A Thought Provoking look at the Blame Game and the Banks the Centre of unpalatable accusations of masterminding the biggest fraud this nation has ever experienced. Brokers and Borrowers are the pawns in this Monster Bank Fraud. BFCSA Members have the collective evidence contained in over 2000 files.
The question is: Does the Banking Industry in Australia now rely on mortgage fraud to underwrite its profits? YES indeedy!
The legal mess associated with mortgage fraud in Australia
By DC Strategy
Well, now it might really be happening – but not for the reasons many people believe. And once you understand the real reasons, you will see that this will have potentially serious ramifications for the whole financial sector in Australia.
The facts are that Australian housing prices are declining in early 2016 although the price changes vary dramatically by region and by state.
Interestingly this price decline does not coincide with an increase in interest rates or a dramatic decline in economic conditions. It coincides much more heavily with the tightening of lending standards by APRA and other regulatory authorities. This may explain the sudden slowing of the housing market in Australia more than any other factor.
But a much deeper problem lurks beneath the surface than merely the tightening of lending standards – and this is perhaps the first article to put the pieces together and predict a more sombre outlook for residential property prices for more fundamental reasons.The problem – or at least the potential problem – is widespread mortgage fraud in the independent mortgage broking business, or, put simply, the prevalence of “liar loans” (as they are known in the US) infecting the Australian financial sector.
By now most of us know the story that the GFC was in part triggered by an explosion of lax and inappropriate lending in the United States by independent mortgage brokers, which then triggered a property price collapse when the borrowers could not service the loans.
Over the last two decades or so in Australia, there has been a fundamental change in the way loans are provided to the general public, mirroring past developments in the US. We always seem to lag behind the US in our economic developments and trends, and sadly in this space the regulators appear to have been too slow to learn the lessons from the US.
Decades ago, the only place you could get a home loan was from a bank or building society. The lending criteria were harsh, the standards tight. The person who wrote the loan was often the person who collected the loan, so they had a vested interest in ensuring you could pay.
Then independent (often franchised) mobile lenders came on to the scene, developing a distribution network based on independent operators with remuneration based on upfront commissions and (the real gold mine for the broking industry) “trails”. Trails are trailing commissions on the loans that potentially last as long as the loan itself.
These franchisees or independent brokers are heavily incentivised to book loans and unlike the banks in the old days they do not have to worry about collecting on the loans personally. The rules of the game are very simple: the faster brokers build their loan book, the faster they can sail away in permanent commission-funded retirement on their commission-funded yacht.
These individual loans booked by independent brokers (all with widely varying levels of education, sales skill and financial sector experience) are now packaged up (“aggregated”) by aggregators and then sold to banks and large wholesale financial institutions who no longer have to bother about developing an expensive retail network or dealing with the flotsam and jetsam of the general public.
This commission-driven, highly fragmented system works – until the banks lose contact with the borrower to such an extent that the loans are based on fiction due to perverse incentive structures within the industry that encourage a focus on getting the loan deal done rather than a focus on the borrower’s ability to pay over the long term. And given the legal ambiguities that have arisen because of this fragmented independent franchised structure, identifying precisely who is responsible when fraud is found on the loan book is hugely problematic.
Was it the borrower who defrauded the broker? Was it the borrower and the broker together defrauding the aggregator? Was it the borrower and the broker and the negligent aggregator defrauding the banks? Was it the borrower and the broker and the negligent aggregator and negligent banks defrauding everyone including the regulators? Who knows?
That’s what happened in the US before the GFC.
There are real signs this has been happening now in Australia particularly in some specific pockets of the industry in the last 2 years. The question is – are we going to pay the same price for “liar loans” as the US?
The lesson from the US is that once the fraud is rife, there is no solution other than to put the “fraudulent” loans into default, wipe out the bad brokers, and start afresh. The problem is that the costs associated with this “cleansing” are massive and take years and years to recover from.
In 2016, our firm has seen a wave of independent franchised mortgage brokers come to us in desperation, seeking guidance from us because the aggregator they were previously happily dealing with has suddenly, “out of the blue”, investigated their loan books and discovered one or two (or three) “discrepancies” which has then triggered a full scale investigation. Clearly the individual details of each case are strictly confidential, but the pattern is unmistakable and distinctly noticeable. If we are noticing it, it must be happening across the country.
This seems to have been triggered in recent months when one of the big banks (Westpac, NAB, Commonwealth or ANZ) has initiated an internal audit of their residential loan book (including calling up “employers” and checking “pay slips”) and has then (invariably) found problems with the loan or documentation associated with the loan. They have then asked the aggregator to review the loan books they have sold to the banks. The aggregators have then sought information from the broker who wrote the loan.
Why have the banks suddenly “panicked” over their loan books? There is no economic or financial reason.
It suggests APRA has recently come down harder on the banks, the banks are kicking the aggregators, and the aggregators are kicking the independent (franchised) mortgage brokers.
Invariably this means that the broker being investigated is immediately “suspended” (meaning they cannot write any new loans). Importantly, it also often means that their “trail” – the trailing commission they receive from the accumulated loan book they have built through their career – is suddenly and without warning put on hold until the outcome of the internal investigation is concluded. Sometimes this money is put in a trust account. Sometimes the money is simply taken from them.
The problem with all of this is that the mortgage broker has often spent years – even decades – building up a loan book with a substantial trailing commission. This “passive” income may have been intended to be that person’s retirement fund. It could have represented a substantial asset that they could have sold. Often the passive income – independent of the commissions just writing loans – is between $20,000 and $50,000 per month. They have spent years building up this asset – only for it to be taken away from them by the aggregators at the behest of the banks.
If the mortgage broker is terminated and the loan book reallocated and taken away from them, where does this massive trailing commission income end up? You guessed it – back in the hands of the aggregators and the banks.
Given the amount of money at stake and the life-changing impact this is having on individual mortgage brokers, why haven’t there been more cases of mortgage brokers publicly challenging these decisions?
Terminated mortgage brokers generally do not complain. They are often terrified of being reported to ASIC or being driven out of the industry altogether and losing “authorised representative” status in the industry. They are often thankful just to get out with their reputations intact, leaving their substantial trailing commissions behind to be pocketed by the banks and aggregators.
However this does not discount the reality that their income is often quite arbitrarily being taken from them and their power to protest is severely constrained, even where the “discrepancies” are relatively minor and the “omissions” ordinarily would be accepted as “standard” in the industry.
Is there a large financial incentive for banks and aggregators to internally investigate successful mortgage brokers and – potentially – terminate them for “discrepancies” in loan documentation? You bet there is. At least until they realise it might be systematic throughout the industry. Then it’s not the mortgage broker who has the problem – it’s the whole industry itself.
You might argue that the individual mortgage brokers who engaged in fraud “had it coming to them” and “deserve” what they get. Mortgage fraud is a very serious – potentially criminal – matter and must be dealt with swiftly and aggressively. All of this is true. The question is – if this was so obvious and so easy to prove and investigate why weren’t the banks and aggregators on to this sooner when the loans were first issued?
It appears they have “encouraged”, “incentivised” or at least “allowed” these practices, and then, just when these mortgage brokers are looking for the payoff of passive income and retirement, the aggregators are using these investigations as a pretext to pull the pin and take back the trailing income.
Normally mortgage brokers would have rights both under the Franchising Code of Conduct and under common law to sue the franchisor, their associated aggregators and/or banks for abuse of process if the discrepancies are minor and they have not been deliberately involved in mortgage fraud.
But even good mortgage brokers are too scared to undergo a full investigation and press their legal rights.
There is an analogy here with the 7-Eleven case. 7-Eleven argued it did not have a duty to investigate wage fraud with individual franchisees, as the responsibility for paying award wages was in the hands of the individual business owner. 7-Eleven initially blamed and even vilified the individual franchisees who were engaged in wage fraud.
Subsequent investigation found systematic wage fraud was widespread throughout the business, making a mockery of the scapegoating of the franchisees and the Sargent Shultz-style “I see nothing!” excuses initially pleaded by senior management at 7-Eleven. It appears from subsequent detailed investigation that the model relied on wage fraud.
In the much bigger, much more financially significant mortgage industry, it appears that “liar loans” have become prevalent throughout some sections of the industry and many commission-hungry brokers (and aggregators and banks) have either turned a blind eye or have been complicit in the act.
The pressure to sell has overridden considerations of due diligence in some sectors of the finance industry. This has happened with financial advisors within the Commonwealth Bank. I can say it’s also happening within the mortgage broking industry today.
This is especially true where the desperation for a first home buyer overwhelms all other considerations, especially in some immigrant communities, where even Centrelink income or the occasional family payment from overseas has been magically turned into a regular job with a legitimate employer. Some mortgage brokers are all too willing to assist, and pocket the commission as a result.
The question is: Does the mortgage broking and aggregation industry in Australia now rely on mortgage fraud to underwrite its profits?
Although it is impossible to say whether the prevalence of mortgage fraud in the independent mortgage broking business is as prevalent as the wage fraud in the 7-Eleven case, there are clearly analogies that can be drawn.
In certain sectors of the market it appears the fraud is widespread and any investigator would be able to confirm this as soon as they open a loan book and called the first (non-existent) employer from the first (fictitious) payslip.