THE thing with bubbles, to paraphrase Joni Mitchell, is that you don’t really know you’ve got one till it’s gone.

When the air is expanding inside a speculative balloon, stretching the film of credibility that contains it to an ever-more improbable thinness, you can always find someone to explain why this time it’s different — why technological/demographic/astrological factors justify valuations today that have always proved historically unsupportable.

Until the bubble actually starts to deflate or burst, there’s just enough doubt about whether prices really will revert to their historical mean to keep us all guessing. Even the most convinced sceptic can never say with any certainty when a bubble will collapse, and so the science of identifying bubbles is an inherently retrospective activity.

But it looks now as though we can say with some confidence that the long American housing bubble is over.

To the anecdotal evidence accumulating over the past year — estate agents cancelling holidays in the South Pacific, the houseowner around the corner who is said to have dropped her asking price three times — we now have some firm and depressingly clear data. Last week we learnt that existing home sales in July were 11 per cent below last year’s levels. Within a couple of days, the next report said that new home sales had fallen in the same month by 21 per cent from a year earlier. Just a week before that, it was reported that housing starts fell 13 per cent from a year earlier.

If the housing market really is in retreat, the two important questions are: how far will it fall, and how much damage will it do to the US and, by extension, the world economy? It is not an exaggeration to say that the buoyant US economy has been kept afloat in the past five years by its housing sector. The first and most obvious effect has been the direct contribution a booming real estate market has had on employment and income.

If you dissect the official employment data over the past five years, and lump all the housing-related stuff together — construction, estate agents, mortgage broking, home improvement, housing insurance investment — you get some staggering numbers.

By some estimates all this housing activity has accounted for more than 40 per cent of all the jobs created in the US since 2001. Now, all these new jobs are not going to disappear in a housing slump. But even if residential real estate activity falls by half in the next year or two it will represent a sizeable blow to the labour market that could, if there is nothing else to take up the slack, push unemployment significantly higher, and income somewhat lower.

The much bigger effect of a housing slump, however, is likely to be on household balance sheets. According to the Federal Reserve’s latest figures, the total amount of residential housing wealth in the US just about doubled between 1999 and the first quarter of 2006 — up from $10.4 trillion (£5,500 billion) to $20.4 trillion.

Thanks to a highly efficient housing finance market, Americans have been withdrawing a significant part of this wealth to finance current spending. Exactly how much they have withdrawn is hard to gauge, but the wealth effect of housing on spending has been observed to be substantially larger than traditional estimates of the wealth effect of equities, which is about 1.5 per cent. If the right figure for housing is 3 per cent, that suggests over $300 billion has been taken out in the past six years, about $50 billion a year, or an average of about 0.4 per cent of US GDP. This seems a conservative estimate, as some economists put the wealth effect much higher.

However, people do not join a wave of selling when prices fall: most simply sit tight. Furthermore, the US market is a vast, diversified one, nothing like as dominated by a single, frothy urban market in the way the UK is affected by London. Prices nationwide have in fact never fallen in any year in the last half century.

But even if prices stay flat on aggregate over the next few years, that still suggests a substantial hit to GDP and, given the run-up in prices in the past five years, the chances of an outright, first-ever decline in prices must be substantial.

The other large effect of a housing slump might be considered a non-linear one: the impact on financial conditions of the millions of Americans who will default on mortgage payments as prices flatten, interest rates rise and the economy stalls.

In previous periods of weakness in property markets there have been huge institutional collapses. The savings and loans debacle of the early 1990s is the most recent example. Today, again thanks to increased financial efficiency, the risk of such a massacre seems smaller. The securitisation of the nation’s mortgage market has spread the geographical and sectoral risks to the broader economy.

But there will still be many financial institutions with significantly impaired balance sheets as the value of their mortgage-backed securities declines sharply over the next year. All in all, even on the most optimistic assumptions, post-bubble conditions in the housing market would be highly uncomfortable for America and could seriously sap demand in the world.

Of course, that is what the pessimists said about the collapse of the tech bubble in 2000. But back then, like a guardian angel, along came the housing boom just in time.

Is there anything that might do the same for the US in the next few years? There’s not much room for fiscal support. Unfortunately, and though interest rates have edged lower in the past few weeks, inflation pressures may limit the potential for support there. A further decline in oil prices would be useful, but can hardly be counted on. Which may leave the US in the unaccustomed position of hoping that the rest of the world can come to its rescue with a period of really strong demand growth. Who would bet the house on that?

gerard.baker@thetimes.co.uk

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