Why the Housing Sector Collapse is Wonderful

BALTIMORE, Nov. 15 /PRNewswire/ -- The following statement was written by Porter Stansberry, who is a frequent contributor to www.DailyWealth.com, one of America's most widely read financial e-letters.

Barrington is a subdivision in northwest Charlotte, North Carolina. The houses in Barrington are "tract homes..."

To save money, homebuilders like to develop entire neighborhoods of identical houses. Every house uses the same architecture, so they only need to draw up one set of blueprints. Every house uses the same materials, so they can buy materials in bulk and reduce waste. Construction is easy, too. Once you've put up one, you can build 1,000. So the developers don't need to hire skilled craftsmen to build these houses. They employ the same unskilled worker you'd find on a production line in Detroit.

You'll hear people call these houses "cookie-cutter homes."

Beazer Homes developed the Barrington subdivision. They jammed the houses close together on tiny lots and used the cheapest designs they could find. These tactics reduced the final sales prices and increased Beazer's profits. Houses in Barrington started at only $90,000.

Here's the thing, out of 107 homes in the Barrington, 41 are currently in default and will end up in foreclosure. Normally in North Carolina, fewer than 3% of home sales result in foreclosure. Something unusual happened here...

Beazer arranged the mortgage financing for 37 out of the 41 homeowners who ended up in default.

As the Charlotte Observer discovered, Beazer's mortgage employees were making loans to people who couldn't possibly afford the homes. Beazer completed the neighborhood in November 2002. The first foreclosure occurred two months later.

Everyone, individually, is responsible for whatever debts he incurs. I don't think it's right to blame Beazer for any individual default, and I certainly don't think borrowers should have recourse to sue lenders for making loans.

But look at the corporate culture Beazer established with these kinds of sales and mortgage policies. The company was essentially building a community it knew would fail. Putting so many very high-risk borrowers into one community meant, inevitably, the development would suffer a very high incidence of foreclosure. As a result, the value of the community would be destroyed.

By selling homes its buyers couldn't truly afford, the company was also inflating the sales and profit numbers it reported to shareholders. Worse, the company's culture of irresponsibility systematically destroyed the value of the company's brand and its reputation.

No one should have been surprised when the FBI began to investigate the company's mortgage practices, when the SEC followed with an accounting investigation, or when Beazer's chief accounting officer was fired in June.

Like so many of its customers, Beazer itself wound up in default. Unable to file regular SEC-required quarterly reports because of its ongoing investigations, it violated its bond covenants. Rather than admit its default and seek to compromise with its bondholders, as happens regularly in these situations, Beazer sued its own bondholders, calling them "vulture investors" in court papers. Astoundingly, Beazer denied it had defaulted on the terms of its debt -- despite readily apparent facts to the contrary.

Beazer recently settled out of court with its bondholders, paying them $12 per $1,000 to delay action on the default until next May, by which time the company should be able to file reports again with the SEC. The company also admitted it had, in fact, been in default. But the company's culture of dishonesty and fraudulent dealing has already wiped out many shareholders -- the stock has fallen from $80 to $8.

I've spent a considerable amount of time this month researching shares of homebuilders... including Beazer. No, I'm not crazy.

If you want to be a great investor, you have to buy good companies when their prices are exceptionally attractive. You only get that chance with the best companies in the midst of a crisis. As an analyst, the collapse of the homebuilding sector is a wonderful challenge. Although I think many homebuilders will soon go bankrupt, at least a handful will survive.

And since all of these companies are now trading for more than 50% off their highs, it's probably not too soon to take a serious look.

Good Investing,

Porter Stansberry, editor, Porter Stansberry's Investment Advisory and contributor to www.DailyWealth.com