THE SUMMER FREEZE IN MORTGAGE CREDIT markets generated yet another down-leg to the stunning housing downswing that began in the latter part of 2005. Net home sales fell abruptly, and builders reacted quickly by cutting back starts of new units. The downshift in sales provoked further erosion of the U.S. homeownership rate, but the cutback in starts hardly put a dent in inventories of new homes in the hands of builders. Indeed, vacancies in the stock of new and previously occupied homes on the market actually moved up in the third quarter, and we're approaching year-end with a near-record supply overhang that's putting strong downward pressure on home prices.

HOMEOWNERSHIP DOWN The turmoil in mortgage credit markets took a heavy toll on sales of new and previously owned homes in both August and September, and sales cancellations moved up aggressively during these months as well. Builders report that the virtual shutdown of the subprime and alt-A mortgage sectors disrupted sales and closings not only in the entry-level market but also up the ladder in trade-up segments, and the freeze in the jumbo mortgage securities market severely damaged the high end of the housing market.

The U.S. homeownership rate was gravitating downward from the record high posted in 2004 as the housing downswing deepened, and the abrupt third-quarter downshift in net home sales provoked yet another downward adjustment. The homeownership rate now stands at 68.1 percent (seasonally adjusted), down from the record high of 69.3 percent in the second quarter of 2004 and the lowest level since the second quarter of 2003—just prior to the explosive and unsustainable housing boom.

VACANCIES UP The recent erosion of the homeownership rate has reflected absolute declines in the number of homeowners, an unusual occurrence that has been accompanied by sizable increases in the number of renter households in the country. But overall household formation (whether homeowners or renters) has been weak for more than a year, reflecting deteriorating economic and financial market conditions as well as outsized household formation rates during the previous housing boom.

The slowdown in household formations, combined with placement of many investor-owned homes on the market, has kept the supply of vacant housing units at near-record levels in both the for-sale and for-rent segments of U.S. housing markets.

MESSAGE FOR BUILDERS Next year promises to be another tough year for builders. Avoid speculative building like the plague, since vacancies are very high and the timing of the sales recovery is highly uncertain. Also, be sure that presales involve buyers that are pre-approved for mortgage financing (prequalification is not enough). And do whatever it takes to sell standing inventory, including price cuts and non-price incentives—particularly those that reduce up-front cash requirements. House prices most likely will deteriorate during 2008 in many markets, and hanging on to inventory generally will turn out to be a losing proposition.