The World Changed in September

Sale price statistics can be volatile, but it seems safe to say that the San Francisco real estate market changed in September. Take a look at the chart, below, which shows median home prices for San Francisco County.

The pink line shows the average level of home prices for the three-year period between July 1, 2005 and June 30, 2008. A fair interpretation of the chart is that, monthly fluctuations notwithstanding, prices were in a holding pattern over that three-year period. As late as August of 2008, prices were still within 2.5% of the three-year average. When Lehman Brothers filed for bankruptcy on September 15th, however, the world changed. Stock prices fell 7% during the remaining weeks of September, and have fallen another 25% since then.

I predicted at the time that the San Francisco real estate market would suffer as a result. (Okay, that wasn't much of a stretch.) In fact, San Francisco home prices fell 10% in September alone, and have fallen another 4% through the end of November. It's not clear that the stock market meltdown caused this drop. For starters, most of the sales that closed in September would have been initiated in August, before the meltdown really started. But it's starting to look as if something important happened to the San Francisco market in September.

More on Mortgage Rates

A few weeks ago, I wrote that mortage rates are likely to improve. That was based on 1) the Treasury's proposal to push mortgage rates down to 4.5%; and 2) the fact that the spread between 30-year mortgages and 10-year Treasury's was at 2.8 percentage points, which is nearly double its long-term average.

Paul Krugman weighed in today on the subject in his New York Times blog, arguing that since Fannie Mae and Freddie Mac (i.e., the dominant mortgage lenders in today's market) have effectively been nationalized, there is little reason for investors to shun their debt in favor of Treasury bonds. In other words, Fannie and Freddie should already be able to write new loans at a spread that's comparable to historical levels.

The historical average spread between 30-year mortgages and 10-year Treasury's is roughly 1.6 percentage points. Adding that to the current 2.15% yield on 10-year Treasury's, you get a 'normalized' mortgage rate of 3.75%. For comparison purposes, mortgages are currently being written at around 5.15%, which is already the lowest since the Fed started doing its rate survey in 1971.