Response to the Royal Commission

Response to the Royal Commission

The Royal Commission trundles on.

And most carefully avoids addressing the issue that really matters: How widespread are the problems that it’s exposing?

Bringing in a tiny fraction of the many people who were wronged by banks, financial advisors, super funds and mortgage brokers reveals some outrageous stories. But those have been popping up in the media for ages.

In the years before the Royal Commission, Today Tonight, A Current Affair and 7:30 all featured stories that didn’t lead to outrage.

The very same stories were suddenly deemed national news when the Royal Commission exposed them.

The Australian newspaper covered the court cases that should’ve made people realise the state of mortgage lending in Australia.

There were a lot of them.

But once precedent was established, most cases were settled by the Financial Ombudsman Service (FOS) in secret.

Every now and then, the banks were dumb enough to forget to include non-disclosure agreements in their FOS settlements.

I remember a story where twins or sisters were able to go public about the absurd loan they were given. They told the interviewer about how the FOS had written off a huge chunk of their loan at the expense of the lender.

Thanks to the media and my own research, I explained all this in a speech in 2013. You can find it here.

It has been watched 37,000 times. In the comments section, people tell me I’m wrong and an idiot for exposing what the Royal Commission is ‘discovering’ now.

But back to my point. Nobody has looked into how widespread these problems are. Surely the point of the Royal Commission is just that?

The lack of a systemic investigation is letting the banks and mortgage brokers off the hook.

It presents them with their escape plan on a silver platter. All they have to do is argue that what the Royal Commission looked into were isolated cases.

The Mortgage & Finance Association of Australia (MFAA) has claimed just that in their response to the Royal Commission’s interim report.

Here’s how the mortgage broking industry’s magazine Broker News summarised the MFAA’s response to the Royal Commission’s interim report: ‘ there is no evidence of systemic misconduct 

The absence of evidence is not evidence of absence.

There’s no evidence that misconduct is systemic because nobody ever looked. Calling the investigation a Royal Commission just makes it seem like they looked.

Instead, the Commission just paraded a tiny fraction of the cases and individuals involved in front of the media. The real question is how often their stories are happening.

Why the banks won’t get away with it

Starting back in 2012, I asked mortgage brokers about all this as part of my PhD. About half of those I interviewed were willing to open up about the matter. The conclusion was simple.

Anyone looking for a dodgy mortgage broker can find one easily enough.

Usually, this played out in the following way. A property investment spruiker or developer aligns themselves with a mortgage broker. The broker would be only too happy to help the investment victim – usually someone old or financially illiterate – to raise the cash to invest in the scheme.

To get the loan, the mortgage broker just writes whatever is needed on the loan application, having been trained to do so by bankers. If they don’t fudge the figures sufficiently, the banker calls up the broker to ask why they haven’t added enough income or lied about the profession. Or the banker just does the manipulation themselves.

The investor mortgages their own home to invest and ends up unable to pay that debt when the investment underperforms. Then the bank defaults and the borrower is left without the house they used to own.

When this happens in Australia, the courts or ombudsmen can cancel the debt and the house goes back to the borrower. The bank has to write off the loan and book the loss.

That is why I’m expecting a financial crisis in Australia. And the banks will be wiped out.

How the broker fraud is hidden

Here’s the key to unlocking the MFAA’s claims.

To argue that there is no systemic issue precisely misses the point.

Of those who need their loan applications manipulated, all can find a broker willing to do it.

The reason there is no systemic issue is because the system concentrates the problem amongst the key mortgage brokers who are willing to lie.

It’s not that 80% of mortgage brokers are manipulating 20% of the time. It’s that 20% are manipulating 80% of the time.

So it’s only a small problem in terms of the proportion of mortgage brokers.

However, in terms of the mortgages that get smuggled past lending standards, this does then add up to a systemic issue.

You can’t say that the problem is small because only a few mortgage brokers are dodgy when they’re writing huge volumes of loans.

Remarkably, when presented with the problems in the mortgage broking sector, the MFAA used all this as a defence:

‘The association responded to this claim saying that the complexity of borrower situations was not considered, as it was often that “risky loans” gravitated to the broker channel. Customers in difficult financial situations can benefit from using a broker to obtain finance.’

In other words, they argued mortgage brokers only look dodgier because dodgier customers tend to come to them.

The reality is that people who can’t afford mortgages come to mortgage brokers because they know some are dodgy.

At worst, borrowers have to shop around for someone willing to manipulate their loan application.

But usually, the local mortgage broker, real estate agent and property developer is willing to refer them, and the borrower never realises it took lies to get their mortgage.

The property market professionals know who is willing to bend the rules.

But it’s not just questionable loans that are getting manipulated. Keep in mind that a huge chunk of subprime mortgages are masquerading as prime thanks to falsified figures. Nobody has gone and checked how many – what proportion.

Measuring the impossible

Part of the reason nobody has quantified the problem is that it’s hard to do. How do you compare someone’s mortgage application with their financial position back when they applied?

Doing it on a larger scale is very difficult. Especially because the banks do their best to stop customers from getting their hands on the loan application that was actually processed by the bank.

Even after the subprime crisis fallout in the US, nobody found an efficient way to actually go back and dig through the details. There was no way to compare loan applications with true financial positions on a large scale. It was all surveys and samples.

The closest anyone got was to compare income tax filings with loan application forms on a suburb-by-suburb basis. And they found what you’d expect – enclaves of mass fraud.

The missing fallout

The MFAA also argued that, if the accusations of systemic fraud were true, there’d be systemic consequences:

‘If conflicted remuneration was causing systemic harm to consumers, then the data should show complaints and relative arrears high and rising, competition and consumer support shrinking and prices inevitably rising. But this is not the case.’

So, clearly, they haven’t done anything wrong.

Again, this misses the key point. While house prices rise, the risk of unaffordable lending is close to zero.

Especially on a systemic scale.

Borrowers can just sell their house when they default. And probably make money in the process. Banks are safe in the knowledge that the rising collateral value will cover costs.

They can’t lose money.

The lack of a downside, while house prices rise, is how mortgage brokers justify the dodgy lending in the first place.

That’s what my PhD research was about – asking why brokers do it and how they justify the seemingly fraudulent behaviour.

Originally, I had wanted to quantify the problem.

But the economics faculty didn’t believe there was any problem to find. And they decided they didn’t want to know about a systemic issue in the Aussie banking system.

Once I found one anyway, I was told to start my PhD again on a different topic, because it wasn’t theoretical enough.

I was 3 months away from my approved completion date. Three of my supervisors left the university over the course of my degree.

Anyway, while house prices rise, none of this is a problem. In fact, it enriches Australia.

But once house prices flat line, the problem is exposed.

People who default on interest-only loans can’t cover their debt by selling out anymore. The marginal borrower drops out. House prices fall a little.

Then the subprime loans masquerading as prime get into trouble. Suddenly, the people who had sold their homes to repay their loans show up as defaults. Mortgage stress increases.

The banks are forced to tighten lending standards because rising house prices no longer protect them either.

The virtuous circle of unvirtuous behaviour reverses into a downward spiral.

That’s where we are now. They better stop that Royal Commission soon!

Until next time,

Nick Hubble Signature

Nick Hubble,
For The Daily Reckoning Australia