Australia’s systemic mortgage fraud is back in the news. This time, the ABC is the one feigning surprise about what we all already know:
‘Hundreds of millions of dollars of suspected fraudulent loans have been uncovered at 10 major banks during an operation involving Australia’s top-tier financial regulation and criminal intelligence agencies.
‘Operation Claw has exposed coordinated mortgage fraud and “systemic weaknesses” across the lending sector.’
It’s nice to get a periodic reminder about this running scandal. And confirmation that the same fraud continues, no matter how many rounds of reforms and regulatory crackdowns we get.
But after 14 years of media coverage, journalists still haven’t connected the last few dots.
If they ever do, all hell could break loose. By the time the dust settles, Australia’s sub-prime scandal would easily make America’s look boring.
Yet few people know why.
I do. Finding out was the best and worst few years of my life.
By that story starts in 2007.
In the US, some borrowers in some states were allowed to use jingle-mail to escape their absurd mortgage debts.
They’d mail their keys to the bank that lent them too much money, and walk away from both home ownership and the mortgage.
This forced the bank to book the loss on selling the house, instead of the borrower. And so a burst housing bubble became a regional banking crisis. You know what happened next in 2008.
We are often told Australia can’t experience the same crisis. Nobody denies our mortgage system is dodgy anymore. But we don’t have jingle mail. People can’t just walk away from their debts. So the dodgy lending can’t become a banking crisis.
But Australia actually has a far more dangerous solution than jingle mail.
In some cases of mortgage fraud, borrowers can write off the debt and keep their home.
Yes, it amounts to a free house.
The bank is left with a loss far larger than anything the Americans came up with.
Now that I have your attention, I better explain…
Australia’s version of the sub-prime scandal
In 2012 I first heard about allegations of systemic mortgage fraud in Australia. Consumer advocates claimed that banks and mortgage brokers were routinely inflating people’s incomes on their loan paperwork.
An income of $50,000 would mysteriously become $150,000 by the time the loan got approved. Sometimes, the adjustment even used a different coloured ink!
A series of court cases followed. These made loan application form fraud a matter of public record, but didn’t establish how common it was.
Judges presumed that mortgage fraud was rare. So they established the precedent that borrowers who had been defrauded in this way, and suffered severe financial consequences as a result, could cancel all or some of their debt, but keep their home. The bank simply had to write off the debt and book the loss.
My research uncovered a list of examples.
I wrote a report about how to check if your loan documentation had the same creative ‘adjustments.’ And how to try and get your mortgage cancelled or reduced if you found anything dodgy.
A few subscribers got in touch with pictures of their loan documentation and the absurd claims that had been added by mortgage brokers or bankers.
But we still didn’t know how common the loan application fraud was.
Banks own the ivory tower too
By 2014 I’d decided to study the topic as a PhD. I wanted to establish the size of the problem. Could a 2008 style meltdown happen in Australia?
I went on the record in a speech at an economics conference here. A Royal Commission into the issue was announced a few years later.
Once the university realised that I could prove my claims of systemic mortgage fraud were actually true, and that systemic loan cancellation was on the menu, they quickly pulled the plug on my research.
About four years of my mid-20s went down the drain. I didn’t sleep properly for years afterwards.
What I uncovered went well beyond what the Royal Commission subsequently found. Not just how common the mortgage fraud really was. Again, the key issue was the ability to actually cancel your debt if you’re the victim of mortgage fraud.
Imagine if all Australians knew that victims of loan application form fraud could cancel or reduce their debt without losing their home.
If mortgage fraud is as systemic as my research suggests, it could cause a major financial crisis in Australia.
No wonder the media no longer mentions that part of the story.
If defrauded borrowers knew they can cancel or reduce their debt, it would unleash chaos as the banks would face a absolutely enormous write downs on their loan books.
Will that happen?
Unlikely. The risks are too large. The implications too terrible.
But plenty of savvy borrowers have already succeeded. The newspapers used to report about their court cases.
The liars loans continued
Back in 2012, when I was doing my PhD research, brokers assured me that the problem of pre-2007 liars loans had already been solved. New documentation requirements prevented the sorts of fraud that the ABC reports continues to be ‘systemic’:
‘The money has been lent out in what are called “liar loans”. AUSTRAC described the suspected fraud as using the following to support loan applications:
- inflated incomes
- misrepresented employment
- fabricated or unverifiable business activity’
How does this happen?
My PhD research explained precisely that.
Mortgage brokers and bankers try to help their customers borrow money. If a loan gets knocked back because of insufficient income, here’s what happens next…
The industry is small and close knit. Everyone knows which mortgage broker and banker can get a borrower over the line with some creative accounting. The borrowers who can’t make it over the line the legitimate way simply get referred to the “right” person.
The end result is that anyone can get a loan. They just need to shop around or get directed to the right mortgage broker or banker. Someone willing and able to undermine lending standards.
It only requires one known rotten egg in the industry and all the marginal borrowers can slip through. The Australian Financial Review reports there was more than one:
This week, the problem was laid bare by financial crimes regulator AUSTRAC, which has made about 200 referrals of mortgage brokers, lawyers, accountants and risky companies to other agencies, including the police, corporate regulator and the Australian Taxation Office. At least $4 billion in loans have already been earmarked by our five largest banks as potentially part of the growing scandal.
When I asked mortgage brokers about the terrible consequences of unaffordable mortgages, they laughed. And that exposed the key to all of this…
The linchpin of mortgage
fraud just got pulled
As long as house prices rise, mortgage fraud is profitable for all concerned. That’s because, by the time a mortgage is defaulted on, the house price has gone up enough to bail everyone out.
The borrower sells the house at a profit, the bank collects huge fees, the mortgage broker absconds with a chunk of their fees and the fraud is never uncovered.
The bank’s lending risk is minimal because the value of the collateral, the house, is going up fast.
It’s only once house prices start falling that people get into trouble. Suddenly, everyone faces losses.
The loan’s collateral is worth less than the debt outstanding. The borrower can’t simply sell out. The bank faces a loss even if it repossesses.
Worst of all, questions get asked. The bank’s compliance department wants to know how the unaffordable loan got made in the first place.
Now that house prices are falling, the sub-prime scandal may finally be exposed.
The media is reporting that Sydney is the centre of Australia’s mortgage fraud so far. But it’s merely where house price falls have exposed the truth the most.
I’m not sure I want to be proven right. But for the first time there is a serious chance the banking crisis I warned about could hit.
Of course, we all know how the RBA would respond. We’re hardly the first country to go through this.
That’s why it’s time to prepare. Here’s how.
Regards,
Nick Hubble,
Strategic Intelligence Australia
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