Sept. 24 (Bloomberg) -- Sales of previously owned U.S. homes fell more than forecast in August and prices dropped the most on record, a sign the market remained in a slump heading into the latest financial meltdown.

Sales of existing homes dropped 2.2 percent to an annual rate off 4.91 million units from 5.02 million the prior month, the National Association of Realtors said today in Washington. The median price declined 9.5 percent from August 2007 and the number of properties fell from a record.

The collapse in lending that brought down American International Group. Inc. and Lehman Brothers Holdings Inc. this month may also make mortgages more difficult to get. A lack of credit raises the odds sales will again slump after hovering around a 10-year low this year, even as borrowing costs drop.

``The headwinds facing housing have intensified,'' Peter Kretzmer, a senior economist at Bank of America Corp. in New York, said before the report. ``Delinquencies and foreclosures continue to rise while credit conditions remain tight.''

Resales were forecast to fall to a 4.94 million annual rate, according to the median estimate of 73 economists in a Bloomberg News survey. Projections ranged from 4.7 million to 5.15 million.

Federal Reserve Chairman Ben S. Bernanke said today in testimony before congress that the U.S. is facing ``grave threats'' to financial stability and warned that the credit crisis has started to damage household and business spending.

Bernanke Testimony

``Economic activity appears to have decelerated broadly,'' Bernanke said in remarks prepared for a Joint Economic Committee hearing, downgrading the assessment of Fed officials when they met on Sept. 16. ``Stabilization of our financial system is an essential precondition for economic recovery.''

Home resales were down 10.7 percent compared with a year earlier. Resales totaled 5.65 million in 2007.

Today's figures compare with the 4.85 million level reached in June, the lowest in a decade and 33 percent down from the record reached in September 2005.

The number of previously owned unsold homes on the market at the end of August represented 10.4 months' worth at the current sales pace, down from 10.9 months' at the end of the prior month.

There were 4.255 million properties on the market in August, down 7 percent from the prior month, the biggest drop since December 2006.

Median Prices

The median price of an existing home dropped to $203,100 from $224,400 a year ago. For single-family houses, the median price dropped 9.7 percent, the biggest decline since records began in 1968.

Resales account for about 90 percent of the market, while purchases of new homes make up the rest. Sales of existing homes are compiled from contract closings and may reflect contracts signed one or two months earlier.

Tomorrow, the Commerce Department is forecast to report that sales of new houses dropped to an annual pace of 510,000 from 515,000 in July, according to survey estimates. Sales of new homes are down 63 percent from their July 2005 peak.

Today's report showed resales of single-family homes fell 1.4 percent to an annual rate of 4.35 million. Sales of condos and co-ops declined 8.2 percent to a 560,000 rate.

The Northeast suffered a 6.6 percent decline in sales, followed by a 5.3 percent drop in the West. Purchases rose in the Midwest and Southeast.

Less Credit

``Some of the declines in sales were due to tighter lending standards that Fannie Mae and Freddie Mac had imposed prior to the takeover,'' Lawrence Yun, chief economist at the Realtors' group, said in a press conference.

As sales shrank, builders scaled back construction projects to pare swelling inventories. Work began in August on the fewest houses since 1991, the Commerce Department reported last week. The number of building permits issued also fell, signaling construction cutbacks will continue to hurt the economy.

``The biggest issue is consumer confidence in housing right now,'' Ara Hovnanian, chief executive officer of Hovnanian Enterprises Inc., New Jersey's largest homebuilder, said in a Sept. 19 interview on Bloomberg Television. ``It remains a very challenging environment.''

Hovnanian said sales in ``some select markets,'' such as northern California and the Washington suburbs in Virginia, ``have really started to pick up.'' It's ``absolutely'' too early to call a bottom for the market, he said.

Stabilization

Resales stabilized in recent months as some Americans took advantage of depressed property values. One-third to 40 percent of July purchases reflected distressed properties, including foreclosures, the real-estate agent's group said last month.

Stricter lending regulations and tumbling home prices make it harder for Americans to tap home equity for extra cash. Consumer spending in the third quarter will probably be the weakest since 1991, according to economists surveyed earlier this month.

The housing slump is the ``root cause'' of the turmoil in financial markets, Treasury Secretary Henry Paulson said in testimony before the Senate yesterday. It ``has resulted in illiquid mortgage-related assets that are choking off the flow of credit which is so vitally important to our economy.''

Federal Reserve Chairman Ben S. Bernanke joined Paulson in urging lawmakers to quickly pass a $700 billion rescue plan for financial institutions and warned the economy will shrink if markets don't begin functioning normally.

To contact the reporter on this story: Bob Willis in Washington at bwillis@bloomberg.net

Last Updated: September 24, 2008 10:17 EDT