It is clear now that the origins of this housing cycle's demise trace back over the past few years. Swept up in record sales and operating margins, builders steamed ahead with production. Never mind that it grew evident that they were often selling to speculators intending to flip the house for a tidy profit. Never mind that these same speculators could pull out of the deal at a relatively modest cost, any time before the closing. Never mind that levels of production were geared not to sustainable demand, but to this abnormal presence of investors. And never mind that practically anyone with a pulse could get a loan.

That's all changed, and today's outlook shows a gathering storm. Sales for both new and existing homes have plummeted by double digits since the same time last year, and the months' supply of homes has passed well beyond the six-month point most think demarcates a buyer's from a seller's market. As interest rates rose in 2005, demand for housing cooled and price appreciation started to slow. At the first sign of weakening appreciation, many investors exited the market, further reducing home sales. First American LoanPerformance data suggests that relative to the first half of last year, the number of prime loans to investors and second-home buyers fell by about 110,000, of which about 72,000 was a drop in the number of investor loans.

Builders saw darkness descend quickly. But they were still working off of backlog at the time and had promised specific homes on specific sites. They couldn't just shutdown the production machine all at once.

With new-home sales falling by about 15 percent and big builder orders falling by 20 to 30 percent or more relative to a year ago, single-family starts nationally fell by only the mid-single digits. So, inventory ballooned. Builders did whatever they could to try to clear out as much housing stock as they could. They started with incentives and paying down interest rates with points, and whatever else they could do to try to hold the line on pricing. But no one missed the fact that the effective price of new homes started to fall sharply in many markets.

NEW QUESTIONS For at least five years, reporters have asked whether there is a housing bubble. Now that they think they have their answer, they have new questions: “How long and how deep?”

There is no easy answer, for it rests on a number of uncertainties about the future and interpretations of the past. It is unclear what the Federal Reserve will do to interest rates and equally unclear about whether the economy will continue to expand. Ease rates faster and sooner than most expect, and the market will bounce back quicker even though the market is overbuilt. Increase rates and the downturn will be rougher. Fall into a bona fide recession with job loss before the housing market rights itself, and look for a deeper and longer slide.

But let's assume the economy does stage a soft landing as most predict. Housing itself shaves a half to a full percentage point off economic growth for the next year or two, but other sectors keep the economy growing and adding jobs.

What, then, will it take to get the housing market back in balance? For starters, builders have to cut production and work off excess inventory. Only then will markets tighten so that price pressures are no longer downward and production can rise back to the long-run level of demand.

NO EASY ANSWERS Now, what is the long-run level of demand? How long will it take for the builders to drop production to levels necessary to work off the excess? Will they do it fast enough to keep price wars and margin compression among builders from spreading to the broader market? If it does spread, house price declines will exacerbate the cycle by taking demand below its normal level as buyers wait on the sidelines for signs of the bottom.

First, it looks we are a lot more oversupplied than we were in the last two housing soft landings of 1994–1995 and 2000–2001. But we're a lot less overbuilt than we were when housing last underwent a painful and prolonged contraction from 1987–1991. When you compare the 1980s with the past five years, it looks like the 1980s market was about twice as overbuilt. There is not much precision in these estimates, but most ways of slicing the data lead to the same rough conclusion. Back then, the oversupply led to a prolonged period of production that bottomed out at about half the peak level. This time, with the excess supply looking tamer–and the outlook for household growth turning more favorable over the next 10 years than the last 10 years due to exceptionally strong levels of recent immigration–it looks like we are on a course for starts to fall from the 2 million pace set in 2005 by about 20 percent for a couple of years, and then restore balance.

That said, short-term economic factors could make the correction longer or shorter and affect its depth.

BACK TO BALANCE As for the underlying level of housing demand, over the past five years household growth has run around 1.32 million a year on average or so, depending on how one looks at a variety of government estimates. This is about what the Joint Center for Housing Studies at Harvard University projected. Over the next 10 years, if immigration runs at least at the 1.2 million per year average we expect, household growth will accelerate to 14.6 million. Add to household growth over the past five years the consensus estimates of net removals and change in vacancies, and it looks like the last five years should have seen production, including manufactured home placements of about 1.85 million a year, but we got closer to 2 million on average. But over the next 10 years, given the increase in household growth, demand should run closer to that 2 million annual average. These are rough estimates. But like those above, they also suggest that what will do the trick are a couple of years around 1.6 million to 1.65 million starts and 100,000 to 120,000 manufactured housing placements, followed by a year or two climbing back up to long-term trend growth. Remember, though, that markets move to the beat of unpredictable drummers especially more than one year out.

Will builders suck it up and take down production fast enough to right markets quickly? It's hard to know, but with so much land in inventory, capital committed, and customers able to walk from deposits or renegotiate prices, it is hard for builders to pull back as fast as they might like. After being slow off the dime, starts year-over-year in recent months are off nationally by more than 20 percent, and in some markets by well over 30 percent. If builders hold down production, the correction will happen faster and the risk that builder price wars will take down existing home prices is less. Builders hold the cards to their destiny in their own hands. Do not overbuild; take down production fast enough to clear inventories; restore pricing rationality—and cycles will be less severe. But it takes thousands of builders acting independently to slow production. Let's hope the collective response does that soon. And let us hope that the easy credit standards of the past few years do not come back to haunt the housing market and make this cycle a lot worse.

Eric Belsky is the executive director of the Joint Center for Housing Studies at Harvard University.