G&M On Emili – “Everyone is getting nervous now. There is more and more potential of a downturn in the marketplace.”

“Where banks once sent human appraisers to assess a home’s value and determine whether to provide a mortgage for it, the banking industry – encouraged by the federal government’s own Canadian Mortgage and Housing Corporation (CMHC) – had largely converted to a faster and cheaper system of automated underwriting, using computerized models to determine how much money to safely lend. The models weren’t perfect, but they were close enough. And what did it matter? House prices always seemed to be going up in Canada anyway.”

CMHC’s automated underwriting program – called Emili – had been stamping its approval on millions of mortgages as safe. But in Emili-approved cases where the banks were forced to foreclose, the homes turned out to be worth much less than believed.
As the housing market in Canada begins to cool and the federal government talks of a soft landing for home prices, rather than a hard crash, attention is turning to the factors that fed record borrowing and contributed to overheated sales and price increases – and the risks that now lie within the financial system. Rock-bottom interest rates propelled Canadian real estate to undreamt-of heights, and Ottawa’s decision to loosen mortgage rules added to the froth, as marginal buyers flooded into the market.
That much is amply documented. But an investigation by The Globe and Mail has uncovered a hidden risk in Canada’s housing markets: The rise of automated lending approvals, which has created a rapid-fire system that has financial regulators worried about the foundations that underpin Canada’s housing market. There are worries that the true worth of Canadians’ homes could be lower than what computerized methods spit out. There are also worries that unscrupulous human appraisers can manipulate home values.
Those distortions matter less in a strong economy and a rising market, in which price appreciation covers up any errors. But the days of steady gains in real estate are gone: Almost all major metropolitan markets have plateaued, and in some, such as Vancouver, housing prices are falling at a worrying pace.
“Everyone is getting nervous now,” says Phil West, a veteran of the appraisal industry who is critical of Emili. “There is more and more potential of a downturn in the marketplace.”

An on-site visit to a suburban Vancouver home with Mr. Sieb illustrates the concern. As he begins walking through the house, the appraiser grows skeptical about the information the bank has been given about this home.
The listing says this house – a bungalow listed for $479,000 – was built in 1980 and is newly renovated. He notes some fresh carpet and a recently installed light switch, but the kitchen and other rooms show troubling signs of age. “This isn’t a renovation,” he says flatly. “You wouldn’t call it that unless you were stretching what you see for the purpose of getting the value up.”
Mr. Sieb checks the dates stamped on the plumbing. “This place was built in the 70s,” he says, shaking his head.
This, he explains, is the sort of thing that the computers miss.
Last month, Mr. Sieb appraised a home that turned out to be several hundred feet smaller than what the paperwork on the house claimed.
“In my career,” says Mr. Sieb, who has been appraising for 30 years and now runs Inter-City Appraisals of Coquitlam, B.C., “maybe five times have I had the exact same measurements as the realtor.”

– from ‘Shaky foundations: How Ottawa’s computers get Canadian home prices wrong’, Grant Robertson and Tara Perkins, Globe & Mail, 22 Dec 2012[hat-tip Ralph Cramdown]

An article that is worth the entire read.
We particularly like the way the description of the current state of the market is not sugar-coated, the thorough discussion of the clearly fudge-able Emili system, and, in particular, the observation that these kinds of rethinks of aspects of market ‘regulation’ are only questioned when a market begins to fail. As the authors say: “Those distortions matter less in a strong economy and a rising market, in which price appreciation covers up any errors.”
– vreaa

UPDATE: Further regarding the Emili discussion:
“Over portfolios with hundreds of thousands of properties, there will always be overvaluation and undervaluation, and the overwhelming majority of those cases fall within safe parameters. What the public needs to know is the tail risk of auto-valued applications, versus appraiser-evaluated apps. Unfortunately, we don’t have enough data to gauge that yet.
Inevitably, people will read the Globe’s story and think that CMHC is using some back-of-the-napkin formula to judge property risk. That’s so far from the truth. Emili is not some 100-line computer program written by a college intern. It is multi-million dollar mission critical technology benefiting from the best available data and over two decades of R&D.
CMHC knows the risk of it botching property valuations en masse. It has the public, press and regulators breathing down its neck around the clock. It knows the risks in automated valuations better than virtually anyone in the country because it’s processed millions of mortgage files since 1996. And it tirelessly optimizes its systems to statistically factor in and adjust for those risks. To imply that CMHC cannot account for “recent movements in home prices” is simply laughable.”

– from ’emili Criticisms Resurface’, Rob McLister, canadianmortgagetrends.com, 22 Dec 2012
[hat-tip Ralph Cramdown, added at the suggestion of jesse/YVR]

Okay, fair point. One has to do a careful analysis of the entire risk across the whole CMHC portfolio, agreed; it’s not enough to point to a few anecdotes of errors in valuation assessment and conclude that the entire system is at high risk. The anecdotes could be representative example of a systemic bias towards overvaluation, but they could also simply be outliers.
At the same time, when Rob McLister expresses high confidence in CMHCs risk modelling, refers to the “multi-million dollar mission critical technology”, and states that this criticism of CMHC is “laughable”, we are not immediately reassured. After all, he is
the same guy who called the idea of 40% price drops “farcical”. Any market observer who lacks the imagination to see the possibility of such an outcome is at risk of being blinkered in their analysis.
When we hear market participants calling the idea of certain outcomes “laughable” and “farcical”, we’d strongly suggest one give serious thought to the possibility of those outcomes coming to pass. Why? Because their high confidence reflects the strong probability that a very substantial percentage of market participants are not prepared for that outcome, and that is the very mechanism by which such outcomes come to pass! This is closely related to the analysis of sentiment, and is Contrarianism 101.
When market participants are 100% convinced that stock ‘x’ can only go up, where does it go?
At 125, the thought of Nortel trading at 50 was “farcical”, and “multi-million dollar mission critical technology” showed that such a drop was impossible.
– vreaa

46 responses to “G&M On Emili – “Everyone is getting nervous now. There is more and more potential of a downturn in the marketplace.”

  1. You should link to the CMT article referenced in the last post. The G&M article lacks some data, and as I commented, unless emili uses cap rates to value property there would be distortions in market pricing regardless regulatory oversight.

    • Thanks, update added to original post, with commentary.

      • Why would you use cap rates for Single Family Housing if there is no income? It is used for rentals.
        In which case a system would be needed to determine the actual contract rents, market rents, all sources of income and expenses.

  2. Speaking of getting nervous, this is verbatim from a Vancouver realtor I know: “No one seems to be very motivated in this market to jump in… they are all feeling like the market is dropping and the realtors are frustrated.”

  3. As I’ve said before a few times on VCI, if it took fraud on a large scale in the US to reach 70% of home ownership, it certainly took fraud to a similar scale to get to 70% home ownership in Canada.
    What we’re are witnessing now with Emili is only one link of a much wider and pervasive fraudulent chain. Only once the dust settles down will we realize the extent of the problem. We will then look back and say: “how did we let that happen?” Exactly what happened in the US…

  4. theboywhocriedbubble

    ‘Gaming Emili’ the term conjures up visions of absolute horror. Manipulation of a simple computer program designed in 1996 ? I picture a Speak and Spell plugged into a phone jack in Ottawa somewhere. wow

  5. 5 years ago girlfriend and i were approved for over 400k on a loan…. you know that get pre done before you shop….

    well that was without showing or proving any income. this was by word of mouth at a mortgage broker’s office. i said i have the papers to back my claims, she said doesn’t matter we trust your words.

    why would phoney valuations made by a computer surprise anyone in today’s environment?

    we never pulled the trigger on a place… good thing too!

    USA north is what we are. one question though, how did/does this computer evaluate a condo suite? ( i haven’t read the full article yet so if it is in there ignore the question)


  6. Another crucial difference between Vancouver and Manhattan: in Vancouver, some boomer parents buy housing nearby for their kids. In Manhattan, it’s the other way around.


    This highlights a contrast in robustness of the economy for young professionals in these two cities.

  7. I was approved for about 420k in the spring I only made a little more than 50k last year. I looked at a few condos in Vancouver and decided to keep renting.
    I sold my house on Vancouver island for about 40% over assessment also about 20k more than I thought it was worth. I don’t know if a human came to aprase it.
    My experience of the past year from looking at condos to selling a home and getting pre-approved I see so many holes in our system that will hurt the middle class the most

  8. Looking into the appraisal system at BC ASSessment is why I decided to sell.
    It is evaluations are as phony as a three dollar bill. All based on word of mouth evaluations. Very few actual visits/inspections…
    They increased the assessed value of my property an average of 27% compounded, every year without looking at it… for more than 12 years. Not one document existed to back their claim of value. All based on other property sales….
    The whole real estate system is a Ponzi scheme.
    Oh well sold now…


  9. That “tail risk” thought is just crap. He’s got a twee little diagram of a normal-ish curve with a wee end of one tail shaded. That isn’t how this works. Everyone involved in a real estate deal wants it to go through. Even the lawyers for, while it is true that they get paid either way, most of them don’t care to develop a reputation as a deal killer. The one entity which should be most skeptical is the money lender and, if the deal is in any way guaranteed by CMHC, the money lender has no seat at the table. When a racket is as lucrative as real estate and mortgage brokering can be, a certain fraction of the players will figure out how to game the gatekeeper. Some of them will rationalize that the borrower just went through a rough patch or the house will be worth more than the loan as soon as the renos are done, some mis-measure the property, some lie to Emili or even create false paperwork, all the way up to outright take-the-money-and-run fraud.

    P.S. I got ‘pigged’ on this post; I’d already left some comment on this topic on the previous one.

    • Ralph -> Sorry about bringing the discussion over here and injuring the flow somewhat..
      Agree re your criticism of the diagram.
      More appropriate would be a diagram of two overlapping but different averaged normal distributions, showing how systematic slight overestimation of valuations can have a large effect regarding numbers at the extremes.

      • Hi vreaa: I could do something like this in a few key strokes, but don’t quite understand what you’re saying. I’m confused about what you mean by “different averaged” normal distributions and what relationship that has to numbers at the extremes.

        Thanks (and Merry Xmas!).

      • Something like this…
        Small amounts of systematic bias can make big differences in numbers in the tails:

        If you have a slight bias towards overvaluation in a system, the number of properties past a critical point of overvaluation are going to be a lot more than in a just slightly more conservative system.

    • Mortgage brokers have oft complained about emili undervaluing properties and charging higher MI premiums.

      OSFI is evaluating reliance on emili, I agree with Rob that the potential problem is understood and will be reported to the dof next year.

      My only concern is one of taxpayer exposure.

      • Ralph Cramdown

        Well sure. Just like real estate agents, they sit around and complain about deal killers (appraisers, lawyers, lenders) while they wait for the phone to ring.

        And when they’re not complaining about how THEIR wonderful, responsible borrowers (even the ones doing cash out refis to pay off consumer debt) are getting screwed over by the lenders, they’re booing bank loan officers for diddling Emili:

        “I had one lady who bought a house for $100,000 and then eight months later, with the branch getting approved on Emili, she did a refi for $180K,” he said. “Now she owes $164, through a refi and line of credit on a house that’s really valued at $124,000.”

      • Ralph Cramdown

        I almost missed the casual rooted-ism in that mortgage broker’s lament: “…ethical lapses by transitory mortgage specialists using the valuation system.”

    • Disloyal Cadre. You did not get pigged. It is all the more reason to double your number of posts for more public acclaim!

      (yes its the booze)

  10. Mop Writer Pulls Byline?
    by Ralph Cramdown
    In the newspaper world, editors and writers fight over facts, over slant, over things implied or left out. The editor has final say, but if the writer feels that the story’s problems are odious enough, he can ask that his byline be pulled.

    Such would appear to have happened in Monday’s Globe and Mail, where a story headlined ‘Property sales drop but prices stay steady’ is attributed only to ‘Staff.’ Second graf reads “Observers expect to learn that national sales dropped by about 12 percent in November, when the Canadian Real Estate Association Releases its monthly report, expected Monday.”

  11. the Mop doesn’t know what the Pail is doing?
    we’re Not in the danger zone yet, not until the first few weeks in January. That’s when we’ll know the inflation numbers for December. Are they bad? oh yes, very bad, according to November numbers. So far we have one Canadian city registering Negative Inflation (yes, folks, that’s Deflation: Victoria -0.2). I don’t have to spell out how bad Deflation will suck your RE ‘value’ do I? let me put it to you this way: Deflation means debt, like Mortgage Holder debt, goes up in Real Terms.
    Silver lining to all this… down the road, after much anguish, Emili will be revealed for what is, a government sponsored hoax, and a Court will eradicate your outstanding debt. Unfortunately the next day will be the ‘big population die off’, when we go into hyperinflation….

    • Speaking of deflating…..yesterdays news in the G&M also brought out data on GDP growth from Stats Can and it is not a pretty picture. We have slowed to a crawl and are edging just above an absolute stall. There are now doubts that Mr Carney’s estimate of 2.5% annual growth rate will even reach half that number which was my own assertion some time back. No big surprise here but we do need to be prepared for the possibility of negative growth in future quarters if housing takes a swan dive come early next year. Spring could be crucial depending on how well retailers have done over the holiday season and by how much inventory rebuilding is then underway.

  12. Our personal experience in 2008 really shook my confidence in how mortgage and HELOC approvals are handled by banks.
    We used to own a 1Bedroom 1 Bath 780 Sqft “Penthouse” in East Vancouver, one block to Commercial Drive.
    It was a good location, we renovated it from the inside, great so far… However the building had major issues from the outside and needed a complete rainscreening job. The Strata members fought each other for a long time and renovations were postponed while the damage got worse. Our share when it finally got done $78K.
    We had no mortgage on it at the time and were able to get a loan from CMHC for the repairs which we took not because it was interest free. Anyways, we sold the place for 315K after the renovation was done and made a good profit as I had bought it very cheap, back in 2001 when everybody was afraid of leaky condos and there were no buyers for this even though the location was great and the unit was nice from the inside.
    Here is the part that shows the reclessness of lending though. After we were approved for the CMHC funds one of the major 5 banks who we were banking with at the time called us and offered us a HELOC on the place without we even asking for it.
    I asked them how much could they give us and the answer was that based on the location, size and age they can give us up to 300K if we wanted to.
    I was simply shocked and actually tempted to take it, if I was still single at the time I might have done it 🙂 They even offered to waive all the inspection and simply said we have the option of just walking into the bank and sign the paperwork if we wanted to or somebody could come out with the paperwork to be signed to our location. We ended up only taking a HELOC for 100K, never touched it as we didn’t need it to but we could have taken 300K from the bank and walked away 🙂 After selling the place and paying out the $78K loan on it plus the commission we paid to the agent of $7K we ended up pocketing $230K on it. If we wanted to we could have taken $300K from the bank, and walked away with much more of a profit and without the hassle of having to live through 8 month of hell that came with the rainscreening 🙂
    That’s how well banks assessed risk in the RE market in 2008.

    • Hi.

      Could you explain what you meant that by taking the $300K HELOC you could have walked away with more money? In this case would you not be in debt to bank for amount between purchase price and HELOC?


      • I believe we could have taken the HELOC for 300K and simply walk away leaving the bank on hook with a unit to be sold. Instead we stayed, payed for the rainscreening, sold the unit and pocketed 230K instead of 300K.
        My understanding is that a HELOC is not like a mortgage, the best a bank can do is take the property the HELOC is registered against and sell it. I don’t believe we would have been legaly liable for anything above that, if the bank can’t recovered the amount lent out to us by selling the unit, too bad, their loss. I might be wrong but I think that’s how it works with a HELOC?! We decided not to take the max HELOC offered anyways but I do think that this points to a total lack of recklesness on the part of the banks.

      • Caroica Canuck

        The HELOC would have been secured by a caveat on the property pursuant to a promissory note/revolving loan agreement, which would have attached his personal convenant. So he would have been “personally” on the hook for the entire amount.

  13. “Everyone is getting nervous.” That simple phrase sums the whole situation up right there. All the models and computer simulations in the world can’t predict exactly how this one is going to unwind and that’s just plain nerve racking.

    • Real Estate Tsunami

      Cyril, we’ve surrendered to the modelers and number crunchers.
      Let’s go back to the basics again, like if I make one dollar a day, I can only spend a dollar a day.
      Life is simple, trust your guts, not the money merchants.

      • If we are getting back to basic the correct formula is closer to to “Earn a dollar and spend no more than 75 cents”. Canadians used to be dilligent savers. If we expect to retire with dignity we need to return to the older models of thrift and saving for a rainy day (even if it is contrary to the consumption society model we now know).

  14. Sorry for the typo …
    We had no mortgage on it at the time and were able to get a loan from CMHC for the repairs which we took because it was interest free. 🙂

  15. Village Whisperer

    Merry Christmas

    • And a very Merry Christmas to you too, Whisperer. Sorry I cannot pick up your site anymore. Keep up the good work though. You have been doing a terrific job all year.

  16. …”tirelessly optimizes its systems to statistically factor in and adjust for those risks.”….

    That’s exactly what the RocketScientists at Long Term Capital Management said… Then it was, “Oops.”

  17. Emili should make you proud: it proves that Canadians have their own version of the Gaussian Copula that killed the CDO market in US:

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