Clayton Homes Approach

James Clayton built a Tennessee-based manufactured housing company that was subsequently purchased by Berkshire Hathaway (BRK). Clayton Homes was remarkable because of its ability to expand marketshare and improve profitability regardless of the economy's condition. Today's environment has been no exception.

Why have the owners of Clayton Homes not defaulted? BRK's CEO Warren Buffett attributes it to the borrowers intent: "they took out a mortgage with the intention of paying it off, whatever the course of home prices." This seems excessive praise to the wrong group. Certainly, the borrowers at Clayton Homes were susceptible to the same greedy motives as the rest of us. So what is the real reason?

I believe that the borrowers were not given the opportunity by Clayton Homes to outborrow themselves. As I understand it, after some early losses, Clayton Homes established a policy of forcing the sales managers to split the losses of any bad loans. In this way, the anti-outborrowing gene was embedded in the culture at Clayton. The result is that current delinquincies are running at an extraordinarily low 3.6%.

A company has to be extremely careful about incentives. Excellent arguments have been made that when Wall Street went public, proper participation in the upside and downside of risk was lost and the resulting destruction was only a matter of time. Constructive improvements in compensation structures, aligning risk with compensation so that decision-makers share in the upside and the downside are likely to be more powerful than any regulatory reform.