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Potential buyers arrive for an open house in the Kitsilano neighbourhood in Vancouver, British Columbia, Sunday, October 14, 2012. (Rafal Gerszak For The Globe and Mail)
Potential buyers arrive for an open house in the Kitsilano neighbourhood in Vancouver, British Columbia, Sunday, October 14, 2012. (Rafal Gerszak For The Globe and Mail)

Shaky foundations: How Ottawa's computers get Canadian home prices wrong Add to ...

Finance Minister Jim Flaherty agreed. “Some financial institutions in Canada were accepting mortgages without proper due diligence,” Mr. Flaherty said in a recent interview.

Senior executives at two of Canada’s largest banks acknowledged that there is a need to shore up the country’s underwriting standards, and suggested OSFI’s concern over appraisals is the start of that process.

“We were obviously the core participants in a market that was showing signs of frothiness,” Toronto-Dominion Bank chief executive officer Ed Clark said.

“What [regulators] really want us to do is not get sloppy here,” Mr. Clark said. “And so by and large, the banks are looking to make sure that we’re not sloppy. We get what they’re trying to get after.”

Mr. McKay at RBC agrees with his rival. In a market that is cooling off, banks need to be more certain about what’s on their books. “We know exactly how much we lent,” Mr. McKay said. “We better be just as sure of the value of that home we’ve lent against.”

The most exposed

As First American Financial copes with tens of millions of dollars of losses based on its bad bet in the Canadian housing market, Mr. Sieb, the B.C. appraiser, wonders who is looking out for the homeowner.

He pulls his grey pickup truck into a cul-de-sac in Coquitlam, B.C., and points out two homes side by side. They are virtually identical – most people would have a hard time telling them apart, especially if you were running market data through a computer. But when Mr. Sieb was called by a bank to evaluate the properties in person, the results were surprising. Neither had been on the market in years. One was significantly run-down inside, the other had been extensively renovated. The two homes, similar on the outside, were valued at nearly $100,000 apart.

An automated system wouldn’t have picked up the differences. A refinancing would have slipped through the software.

In a market fuelled by record borrowing and price inflation over the past decade, buyers are the ones exposed to the most risk, he figures. When prices fall, valuation problems come to the surface. “The only person hurt,” he says, “is the person who pays too much.”



Since 1996, the use of automated computer systems by banks to determine how much should be lent in a mortgage or home refinancing has flourished in Canada. For banks, these computer models were cheaper and faster than conducting a full appraisal. However, documents showing discussions between Canada’s banking regulator and the financial and real estate sectors indicate there are serious concerns about the accuracy of these automated systems, and an overreliance on them by banks. This adds risk to the housing market.

The documents, marked Protected – For Internal Purposes Only, were obtained by The Globe and Mail through Access to Information during a six-month investigation into lending practices in the housing sector over the past decade. Below are excerpts, along with an explanation of what is being said.

Excerpt 1

“Automated models… have their drawback – primarily that they are driven by the sellers’ listings, which often inflates the value of the home.” – OSFI.

What it means: Canada’s banking regulator is warning the banking sector that the computer models they use to determine how much to lend use data that are skewed toward making the home look more attractive by the sellers, which inflates prices and calls into question the accuracy of the system.

These concerns are significant, since the regulator has never discussed this problem publicly.

Excerpt 2

“FRFIs should use other valuation methods, including on-sites. This is the lender’s responsibility. Property appraisal is the lender’s responsibility.”

What it means: The regulator is urging banks (federally regulated financial institutions, or FRFIs) to stop relying solely on computer models and databases to evaluate home values and loan risk, and to see the homes in person through on-site appraisals.

Grant Robertson

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