For several months, public homebuilders have been telling investors that the market's instability made it all but impossible for them to provide guidance about their businesses for the rest of the year. But after Lennar and KB Home reported huge quarterly revenue declines and net losses late last month, you don't need a crystal ball to see that recovery in the nation's housing market is not in sight, and that many of the industry's leading companies are bailing water under the guise of "managing" their balance sheets.

At least one CEO of a major builder believes it is only a matter of time before some of the industry's shakier companies either go out of business or are sold. "There's going to be blood on the streets," predicts Robert Schottenstein, president of Columbus, Ohio-based M/I Homes, which saw its net income for the quarter ending March 31 plummet 86 percent to $2.23 million. In late May, M/I expanded into the Chicago market.

The patient's critical condition could become more evident when three of the industry's giant builders--D.R. Horton, Centex, and Beazer Homes--report their quarterly financial performances later this month. But it would take titanic optimism to expect good news when, as reported on July 2, the top 19 public builders recorded nearly $7 billion in inventory impairments in their latest quarters, and quoted one analyst, Alex Barron of Agency Trading Group, as saying he's not sure if builders are even halfway through the impairment process yet.

Builders are writing down the value of land assets they walk away from at the same time they continue to offer homebuyers generous incentives as a means to lower their inventory oversupply. Lennar, for example, reports that its incentives in the second quarter averaged $43,700 per house, versus $24,700 for the same quarter a year ago. Builders are also finally cutting prices a bit to position their products competitively against for-sale existing homes that are going through similar price adjustments. In May, median prices for existing homes fell for the 10th consecutive month, even as sales nationally declined to their lowest levels in four years.

Housing analyst John Burns recently looked at resale prices in 41 metro markets, and concludes that all of them are "clearly" overpriced. Prices in 10 of those markets--including Miami, Riverside-San Bernardino, Calif., Los Angeles, Las Vegas, and Washington, D.C--would need to drop by at least 30 percent to return to their normal ratios of housing cost-to-income levels. For example, Burns estimates that prices in the D.C. market would have to decline by another 33.3 percent from their current median existing home price of $404,517.

"If you are a home builder, you know you are an incredible value in comparison to several years ago. Before resale prices drop, sell a lot of homes now," Burns recommends. However, that's a Catch-22 strategy for builders struggling with evaporating profits. "The entire homebuilding sector is in danger of reporting losses for the year because of falling housing prices and high inventory levels," reports.

That assessment, of course, is based primarily on the travails of the industry's largest players. Observers and analysts tend to take notice when a company like Pulte Homes, which lost $85.6 million during the quarter ending March 31, says it will lay off 16 percent of its workforce and take a pretax charge of between $40 million and $50 million to cover its restructuring; or when Hovnanian Enterprises--which through the first six months of this year lost $82.7 million--projects its deliveries this year would be down between 30 percent and 35 percent from 2006 totals.

But one should be cautious about drawing conclusions about when or how quickly the industry will recover based on the performances of its largest players. Smaller builders with tightly managed operations seem to be weathering the downturn better. Take, for example, Westbrook Homes in Las Cruces, N.M., which cracked into BUILDER's list of the top 200 companies for the first time last year. Its business is off 25 percent this year, but this summer Westbrook has been looking for growth opportunities in El Paso, Texas, and Phoenix, says its president, Paul White.

Still, big builders for a number of months have been lowering the bar in terms of what constitutes good news. KB Home, which through the first half of its fiscal year lost $163.5 million from continuing operations, sees hope in the fact that its second-quarter cancellation rate was 34 percent, unchanged from the first quarter of 2007 and substantially lower than the 58 percent cancellation rate in the fourth quarter of 2006. "While we cannot predict when market conditions will improve, we remain committed to our operating disciplines, prudent fiscal decision-making, and strategies that enhance our financial flexibility to navigate the current tough market environment," says its CEO Jeff Metzger.

This spring, KB agreed to sell its 49 percent stake in its French operations. And as builders scramble to stabilize their operations, the conventional wisdom in some industry quarters is that wholesale sell-offs, mergers, and acquisitions are inevitable. Speculation about the respective fates of builders that have hit rough financial patches continues to swirl around several companies, including Neumann Homes, WCI Communities, Dominion Homes, Orleans Homebuilders, TOUSA, Comstock Homebuilding Companies, and Standard Pacific Corp. So far, though, private equity hasn't pounced, and Schottenstein of M/I Homes thinks that's because "no one is willing to sell their companies for under book value. The problem is that the only thing accurately stated on their balance sheets is their liabilities; everything else is inflated."

Schottenstein doesn't expect builders' to start recouping lost profits for quite some time. And other builders are hinting that more of the same could be in the offing for 2008. But Schottenstein also thinks what's going on in the industry is a "healthy correction." The question he and every other builder still don't have an answer for yet, though, is "Who will get healthy?"

Learn more about markets featured in this article: Columbus, OH, Los Angeles, CA, Riverside, CA.