It's getting pretty ugly out there in the real estate market

In today's NY Times, David Leonhardt tells us that homes in the US are overvalued by about 20%, perhaps more, and in some areas may be overvalued by as much as 40%.

From the late 1960s until 2000, the price of the typical American home and the income of the typical family moved almost in lock step. House prices rose a bit more quickly than incomes during the occasional real estate boom, but would always settle down again. In 2000, the median home cost about $130,000, roughly three times the typical household income — almost precisely the ratio that had held since the ’60s.

Then came a real estate boom unlike any before it. By last year, this ratio of prices to incomes had suddenly shot up to 4.5. For it to return to its old level, home prices would have to fall by an almost unthinkable one-third, and probably more in California, Florida and the Northeast.

There are good reasons to believe that the real estate slump won’t be quite that severe — more on that shortly — but there is also reason to think the slump still has a long way to go. That’s why the Fed went further than most Wall Street analysts expected yesterday, cutting interest rates by half a percentage point and announcing, in effect, that it is now on a recession watch.

And whether home prices begin falling noticeably or merely stagnate for years until incomes catch up, it’s clear that the real estate bust has become the dominant force in the economy.

... The exact path that housing prices will take over the next few years is, obviously, unknowable. But there is a good deal of evidence to suggest that the typical home last year was overvalued by something like 20 percent. I wouldn’t necessarily argue with anyone who insisted on 15 or 25 percent.

The reason it may not be bigger is that mortgage rates remain a good bit lower than they were for much of the last generation. But they’re not so different as to suggest that home prices have returned to rational levels. Mark Zandi, chief economist of Moody’s Economy.com, ran an analysis for me this week in which he looked at home values, mortgage rates, tax rates and incomes going back to 1968. Taking all these into account, he found prices were about 20 percent too high.

... The scariest part of a national decline like this is that it could be more like 40 percent in some parts of the country. That’s difficult to fathom — and, in fact, construction would probably come to a halt in those places, cushioning the price drop locally and, by extension, a bit nationally. But 40 percent is not out of the question in a few places, like the southwestern coast of Florida.

As Leonhardt says, there are basically only two possible scenarios with some mix of both likely: 1) either housing prices plummet 20% or so quickly or 2) they stagnate for six years or so waiting for household incomes to catch up to them. Either way, things look pretty grim.

You can see it already just driving around my neighborhood. The number of "for sale" signs has exploded in the past year.