A Bad Day for Stocks, A Good Day for Housing?

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If you took even a glance at CNBC or yahoo finance or CNNMoney.com or where ever you go to check up on the market, you probably know that today was a bad day for stocks. The S&P 500 hit an 8-month low, and the Dow was down as much as 326 points at one point. It ended down only 268 and change. (Feel better. Behavioral economics at work.) Something you may have missed is that bonds, as they have been doing recently, rallied. The yield on the 10-year Treasury note fell below 3% for the first time since April 2009, ending at 2.97%.

Lower interest rates are good for lots of things. They make it easier to borrow money and should in theory boost the economy, though that hasn’t been happening lately. One of the things that people often think are a big beneficiary of low interest rates is housing prices. So this should be a good time to buy a house. Yes. Actually, no, according to Felix Salmon, the excellent blogger over at Reuters. He takes it a step farther and flips the classic argument. Salmon wonders that if interest rates and housing are so linked, is the fact that we are at a year and a half low on the 10-year bond actually bad for housing. If interest rates have no where to go but up, doesn’t that mean that housing prices have no where to go but down.

when was the last time that historically low mortgage rates signalled a good time to buy, in any country? In pretty much every such case, I think, prices have only gone up if rates have fallen lower still. But now we’re bumping along the zero lower bound, and the only way that mortgage rates are falling significantly from these levels is if we get another monster recession. Which certainly won’t help house prices.

I don’t know where housing prices are headed, but what I do know is this: Low interest rates don’t really signal very much about housing prices at all. Here’s why:

Early in his blog post, Salmon states this, and here’s where he heads down the wrong track:

The big picture, in terms of house prices and interest rates, is clear: prices go up when rates are falling, and they go down when rates are rising. That stands to reason: people buy what they can afford. When you’re selling your house you care about the headline price, but when you’re buying it you mostly care about how much money you’re going to have to spend each month in mortgage, taxes, and maintenance. If mortgage rates go up, the amount of mortgage you can get for any given monthly payment goes down, and so house prices have to come down lest they become out of reach.

It seems simple enough logic. But in fact it’s a little too simple. In reality, there is very little research that links housing prices to interest rates. I looked into that link a year and a half ago when the Treasury was proposing a plan to buy down mortgage rates to stimulate the housing market and found this out:

On another troubling note, some economist question whether the lower mortgage rates would even boost sales or home values. A 2006 study of mortgage rates and New York City housing prices going back to 1975 by Lucas Finco of Quadlet Consulting found no correlation between lower mortgage rates and higher housing prices, or vice versa. “The relationship between mortgage rates and home prices is pretty obscure,” says Jack Guttentag, a professor emeritus of finance at the Wharton School of Business.

James Hamilton, a professor of economics at the University of California, San Diego, says he used to think that lower mortgage rates were responsible for rising home sales in the first half of this decade, and for that reason he projected home prices would rebound in 2007. He now says rising home sales were the result of deterioration of lending standards and not lower mortgage rates. “I was wrong. The real story with home sales has to do with the availability of credit,” says Hamilton. “And credit is tight now.”

There’s a lot of factors that go into housing prices. Felix says the math of interest rates and housing prices gets disrupted during a housing bubble. But my question would be doesn’t the same math then disrupted during a housing collapse. No matter how affordable housing gets, people won’t buy in. The real answer is there is no math that links interest rates and housing. So think what you want about where housing prices are headed. There are a number of reasons–foreclosures, the job market, low expectations about housing market returns–to believe housing prices won’t pick up anytime soon. Low interest rates, and the threat of them going higher, though, are not one of them.