“It’s what I’ve heard coined as ‘gaming Emili,’ ” Mr. West says. “You submit a variety of different numbers until you get to the number that Emili kicks out and says: unlikely or highly unlikely” to default.
Officials at CMHC play down these concerns.
“Yes, Emili can approve an application on its own, but only after it looks at all the factors and it satisfies our predetermined parameters,” Mr. Serré said. “All Emili does is rank the mortgage loan applications from low to high in terms of applications that are more likely to default. That’s its purpose in life.”
And CMHC officials say the system is designed to catch manipulation. “If lenders submit multiple purchase prices, this will raise a red flag in the system,” a spokeswoman said in an e-mail.
However, several banking industry insiders, speaking on condition of anonymity, told The Globe that commissioned staff within their ranks have been found gaming Emili in order to boost their bonuses.
The OSFI documents show that one industry official warned the regulator that Emili distorts the market by sending the wrong signal on housing values to homeowners.
“Buyers feel reassured with respect to the value of their investments because it was validated by a Crown corporation, while the CMHC does not appraise the real value of the purchased property. Instead it appraises the risk associated with the debtor,” the industry member said.
Although automated systems save time, there is also cost to consumers. Since CMHC charges premiums for insuring loans against default, larger mortgages approved by the system mean bigger premiums.
“The time saved comes with a high price tag for the consumer,” an industry member argues in the documents. “If the property is overvalued, the insurance premium will be based on the overvaluation and multiplied by 25 years of mortgage payments.”
“The resulting sum may be considerable. Thus, the CMHC, a Crown corporation, cuts corners by not demanding professional appraisals and generates higher revenues by basing its premiums on overvalued figures.”
In the past decade, CMHC has made more than $17-billion for the federal government, including income taxes.
In an interview, CMHC officials pointed to the country’s low default rate as evidence such worries are overblown. Since 1996, Emili has handled about five million mortgage applications, and defaults are running at less than 1 per cent.
However, economists and real estate experts note that this statistic tends to lag behind market reality, and the true extent of the problem will only be known after housing prices cool off.
“You can hide a lot of sins in underwriting through market appreciation,” Mr. West says. “No one cares when it’s good times and everyone is happy, and your only need is to put as much money out as you possibly can, as opposed to balancing risk.”
For banks, sound appraisals are essential to measuring the ratio of loans to home values, critical for lenders in monitoring their own loan portfolios – which are mostly comprised of mortgages. If home values are off, then so too will be the ratios used by banks to manage risk.
As the market gets more volatile, the data used in automated systems become less reliable, since the information does not capture the most recent movements in home prices.
Automated models are “imperfect,” Mr. Somerville of UBC said. Just as computers can mistakenly overestimate the value of a house, they can also underestimate a property with faulty data, making a good loan appear to be high-risk. Because of these issues, the systems must be used carefully, he says. “Cheaper and faster is not always better for the health of the financial system.”
OSFI’s request last March that lenders stop relying solely on automated valuations was the first hint of a problem with appraisals. The regulator ordered banks to conduct in-person appraisals or – at the very least – drive-by inspections to confirm basic details. In an interview with The Globe, OSFI superintendent Julie Dickson said the regulator grew concerned that some lenders weren’t “sticking to policies” on lending, particularly “in a market with froth.”