HOUSE: n. A building for human habitation, especially one that consists of a ground floor and one or more upper storeys.

In any list of human essentials, housing must rank near the top – slump-proof, one might think. But look around. The credit crunch and the evaporation of confidence has struck the housebuilding industry with hurricane force and is bringing work on many building sites to a standstill.

Housebuilding, and the wider construction sector, is being hit by a double whammy of a severe contraction in the supply of finance from banks and the money markets, and a severe slump in confidence.

Figures last week showed the number of mortgages approved by banks had tumbled 56% year-on-year in May and was down by 65% since late 2006. Indeed, even when buyers can arrange the finance for a purchase, they are holding back because of a belief that house prices will be lower still three to six months from now. This confidence slump is showing ominous signs of becoming self-feeding as we head into the autumn, bringing the prospect of widespread failures and closures across the industry.

On the stock market, shares in housebuilding companies have cratered, with Barratt Developments down by more than 90%. Each week brings fresh rumours of projects being abandoned, breaches of banking covenants and crisis talks with lenders. According to Citigroup analysts, shares in Britain's top seven housebuilding companies are trading at an average 54% discount to 'doomsday scenarios' of tumbling profits and slashed dividends.

Far from Scotland being only lightly affected, the housebuilding sector is in disarray and shows no sign of stabilisation, still less a return of confidence. Statements from Homes for Scotland, a housebuilding trade body representing more than 135 companies responsible for 95% of all new homes built for sale, have become markedly more blunt and outspoken in recent weeks.

The phraseology has progressed from "stark warning" through "severe impact" and "significant deterioration in general market confidence" to "serious jeopardy". In the past week, its chief executive Jonathan Fair has warned of "significant redundancies" and that a "negative knock-on impact on Scotland's economy cannot be over-estimated".

This could be dismissed as industry hype were it not for the severe share price falls, the growing redundancies in a sector that accounts directly or indirectly in Scotland for some 100,000 jobs, and the ever darkening anecdotes of builders now going for weeks without a single house sale.

The climate has deteriorated sharply in recent weeks, causing Homes for Scotland to tread an ever thinner line between telling the Government and local authorities "how it really is" and not triggering an even greater flight of confidence among the public.

Central and local government have cause to be concerned on two counts. First is the certainty, barring a miracle, of the official house completion target of 35,000 being missed by a mile both this year and next. "This level of output will not be possible whilst consumer confidence languishes at an all-time low," Homes for Scotland bluntly warned last week.

The second is more insidious, but no less worrying. Banks are becoming much more picky about the projects they will – and will not – finance. Until this year, developments proceeded through the local authority approval process with the builder pledging to undertake infrastructure and utility work together with 'social' developments such as a quota of 'social' housing, provision of leisure facilities and help with school and education projects.

Today the problem is not just that with sites being abandoned these developer-provided add-ons also go on the back burner, but that there will be fewer of these add-ons in the future. Finance is being made available on the proviso that projects are strictly limited to housing and the lenders start to see a return in 12 to 18 months.

In the new era of credit scarcity, the 'social housing' quotas and amenity projects, affordable in the boom years, are now a barrier to obtaining finance, putting more than the Scottish Government's housebuilding targets in jeopardy.

Allan Lundmark, director of planning and communications for Homes for Scotland, says: "A lot of developments will not go ahead because of these infrastructure burdens. We are in the business of building houses, not infrastructure.

"We just cannot get the funding. And we are not convinced that local planning authorities have yet got this on their radar. Local authorities must address the question of how we can build more houses. The planning system needs to take note of the changed circumstances for developers and to be more helpful. But there is little evidence that they have got this key message. "

The industry gave a cautious welcome last week to the commitment by Nicola Sturgeon to invest £250m over the next three years through the expansion of the shared equity scheme. Jonathan Fair said builders were also encouraged by her commitment to increase the level of the Homeowners' Support Fund through the investment of more than £25m within the Government's 'mortgage to rent' scheme.

But the sector wants to see the Scottish Government free up Registered Social Landlords – housing associations – to enable them to buy both land and completed housing from the private sector.

The longer-term problem for Government, the industry and first-time buyers is that the more building sites are abandoned or mothballed in the coming months, the greater the likelihood of a sharp contraction in supply in 2009 – and of a subsequent sharp rebound that could drive prices even further out of the reach of first-time buyers.

That is why the industry is pressing for the lifting of the stamp duty threshold to help buyers at the lower end of the price scale, and for the re-introduction of mortgage interest tax relief for first-time buyers.

The obvious objection is that the Treasury has no money. But given the expected sharp fall in stamp duty revenue already this year, lifting the threshold would not cost that much more relative to the loss of income already being experienced, while measures to stabilise the market should encourage house sales and increase revenue.

There is also a wider macro-economic argument for a substantial budget package this autumn. This is that confidence in the housing market is a key determinant of consumer spending across the economy, and as such, timely action to stabilise conditions could spare the economy a sharper downturn. As it is, the slump in housing transactions will almost certainly drive prices lower and risk a wider fall in consumer spending.

The market today is caught between over-inflated values, high household debt, erosion of real incomes via high inflation, and the credit crunch. "All housing guides are extremely weak," says Citigroup's UK economist Michael Saunders, "and, with the credit crunch ongoing, a major rise in unemployment ahead, no prospect of early MPC easing… our base case – not worst case – is for house prices to fall 20% from the end-2007 level over 2008-10 combined. It may turn out even worse than that."

A government seen to be doing nothing risks the charge of complacency at best and downright negligence if, as builders fear, confidence continues to slide.