The truth behind rising mortgage fraud

published 17 December 2007

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It seems that crime really doesn't pay.

"Banks are seeking to crack down on mortgage fraud as evidence mounts of a rise in the number of fraudulent borrowers," reported Ellen Kelleher in the FT this weekend, citingseveral high street banks, who claim they've had to tighten lending controls in response to a large rise in the number of "potentially fraudulent mortgage applications".

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We don't know why they're so worried. These people clearly aren't criminal masterminds. After all, you'd have to be a pretty stupid fraudster to be attempting to climb onto the property ladder now, just as it's collapsing under its own weight.

All the same, it's strange that after a decade-long boom in house prices, it's only just now that banks are starting to find that fraudulent claims are rising.

It's almost as though they've only just started looking

Experts claim that cases of mortgage fraud have risen sharply this year. Nigel Moden, Ernst & Young's director of mortgage lending advisory, tells the FT: "There is growing evidence to suggest that the credit crunch and the increasing sophistication of fraud networks are requiring lenders to be ever more vigilant across all their mortgage businesses."

It really is quite astonishing. After all, we've had a massive housing boom, fuelled by incredibly clever and innovative forms of credit that allowed people who'd never had access to mortgages before to sign off on their own income details.

Ever-rising house prices have created huge incentives for people to, shall we say, exaggerate their personal circumstances in order to make what seemed like a fast return on the property market.

Even normally honest people, desperate to buy a house and stop "wasting money" on rent, might have been tempted to bump up their wage packets a little on the application forms.

And yet it's only now, as prices are collapsing and transactions are drying up, that financial institutions are discovering rising cases of potential fraud.

Hmmm. Are you thinking what I'm thinking?

The truth, of course, is that banks are only discovering' mortgage fraud now, because they need excuses to knock back as many mortgage applications as they possibly can. Up until now, they haven't cared who they lend to, because there was always a willing buyer for the mortgage, regardless of how badly vetted it was. That market disappeared when the US subprime crisis finally exploded.

So now banks are worried that they've been left holding a whole great pile of mortgage-backed dynamite, relying on over-stretched borrowers to maintain payments they can't afford, on collateral that is losing value by the day.

Lenders focus on quality, not quantity

That means as we've been saying for a while now that banks are now chasing profitable customers, rather than market share. The focus is back on quality, not quantity. And it's amazing how when a credit crunch arrives, what was once seen as something that was OK because everyone was doing it (giving yourself a pay rise or an extra nought on your bonus to stretch your multiples that little bit further), becomes plain old fraud.

Way back in October 2003, the BBC's Money Programme uncovered plenty of examples of mortgage brokers more than happy to recommend that clients overstate their income. And earlier this year the FSA discovered in a review of lenders and brokers that in a third of cases, checks on ability to repay the mortgage were "inadequate".

So fraud cases aren't rising at all it's just that banks are only now finally making any effort to detect them. The FT continues, "lenders now require brokers to introduce plausibility checks' before agreeing self-certified mortgage applications, which do not require borrowers to offer proof of income."

Meanwhile, Ian Clegg of mortgage broker Clegg Gifford Private Clients tells the paper that "banks are now trying to ward off fraud before it happens." Meanwhile, Stephen Bland, who deals with mortgage fraud investigations at the Financial Services Authority, says that "next year we're going to take a more proactive stance on [mortgage fraud]."

Needless to say, it's far too late. There's been much slamming of stable doors since the credit crunch hit the headlines in August, but this lot take the biscuit. The horses all bolted long ago and are now stampeding right over the edge of a cliff.

Only a miracle can save the housing market now

The latest gloomy forecast to come out about house prices is from Citigroup, which reckons that prices will fall by 10% over the next three years. And I'd say that's optimistic.

All those lending practices that the banks had been turning a blind eye to are about to bite them in the backside. Just as the supply of credit that has fuelled this housing bubble is being turned off, so banks and regulators are making sure that any money left available for lending will be almost impossible relatively speaking, anyway to get hold of.

Forget interest rate cuts and liquidity injections it'd take a miracle to save the housing market now.

Turning to the wider markets...

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US stocks tumble on inflation data

London's benchmark FTSE 100 index closed 32 points higher, at 6,397, on Friday after a day of light but volatile trade. Rexam and Rentokil saw some of the session's biggest gains as bargain hunters stepped in following Thursday's sell-off. But Northern Rock was the day's star performer as Virgin was stripped of its status as preferential bidder for the mortgage bank. For a full market report, see: London market close.

Elsewhere in Europe, the Paris CAC-40 added 14 points to end the day at 5,605. And in Frankfurt, the DAX-30 closed down one point at 7,948.

On Wall Street, stocks fell sharply on Friday - taking the major indices to their biggest weekly drop in five weeks - as rising consumer prices reduced hopes of another interest rate cut next month. The Dow Jones closed down 178 points at 13,339. The tech-rich Nasdaq was 32 points lower, at 2,635. And the S&P 500 was 20 points lower, at 1,467.

Asian stocks nosedived today as investors took their cue from Friday's weakness on Wall Street. The Nikkei was down 264 points, at 15,249. And in Hong Kong, the Hang Seng dropped 967 points to end the session at 26,596.

London house prices fall 6.8%

Crude oil had risen to $91.55 this morning, whilst Brent spot was at $92.50 in London.

Spot gold hit $798.50 today as bargain-hunters took advantage of Friday's falls, but had since fallen back to $792.80. And silver was at $13.81.

In the currency markets, the pound was at 2.0137 against the dollar and 1.4003 against the euro this morning. And the dollar was at 0.6951 against the euro and 113.11 against the yen.

And in London this morning, a report by Rightmove revealed the biggest drop in UK house prices for five years this month. The average price fell 3.2% from November due to the rising cost of borrowing and a downturn in market sentiment. London led the way with a staggering 6.8% drop.

Finally, our recommended articles for today...

Greed, fear - and the art of investing

- America experienced its own Northern Rock moment recently as over $13bn was withdrawn from Florida's state-run investment pool. But according to the 'blood on the streets' theory, such panics may well be the best time to buy. For more on why learning to scent investor fear can be highly profitable, read: Greed, fear - and the art of investing

Northern Rock - who's to blame?

- As Northern Rock heads towards nationalisation, it might be worth looking at how the mortgage bank got into this mess in the first place. In this MoneyWeek article - just available to non-subscribers - we look at the main figures involved in the creation of both the credit bubble and Northern Rock's dodgy business model: Northern Rock - who's to blame?

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.