Each time a builder files for bankruptcy, it’s like a neutron bomb detonates in the market, knocking out all the people—potential buyers, dealers, subcontractors, existing-home owners. Only the buildings, some half-complete, are left standing. These days, the shock waves spread outside the Chicago market where Neumann Homes fell and the Florida market where Levitt & Sons went under. They ripple throughout the country over the ­Internet, paralyzing potential buyers who breathe deeply and think twice, or three times, before writing a big deposit check.

Builders everywhere must devote a mounting chunk of management time to convincing buyers that their companies are financially viable. The big names that have gone out, and the negative publicity that has flowed from these events, has put the entire industry’s reputation on the line.

We set out to document the collateral damage from bankruptcies with this month’s special field report (see “Shock Waves,” page 86). We interviewed beleaguered building material dealers in Chicago, who have not been paid for their work. We visited with angry homeowners in Memphis, Tenn., fighting to get resolution to warranty claims. And we toured the epicenter of the building bust, Fort Myers, Fla., where the casualty list is so long, the damage so great, experts believe it may be a decade before the market fully recovers.

Collateral Damage

One of the most unfortunate repercussions of the rolling wave of builder bankruptcies is the impact on subcontractors. Often poorly capitalized, subs struggle to make payroll when they don’t get paid, and their output suffers. You’d think that framers, electricians, and drywallers would be hungry for what work remains. Some are. But many are so financially hampered that they are taking longer to finish work.

Building material dealers may be better capitalized, but they are hurting, too. Some of the biggest now have tens of millions in accounts receivables aged to the point of futility. Typically listed as unsecured creditors in bankruptcy proceedings, they are often near the end of the settlement lines. Dealers are threatening to file liens against builders who don’t pay their bills on time and clamping down on credit in an attempt to remain solvent.

The most piercing outcries are heard today from people whose homes are stopped in mid-construction by bankrupt builders. Once construction begins, they are often caught in a binding contract. Their home may well be completed by a bank or some other third party down the road. But the wait, and the uncertainty, is a killer. People who bought homes in an unfinished ­community are caught behind the eight ball, too. The fact that the community is undone—the roads aren’t complete, the recreation center wasn’t built—negatively impacts the value of their property. The monetary loss makes them especially attentive to warranty work. Builders report that warranty claims from financially strapped homeowners are on the rise everywhere.

Playing for Keeps

When a major builder falls, it casts a pall over the entire market. Potential buyers ­decide to take the path of less risk and buy an existing home; there are certainly ­plenty for sale. They ask that their deposits be put in escrow, if that’s not already required. They insist on bankruptcy clauses in contracts. They perform extensive due diligence on potential builders.

The current market environment is one that for years the industry has sought to avoid by joining associations, sharing best practices, and offering free management advice to fledgling builders. It’s the reason why white knight builders would clandestinely buy land off a suffering builder’s books or even quietly step in and finish work.

During previous housing recessions, there was more talk from builders about trying to work through their troubles and make sure everyone’s bills got paid. It was a point of honor. This time around, you see a lot more builders just throwing in the towel, That’s going to hurt the entire industry’s reputation down the road.