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Personal Finance Lessons From Warren Buffett's Clayton Homes

During the financial crisis, lenders across the United States collapsed as borrowers failed to meet their mortgage payment obligations due to the economic situation.

One company fared better than most in this environment. That was Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) housing subsidiary, Clayton Homes.

Lessons from Clayton

Clayton Homes is the largest builder of manufactured housing and modular homes in the U.S. Berkshire acquired it in 2003 for $1.7 billion, and since then, it has been a profit powerhouse for the business.


That said, the business has attracted some criticisms for its lending practices, though Buffett has been quick to rebuke these criticisms and concerns.

For its part, the company has remained popular with homebuyers and borrowers. Actions speak louder than words in this case.

In Berkshire's 2008 letter to investors, Buffett wrote at length about Clayton's business, and how it was performing in the financial crisis. As other lenders collapsed around it, Clayton was performing strongly.

Buffett wrote that at the end of 2007, Clayton's delinquency rate on loans originated was 3.6%. Why was the company performing better than many of its peers at the time? The Oracle of Omaha explained it as follows:


"Why are our borrowers - characteristically people with modest incomes and far-from-great credit scores - performing so well? The answer is elementary, going right back to Lending 101. 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.

Simply put, they took out a mortgage with the intention of paying it off, whatever the course of home prices. Just as important is what our borrowers did not do. They did not count on making their loan payments by means of refinancing. They did not sign up for "teaser" rates that upon reset were outsized relative to their income. And they did not assume that they could always sell their home at a profit if their mortgage payments became onerous. Jimmy Stewart would have loved these folks."



Conservative financial planning

I've picked this statement out because it highlights just how vital conservative financial planning is. In times of crisis, it becomes disastrously apparent how many people plan their lives not around what they can afford, but what they want to afford.

This doesn't have any bad side effects in the good times, but as Buffett once said, when the tide goes out, you find out who has been swimming naked. Buffett went to say in his letter:


"Commentary about the current housing crisis often ignores the crucial fact that most foreclosures do not occur because a house is worth less than its mortgage (so-called "upside-down" loans). Rather, foreclosures take place because borrowers can't pay the monthly payment that they agreed to pay. Homeowners who have made a meaningful down-payment - derived from savings and not from other borrowing - seldom walk away from a primary residence simply because its value today is less than the mortgage. Instead, they walk when they can't make the monthly payments."



The same is just as true for investors who buy stocks using borrowed money or invest while trying to maintain significant levels of borrowing elsewhere on their personal balance sheets. Trying to maintain high levels of leverage makes you do things that might not necessarily be sensible from a long-term perspective.

In recent years, Buffett has attracted a lot of criticism for holding a cash pile on Berkshire's balance sheet. Now, this strategy does not look so silly. The whole of corporate America is crying out for cash, and the Federal Reserve has had to act quickly to maintain liquidity in the financial system. Buffett has no such worries. His $128 billion cash pile gives him plenty of flexibility in tough times.

Private investors can learn a tremendous amount from this approach and benefit from implementing it in their own portfolios.

Disclosure: The author owns shares in Berkshire Hathaway.

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This article first appeared on GuruFocus.