US News and World Report gets in on the housing bubble story.
For much of the past 30 years, median home prices in the United States remained between 2.7 and 2.9 times Americans' median household income. In other words, if you spent every dime you earned to pay off your house (not including interest), you'd do it in about three years. But starting in 2000, that ratio began climbing to about 3.4 times personal income. In relatively subdued markets like Pittsburgh and Milwaukee, it remains closer to the historic norm. In the hot markets like San Diego, however, where prices have doubled since 2000 while income has increased by only 10 percent, the cost of houses approaches 10 times what buyers earn each year.Hmm, "best case scenario" is an 8% fall in prices in bubbly California? You probably don't want to look into the "worst case scenario" crystal ball, then.
At a 5 percent annual interest rate, that represents a mortgage payment of about half of your household income. "I suppose you could pay that much if you stopped going out to dinner and cut back on travel," says Shiller. "But what if you have an adjustable-rate mortgage, and we get an oil shock that pushes interest rates way up? Then you've got a major family crisis."
. . . some experts believe an interest rate spike could be the pin that pops the housing bubble. In the best-case scenario (one already underway since the Federal Reserve began raising interest rates in June), a steady but modest rise in mortgage rates begins to cool demand as buyers find they can't afford to pay top dollar. Sellers unwilling to accept lower offers hold out, increasing the inventory of unsold homes over time and eventually forcing sellers to begin lowering prices. In such a case, "it's not going to be a free fall," housing economist Celia Chen of Economy.com says of forecasts that call for slowing price increases over the next year or two, followed by a small decrease in prices for a few quarters. "We see up to about an 8 percent decline in the overpriced areas."
Far scarier, however, would be an oil price shock, a rapid decline in the U.S. dollar, or ever mounting budget deficits (or all three), which could force the Fed to aggressively raise interest rates to stave off inflation. That could quickly bring the real-estate market to a standstill. As higher rates begin to affect homeowners' ability to pay their adjustable-rate mortgages, some will be forced into foreclosure while others who have put little money down will simply walk away. (Even those with fixed-rate mortgages could find themselves in trouble if circumstances force them to sell into a declining market.) Banks will be left holding the bag, as will Fannie Mae and Freddie Mac, the nation's largest purchasers of mortgage debt. If they stumble, "we will be looking at trillions of dollars of losses and a major recession or a possible banking crisis," says economic consultant John R. Talbott, who predicts such a meltdown in his book The Coming Crash in the Housing Market.If the US is going to get its current account deficit house in order, higher real interest rates must be part of the bargain. They dampen asset price bubbles, reduce overall consumption -- the most important component being import consumption -- and stimulate the savings necessary to fuel future investment. "This will provoke a recession," you protest? The US is so far around the corner on this bender that a recession is all but inevitable. The real task is to  alleviate its worst impacts and  make the rich pay for it since they're the ones who through tax cuts and asset bubbles and deindustrialization got us into this mess in the first place.