I completely agree with you. Customers do look at the eye level, which is how overselling hosts are able to gain such a big customer base (And also bad reviews thereafter ). There has been a significant amount of companies that have gone 'under' recently and new ones will just keep on popping up.
I do believe it hurts the hosting business, nowadays you seen countless numbers of VPS hosting companies that are starting up and offering VPS servers at very low costs just like the web hosting industry is.
Its a cycle and clients should definitely do a lot of research on their host before signing up (ie: legally registered? how long in business? good or bad reputation? do they have experience?).