Construction continues to stall as housing starts dropped 10.2 percent in September, while building permit activity plummeted 7.3 percent, according to a joint report from the Commerce Department and the U.S. Department of Housing and Urban Development (HUD) on Wednesday.

The monthly report revealed that housing starts set an annual pace of 1.191 million units in September, reaching their lowest level since the March 1993 rate of 1.083 million units. Brian Bethune, an economist for Massachusetts-based Global Insight, calls current housing sector conditions a "perfect storm."

"Imbalances in the housing market overall are being exacerbated by rising inventories of existing homes, a situation that has been fueled not only by declining demand, but also by a rising number of homes being reverted to the market due to foreclosures," says Bethune. "In addition, tightening credit standards and a lack of liquidity in the subprime and jumbo loan markets continue to restrain demand of both new and existing homes."

"The housing market is now navigating through "perfect storm" conditions - a downward spiral involving reductions in demand, repetitive slashing of output, downward pressure on prices, tightening credit conditions, and rising foreclosures," Bethune continued.

September single-family housing starts decreased 1.7 percent to 963,000 while housing with two or more units decreased 34.3 percent to 228,000. Multifamily home construction dipped 36 percent.

Regionally, housing starts fell 10.1 percent in the West, 11.7 percent in the South, and 28.4 percent in the Midwest. Construction in the Northeast was up 45.4 percent.

Wednesday's news should be no surprise to industry insiders. Builder confidence has hit a 22-year low and Treasury Secretary Henry M. Paulson Jr. is calling industry woes an economic risk.

Bethune predicts continued murky conditions in the home building industry until mid-2008.

"It is likely that the peak of this storm will impact the economy in [the fourth quarter of] 2007 and [the first quarter of] 2008," he explains. "Global Insight is forecasting that residential investment will subtract a massive 1.5 percentage points from real GDP growth over the next two quarters. The drag from housing is expected to persist until the middle of 2008.

"Beyond the drag on growth, which is baked in the cake from recent reductions in starts and permits, however, the downward spiral in the housing market continues to pose significant risks to the stability of the financial system."

Click here (PDF) to view a copy of the joint report.