Despite widespread acknowledgment among economists that inventory is well above healthy levels and must be reduced, total housing starts increased in the final months of 2006, from 1.478 million in October to 1.643 million in December.

NAHB chief economist Dave Seiders sees the late 2006 increase in starts as weather-driven, due to bad conditions in October, and not as a sign that builders are ramping up construction.

January's numbers back Seiders up, as builders reduced their starts 14.3 percent to a seasonally adjusted level of 1.408 million, according to the U.S. Census Bureau. Still, it will take more than one month of fewer starts to aid the housing industry's recovery, says David Berson, Fannie Mae chief economist.

“We need a period where sales exceed starts,” he said at the 2007 International Builders' Show in Orlando, Fla., in February. There were 1.12 million new-home sales in December.

A number of factors could alter the inventory picture in 2007, and not for the better. Current inventory data suggests a 5.9 month's supply of new and unsold homes and a 6.8 month's supply of existing homes, according to the Census Bureau and the National Association of Realtors. But those statistics do not cover large amounts of inventory that is available, or could become available.

Cancellations of new-home sales are not counted in either the supply of new homes or existing homes, Seiders notes. Large builders took the hit especially hard, seeing cancellations in far larger numbers than smaller builders, which he says saw “almost none.” The top 30 builders experienced cancellations for 25 percent of their for-sale market, Seiders adds.

Reports of high foreclosure rates around the country also create a worry, as ARMs re-set in 2007 and 2008 at higher interest rates, potentially pushing more people toward foreclosure, says Frank Nothaft, chief economist for Freddie Mac. Nothaft estimates that 28 percent of foreclosures for prime mortgages end with a bank owning a home, while the Federal Reserve in St. Louis estimates that of all subprime mortgages to enter foreclosure, 50 percent end up with banks.

But more could, and that would further increase inventories of existing homes, says Seiders.

“It's been a very small factor, to this point, but it is a threat going forward,” Seiders warns. “There are going to be a lot of ugly stories.”