesn’t bode well for U.S. home sales if the scenario repeats itself on a larger scale.
Buffett explained that manufactured-home mortgages were typically bundled and peddled by Wall Street to investors. This “securitization” of mortgages contributed the late 1990s “fiasco” in manufactured housing.
Conseco, which filed for bankruptcy in 2002, had large exposure to manufactured-home mortgages that went bad. Conseco bought Green Tree Financial Corp. — which specialized in manufactured-housing mortgages and was later called Conseco Finance — in 1998, when sales of mobile homes were booming, thanks in part to loose lending standards.
Investors, the government and rating agencies “learned exactly nothing from the manufactured-home debacle,” wrote Buffett, who often uses narratives when dispensing his wisdom.
“Instead, in an eerie rerun of that disaster, the same mistakes were repeated with conventional homes in the 2004-07 period: Lenders happily made loans that borrowers couldn’t repay out of their incomes, and borrowers just as happily signed up to meet those payments,” he said. “Both parties counted on ‘house-price appreciation’ to make this otherwise impossible arrangement work.”
He said the consequences are now making their way “through every corner of our economy.”
Beyond FICO scores
However, Buffett reported that most of Clayton’s nearly 200,000 borrowers are continuing to pay off their mortgages despite the housing bust, even though their credit ratings are below the national average.
At the end of 2008, the delinquency rate on loans Clayton originated was 3.6%, up “only modestly” from 2.9% in 2006 and 2.9% in 2004. Clayton also was able to sidestep much of the carnage during the manufactured-home crisis in part because of its conservative lending practices.
The percentage of U.S. mortgage holders who were behind in their payments stood at about 7% of loans outstanding in the third quarter, according to the Mortgage Bankers Association. The fourth-quarter figures are scheduled to be released on Thursday. The Wall Street Journal recently reported that about 6.9% of prime “jumbo” loans were at least 90 days delinquent in December.
“Why are our borrowers — characteristically people with modest incomes and far-from-great credit scores — performing so well?” Buffett asked in his letter. He said the answer involves the basics of lending.
“Our borrowers simply looked at how full-bore mortgage payments would compare with their actual — not hoped-for — income and then decided whether they could live with that commitment,” Buffett added. “Simply put, they took out a mortgage with the intention of paying it off, whatever the course of home prices.”
The borrowers didn’t depend on refinancing, weren’t enticed by teaser rates and didn’t assume eternally rising house prices. “Jimmy Stewart would have loved these folks,” he wrote.
Despite Clayton’s relatively low delinquency rate, Buffett said some borrowers will run into trouble as unemployment rates rise, and that they generally don’t have a big savings cushion. “But our problems will not be driven to any extent by the trend of home prices.”
Home ownership is a wonderful thing
Buffett called for tougher underwriting standards and income verification, and said that the housing crisis offers important messages for home buyers, banks, brokers and regulators. “Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income.”
In most cases, homes go into foreclosure simply because the borrowers can’t keep up with the monthly payment, not because they owe more than the house is worth due to falling prices, he said.
“Home ownership is a wonderful thing. My family and I have enjoyed my present home for 50 years, with more to come,” he commented. “But enjoyment and utility should be the primary motives for purchase, not profit or refi possibilities. And the home purchased ought to fit the income of the purchaser.”
Buffett still lives in the house in Omaha he paid $31,500 for in the late 1950s.
“Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective,” he wrote. “Keeping them in their homes should be the ambition.” — [Hat Tip: John Spence / MarketWatch]