This first chart shows the housing price bubble. It uses the broadest measure of US home prices, as calculated by OFHEO, and I have adjusted it for inflation as measured by the personal consumption deflator. The 1.3% trend line is my guess for how much real home prices tend to rise over time, given increases in real earnings and a tendency for homes to increase in size. The difference between actual and trend would be the size of the current bubble. If the trend holds, then at the peak of the market a few years ago, prices were "overvalued" by about one-third. If prices overshoot on the downside as they have in the past, they could end up falling by 35% in inflation-adjusted terms from their peak. Unfortunately, this would suggest we're only in the initial stages of a protracted decline.
This might be a better way to look at it: The second chart shows another version of inflation-adjusted home prices, as measured by the Case-Shiller folks and adjusted for the same measure of inflation. This index covers only properties in the 20 largest metropolitan markets of the country, whereas OFHEO covers the whole country. But that's probably not a bad thing, since the big cities tend to be the areas where prices increased the most and have now fallen the most and the fastest. In any event, the Case-Shiller index appears to respond much more quickly to changing conditions than the OFHEO index.
Even so, the official description of this index says that it is "calculated monthly using a three-month moving average and published with a two month lag." With the latest data being in July, that means this index is only giving us the average of home prices during the months of May through July. So, if prices were moving down throughout that period, as seems quite likely, then the index is overstating the level of prices. I have extrapolated the index through the end of this year, in order to get a feel for what prices might be doing right now. I've assumed that the price index will fall each month by the average of monthly declines from January through July, and inflation will be essentially zero given the big decline in energy prices. Both of these are pretty conservative assumptions. The bottom line is that this measure of inflation-adjusted prices today has probably fallen 30% from the high. That is the same order of magnitude as the size of the bubble suggested in the first chart. If true, this would mean that in major markets around the country we may be getting close to the end of the bursting of the housing bubble.
Caveat: this analysis has lots of apples vs oranges problems (e.g., comparing two very different indices), and I have made assumptions which could be wrong. But I do think it is reasonable to say that we have seen the bulk of the decline of housing prices by now. The August data for the Case Shiller index will be released next Tuesday.