Mortgage Rates Seem Likely to Improve

Here's an encouraging piece of news for the real estate market: The Treasury Department is working on a plan to push mortgage rates down to 4.5%. The details are being worked out, but the essence of the plan is that the Treasury will act as a bank: They'll borrow money from private investors (by selling Treasury bonds) and lend the proceeds to homeowners. As long as the loans get repaid, the Treasury will actually earn a profit, determined by the spread between its lending rate (4.5% in this case) and its borrowing rate.

The Treasury's borrowing costs have been coming down lately, as investors all over the world dump risky assets and pour money into Treasury bonds. Since December of last year, the yield on 10-year Treasury bonds has fallen from 4.1% to 2.7% (as of December 5th). That's the lowest rate in the last 50 years, by a good margin.

Meanwhile, 30-year mortgage rates have remained stable. When the subprime loan crisis started making headlines in 2007, mortgage rates were in the low 6%-range. They've fallen since then, but are still within 0.75 percentage point of their pre-crisis levels. In contrast, 10-year Treasury yields have fallen by almost three times that amount.

With Treasury yields falling and mortgage rates remaining stable, the interest rate spread between the two classes of securities has increased to levels that haven't been seen in the last twenty years. (This is one of the primary indicators of distress in the credit markets.) From 1987 to 2006, the average spread between 30-year mortgages and 10-year Treasurys was 1.6 percentage points. Today, the spread is 2.8 percentage points. It hasn't been that high since the early 1980's, when inflation was running rampant.

Anyway, back to the Treasury's plan. Assuming that Treasury yields remain below 3% (a good bet when inflation is running at close to 0%), a mortgage rate of 4.5% represents a spread of at least 1.5 percentage points. That's consistent with historical averages. So even if the Treasury plan is abandoned, there are good reasons to expect that private lenders will push mortgage rates down to the same levels.

Banks will have to be recapitalized in order for that to happen, but I don't think we'll have to wait for home prices to stabilize. (During the housing market downturn of the early 1990's, the mortgage spread actually fell below 1.5 percentage points.) Even if the Treasury plan is abandoned, there's a good chance that we'll see 30-year mortgage rates below 5% within the next year.

A Temperature Gauge for the San Francisco Real Estate Market

How is the San Francisco real estate market doing? Unfortunately, that can be a difficult question to answer. Take a look at the chart, below, which shows historical sale prices for two-bedroom condos.

I'd summarize this chart by saying that prices plateaued in the summer of 2005, and haven't shown any obvious trend since then. So much for the last three years, you say, but what about the last three months? Consider the chart, below, which shows the annual rate of change for two-bedroom condo prices.

Unfortunately, I find this chart even more difficult to summarize than the first one. If you asked me how the market is doing and this was all I had to go on, I'd probably wind up reading data points straight from the chart. That doesn't seem helpful, particularly if you're not interested in two-bedroom condos. There must be a better way to characterize the state of the market.

You may remember that when the housing frenzy was at its peak, overbidding and multiple-offers were common. Take a look at the chart, below, which shows the percentage of two-bedroom condos that were sold above the asking price.

I've also included the change in average sale price (taken from the second chart, above). The two series track each other fairly closely, which suggests that either one can be used as a proxy for the other. The advantage of focusing on bidding activity instead of price changes is that it provides a cleaner snapshot of the market.

If I say that prices have fallen 5% in the last three months, you'll probably want to know how much they changed in the three months before that. Or maybe you'll want to know the level from which they started, and whether I believe that that level was appropriate. Pretty soon, we'll be far afield from the original question, which was, "How is the market doing?"

Okay, here goes: During the last few months, only about 20% of the housing units sold in San Francisco have gone for more than the asking price. In contrast, when the dotcom and housing bubbles were at their peaks, 80% of sales were for more than the asking price. Except for a few months following September 11, 2001, the recent rate of over-bidding activity is at its lowest level in the last ten years.

In other words, the San Francisco housing market has cooled dramatically.