Empty Nests

The stock went down 30 percent on the day of the report.

Class-action lawyers raced to file complaints against the company on behalf of shareholders who had seen their portfolios suffer. One Connecticut team of lawyers accused NovaStar of creating an "illusion."

NovaStar hired Lanny Davis, Bill Clinton's former lawyer, to manage the crisis. In an interview with The Kansas City Star, Davis dismissed the shareholder suits as "boilerplate complaints." NovaStar officials blamed the problems described in the Journal article on a faulty Web site and a rogue branch manager.

Lawyered-up investors weren't the company's only problem, though.

In 2002, the PMI Group, an insurance company, stopped insuring NovaStar mortgages. A year later, NovaStar sued PMI for payment on loans that had defaulted. In a counterclaim, PMI said NovaStar "misrepresented ... material facts" about their borrowers — such as income levels.

Regulators were also watching NovaStar closely. In September 2004, the inspector general for Housing and Urban Development found that NovaStar's branch system didn't comply with HUD rules. (NovaStar rejected the audit's conclusions. The branch system shut down last year.)

Finally, NovaStar came under attack by borrowers.

In 2005, a group of homeowners in Washington state accused NovaStar of violating truth-in-lending laws. The suit alleged that NovaStar had charged what amounted to a hidden fee by paying brokers who persuaded borrowers to take out loans with higher interest rates. A judge allowed the case to proceed as a class action.

But as it celebrated its 10th anniversary, NovaStar projected an image of success. In February 2006, the company predicted that its shares would continue to produce a $5.60 dividend.

The good times wouldn't last.

The Easter Bunny's message began: "Folks, like you, I have been body-slammed by this."

The message appeared on a Web site called Investor Village on February 27, 2007. A few days earlier, shares of NovaStar had fallen almost 43 percent. The company had announced a loss of $14.4 million and didn't foresee a return to profitability anytime soon. Like other subprime lenders, NovaStar was reckoning with mounting defaults on its loans.

The stock price bottomed out in early March at $3.25, and the company's near collapse caused its loyal investors to lose faith. The Easter Bunny was the nom de plume of a NovaStar believer who also blogged under the name Bob O'Brien. When times were good, O'Brien had gone after NovaStar doubters with a fury. (On one message board, he posted the names and addresses of the family of a prominent short seller.)

O'Brien was such a tireless defender that The Wall Street Journal wrote a story about his efforts. O'Brien gave an interview, but he refused to divulge his real name. The New York Post later identified him as a salesman on the West Coast named Philip Saunders.

NovaStar's plunge caused Saunders, once an adherent, to swear off stocks. "This casino has just lost its allure," he wrote on the Investor Village message board devoted to NovaStar. (Contacted by the Pitch, Saunders says he no longer comments on NovaStar.) On the same site, an investor who went by the name Sealman29 described the pain of liquidating 21,000 shares of NovaStar. "Mom and Dad were right," Sealman wrote. "The stock market is pure gambling."

Skeptics, meanwhile, felt validated. Herb Greenberg called NovaStar a "high-wire act." Excitable cable TV host Jim Cramer wrote on TheStreet.com: "Now we have another horror story about the industry and I keep thinking, 'Wait a second, NovaStar routinely lowered standards and did whatever was necessary to keep the balls in the air.'"

The company put on a brave face. "We've been through down cycles before," Lance Anderson told Star reporter Dan Margolies in a sit-down interview in March.

A month later, NovaStar announced that it was exploring "strategic alternatives," which included selling the company.

NovaStar's stock price has made up a portion of what it lost in the subprime lending crack-up.

In recent weeks, the company's worst days have not been on Wall Street but in courtrooms.

A federal lawsuit filed in Washington, D.C., in May accused NovaStar Mortgage of discriminating against African-Americans, Native Americans and the disabled. The National Community Reinvestment Coalition alleges that NovaStar violated the Fair Housing Act by refusing to offer mortgages on rowhouses in downtown Baltimore, homes on Indian reservations and homes that may be used as adult-care facilities.

NovaStar says the coalition's charges are baseless. In court papers, the company said its actions were based on legitimate business reasons: It avoided Baltimore rowhouses because they had abnormally high instances of mortgage fraud; writing loans on Indian reservations was "like lending in a foreign nation"; and it stayed away from adult-care facilities because of its policy of not making loans to purchase commercial-use property.

On June 21, NovaStar agreed to pay $5.1 million to resolve the class-action suit in Washington state. Approximately 1,600 borrowers will receive a settlement. "By winning this lawsuit, we hit them where it hurts — in the pocket," said one of the borrowers, Larry Brown, at a press conference.

In a statement, NovaStar said it settled the case to avoid paying further legal costs. The company said the broker fees ("yield spread premiums," in industry parlance) were appropriately disclosed and standard practice. On June 29, the lawyers who represented the Washington borrowers filed a similar suit against NovaStar in San Francisco.