Commercial Loan Shenanigans: A Looming Financial Disaster is on the Horizon

ProPublica reports that a whistleblower complaint filed with the Securities and Exchange Commission alleges that fraud in loans on commercial properties is increasing. This echoes the fraud in financial residential real estate that lead to the 2008 housing market collapse. Back then, residential home values were often inflated and the borrower's ability to repay the loan was also frequently overstated. Those home loan were bundled into securities and sold. The securities collapsed leading to tens of billions in losses for investors who bought the fraudulent securities.

ProPublica writes:

“Twelve years later, there’s evidence something similar is happening again. 

Some of the world’s biggest banks — including Wells Fargo and Deutsche Bank — as well as other lenders have engaged in a systematic fraud that allowed them to award borrowers bigger loans than were supported by their true financials, according to a previously unreported whistleblower complaint submitted to the Securities and Exchange Commission last year. 

Whereas the fraud during the last crisis was in residential mortgages, the complaint claims this time it’s happening in commercial properties like office buildings, apartment complexes and retail centers. The complaint focuses on the loans that are gathered into pools whose worth can exceed $1 billion and turned into bonds sold to investors, known as CMBS (for commercial mortgage-backed securities).”

ProPublica looked at six loans in CMBS packages and found the whistleblower complaint to be accurate. In particular, past profits reported for some buildings were listed as much as 30% higher than the profits previously reported for the same buildings and same years. That is not supposed to happen. Regulators are supposed to flag anomalies like that and find out if fraudulent loans are being made. Given the virulently anti-government and anti-regulation attitude of the president and his appointees, one can reasonably believe that honest regulators have been ordered to allow fraud like this.

The shenanigans include wiping out of some expenses for a commercial building that were listed in earlier loan documents. No explanation is given for disappeared expenses. By falsely claiming lower expenses to operate a building, a fraudulent loan, the loan is more profitable for the lender. The problem is that the risk of default on the loan increases. If too many defaults happen, that can lead to another financial meltdown similar to that in 2008.

With trillions of dollars committed to bailouts, overvaluations in commercial real estate now constitute a much larger risk than before the pandemic slammed the economy. In fact, data from early April showed a sharp spike in missed payments to bondholders for CMBS that hold loans from hotels and retail stores. ProPublica comments that the default rate is expected to increase because of Covid-19 economic lockdowns.

Not surprisingly, the Trump administration is moving after lobbying by commercial real estate organizations to prop these loans up. Commercial real estate groups lobbied for federal support after warning about a possible commercial mortgage crash. In response, the Federal Reserve pledged to prop up CMBS by loaning money to investors and letting them use their CMBS as collateral. Once again, taxpayers could be on the hook for tens or hundreds of billions in bad loans.

Also not surprisingly, the Mortgage Bankers Association, representing institutions who make money on bad loans backed by taxpayers, claims they are unaware of any such fraudulent activities and have no other comments to make. Their comment: “We aren’t aware of this occurring and really don’t have anything to add.” So much for concern among financial institutions. Why should they care if bad loan risk is on taxpayers and not themselves? What have they got to lose? Under current political conditions, they have little or nothing to lose, but a lot of profit to gain.

After the 2008 disaster, this kind of corruption wasn't supposed to be able to happen again. Regulators were supposed to stop this kind of criminal activity before it became widespread. Regardless, it appears to be happening again. Coupled with corruption and incompetence, financial disaster is what a anti-government and anti-regulation mindset can allow.