Housing starts, an index looking at the number of homes being built, fell to their lowest level in 17 years in the August report, but economists say that, while the monthly decline was steeper than anticipated by markets, a drop in construction is a precondition for the housing sector to stabilize.

The U.S. Department of Commerce report showed starts fell 6.2% to an annualized pace of 895k, down from 954k in the prior month. Building permits, an index looking at plans to construct new homes in the coming months, fell by an even steeper 8.9% in the month, pushing the annual pace down to 854k from July's 937k.

Ian Shepherdson, chief U.S. economist from HFE, said the decline, while "undoubtedly grim," isn't as bad as it appears because of how volatile the multi-family unit is. "Multi-family starts and permits rose ahead of new building codes in NYC effective July 1 and the steep declines since then represents a give-back of those gains," he added.

The decline in multi-family starts was a whopping 15.1% in the month, compared to a 1.9% decline in single-family units, which represent four-fifths of the sector.

Jennifer Lee, economist at BMO Capital Markets, noted that starts have fallen 33.1% from year-ago levels and are down a dramatic 61% from peak levels in January 2006.

However, she said the August decrease is actually a good thing. "Ideat's akin to having a teaspoon of Buckleys for your cough," she said. "It tastes bad, but it will work to get rid of the still-huge oversupply of unsold homes sitting out there."

In the most recent new home sales report, the level of overhang at the current sales pace was 10.1 months, or 416k homes for sale.

Shepherdson also said the cuts homebuilders are forced to make are "the essential precondition for stability."

The lower-than-anticipated headline was also partly attributed to an 11k downward revision to the July index.

On a positive note, TD Securities' economics strategist Millan Mulraine said the government rescue of Fannie Mae and Freddie Mac appeared to have provided "some semblance of normalcy" to the mortgage insurance and securitization business, though he expects construction activity to remain "tepid" in coming months.

Also released on Wednesday, MBA mortgage applications for the week ended Sept. 12 spiked 33.4%, likely as a result of the 30-year fixed mortgage rate having fallen by 75 basis points since early August.

According to Bankrate.com, the current rate for a 30-year fixed mortgage is 5.73%.

By Patrick McGee and edited by Sarah Sussman
©CEP News Ltd. 2008