United and City were the big spenders during the summer and both were expected to battle it out for the Premier League crown.
However, recent results have left United languishing in seventh place in the Premier League table and City without a win in five games in all competitions.
Dunphy, speaking on 2FM's Game On programme said United need four or five years to rebuild and said City manager Pep Guardiola is "off the chart crazy".
"Everyone is looking for a quick fix. David Moyes was given seven months and no budget and then they got Louis van Gaal, who was supposed to be a quick fix. He was given some money, but he wasted it. And now Mourinho has come in." said Dunphy.
"The waste in the summer of £100m on Paul Pogba is one example, the centre-half Eric Bailly, who some people think can offer something, he cost £35m.
"They’re in denial about where the club is. It's on a downward spiral that is beyond the capacity of one coach to fix unless you gave him a couple of billion.
"They're doomed to mid-table or maybe scrapping for a Europa League place, that's where they fit now."
He added that Eddie Howe of Bournemouth could be the man to rebuild the Red Devil's tarnished reputation.
Dunphy, a former Millwall player and Republic of Ireland international, who spent his youth career at Old Trafford, was equally pessimistic about United's crosstown rivals.
"They’re in a worse state than Manchester United. They have got fewer players and their manager is off-the-chart crazy.
"What’s happening at Manchester City and what’s happened over the last several years is mad stuff.
"They’ve spent the kind of money Manchester United would need to spend now. Theirs is gone. They burnt it."
United and City play each other in the EFL Cup tomorrow night and Dunphy believes United will edge the contest.