More government intervention may be needed, too, if the free market system doesn't work quick enough.
"The housing value crisis is spreading and deepening," said David Abromowitz, a senior fellow at the Center for American Progress. "It has gone way beyond subprime borrowers stretched too far with bad loans and now has clearly extended into the housing markets more broadly."
U.S. home prices dropped 8.9 percent in the final quarter of 2007 compared with a year ago, according to the Standard & Poor's/Case-Shiller home price index released Tuesday. That marked the steepest decline in the index's 20-year history.
Meanwhile, the narrower Office of Federal Housing Enterprise Oversight said Tuesday that nationwide prices dipped 0.3 percent in the fourth quarter, the first annual decline in 16 years. Eleven states posted declines in values for the year, while prices in nine states appreciated more than 5 percent.
The OFHEO index is calculated using mortgages of $417,000 or less that are bought or backed by government-sponsored mortgage companies Fannie Mae or Freddie Mac. That excludes properties bought with some of the riskier types of home loans or homes in more expensive markets like California and the Northeast.
"We reached a somber year-end for the housing market in 2007," said Robert Shiller, one of the architects of the S&P/Case-Shiller index. "Home prices across the nation and in most metro areas are significantly lower than where they were a year ago. Wherever you look, things look bleak."
That's bad news for Sheila Prior and her husband, Matthew. Despite the weakness in the housing market, the couple is putting their three-bedroom home in Durham, N.C., up for sale this week. After being laid off in December from GlaxoSmithKline PLC, Matthew accepted a job offer in Plymouth, Minn.
The couple, who has a 1-year-old daughter, initially wanted to list their home for $250,000. But after checking what other homes sold for in the area recently, their real estate agent recommended $233,000 - the same price they paid for it in June 2006.
"It was less than what we were hoping for, but renting it out wasn't financially viable either so we decided to sell it anyway," Sheila Prior said. She's optimistic that they can sell the house within six months, but worries about the competition from KB Home, which is selling new houses in the area at discount prices.
Builders across the nation are slashing prices, giving upgrades, even offering trade-ins to sell homes from an inventory that's near record levels. Residential construction, meanwhile, has fallen 60 percent from the peak.
"That's the only way of clearing out a mountain of unsold inventory to allow markets to find a bottom," said Mark Zandi, chief economist with Moody's Economy.com. "But also housing won't pick up again until mortgage credit becomes available."
Right now, only the most creditworthy qualify for mortgages. Lenders started to keep a tight leash on credit after homeowners started losing their houses to foreclosures at an increasingly rapid rate as interest rates on home loans reset higher and declining values ate into equity.
Irvine, Calif.-based RealtyTrac Inc. said Tuesday that the number of homes facing foreclosure climbed 57 percent in January from the previous year. A wave of adjustable rate mortgage resets expected in May and June threatens to push many other homeowners into default.
Consequently, more lenders are being forced to take possession of homes they couldn't dump at foreclosure auctions and investors are taking huge losses to rewrite the declining value of securities backed by these mortgages. Bond insurers also are taking a hit and could have trouble paying back bond holders if default levels soar.
While the vast majority of homes in the U.S. are not in danger of foreclosure, economists worry that the housing slump will plunge the broader economy into a recession. The economy grew an anemic 0.6 percent in the fourth quarter.
Earlier this month, Congress passed a $168 billion rescue package with provisions aimed at helping beleaguered homeowners refinance into more affordable loans. The Federal Reserve also has aggressively slashed interest rates to spur growth and free up the credit markets.
"If it doesn't look like the financial system is improving by May or June, we'll see other bigger steps from the government to stabilize it," Zandi said. "A bottom won't happen until the financial system works itself out."
