Birds and Dinosaurs

Credit Crunch Casualties:
Publicly-Traded Builders

While Washington is focused on rescuing the financial dinosaurs, outside of Wall Street, the future appears to belong to much smaller, sleeker, and more mobile organisms. Specifically . . . birds.

Take the home construction industry.

For the last 20 years or so, size conferred a huge advantage. Big, publicly-traded builders like Toll Bros., Pulte and Lennar all enjoyed practically unlimited access to healthy (if not hyperactive) financial markets. Like REIT's ("Real Estate Investment Trusts"), they used that access to raise capital and debt (especially debt), which let them muscle out (or acquire) smaller, local competitors.

Now, size is a distinct liability, for three reasons.

One. Short-term debt isn't available from the credit markets anymore. That's why all the investment banks -- plus entities like American Express and GMAC -- have rushed to turn themselves into bank holding companies (that, and to be eligible for government bailouts).

If you can't tap the credit markets, you either have to find another way to access capital (from depositors, operations, etc.) -- or go on a diet, quick.

Two. Highly-leveraged builders are poor credit risks.

Eventually, the credit markets will thaw. But that still doesn't make the national builders a good credit risk.

Their assets -- raw land and unsold, finished new homes -- are declining in value; their cash flow is dropping; and they have crushing debt service, courtesy of their long, expansionary period. Not a very promising business model!

Three. In a lean environment, small is more nimble and sustainable.

Small, local builders ("birds") don't need tons of fresh meat or vegetation every day to live. They can subsist on worms -- and go to wherever they are. With the inventory of unsold homes at record highs, "worms" may be all there is to eat for awhile in many beleaguered housing markets.

Fortunately, there is ample evidence that decentralized industries not only may be more efficient, but are healthier for the economy (and less expensive to taxpayers).

They could hardly be more expensive. Fannie Mae, Freddie Mac, AIG, Citigroup, Goldman Sachs, the "Big Three" automakers -- the complete list is quite a bit longer and growing -- have cost taxpayers more than $1 trillion just to date because they were all putatively "too-big-to-fail."

Far from realizing economies of scale or "operational synergies," they appear to have been bloated, oblivious to risk, and, at least in retrospect, shockingly fragile.

"Small is beautiful" -- again.