Even though data Friday from the Mortgage Bankers Association indicated that U.S. foreclosures hit a record in the second quarter, that won’t necessarily translate into big declines in home prices.

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That appears to be the conclusion based on the findings of a trio of economists in a National Bureau of Economic Research paper.

“Even in the face of an extreme foreclosure wave such as that experienced in 2007, our evidence indicates that foreclosure shocks have relatively small effects on U.S. house prices,” the authors, Charles Calomiris of Columbia University and Stanley Longhofer and William Miles of Wichita State University wrote.

The authors’ model incorporated MBA foreclosure and Ofheo home price data from 1981 to 2007, and used home foreclosure forecasts for 2008 and 2009 from Economy.com. The model included data on employment, building permits and existing home sales. In their paper, the authors said the study was first to estimate the effect of foreclosures on home prices for all the U.S.

Even under an “extreme” foreclosure shock scenario, with foreclosures up 75% compared to the baseline in 2008 and 2009, U.S. home prices only decline about 5.5% between the the second quarter of 2007 to the end of 2009, the authors estimated.

Home prices, they wrote, “are quite sticky,” and “fears of a major fall in house prices, with all of its attendant negative macroeconomic consequences, typically are not warranted even in extreme foreclosure circumstances.”

“We conclude that a reasonable estimate of the future path of U.S. housing market prices is that they will remain essentially flat, on average, for the next two years notwithstanding the large predicted increase in foreclosures,” they wrote. –Brian Blackstone

A top economic advisor to Sen. Barack Obama cited stark differences between the Democratic presidential candidate’s plan for the economy and that of Republican rival Sen. John McCain on Friday, expressing confidence that voters will side with Obama on what is likely the top issue in the November elections.

Goolsbee

“As we go forward in the next two months, all we’ve got to do is lay out what’s actually in their programs and I think if people start looking at the content I don’t think it’s even close,” Obama advisor Austan Goolsbee said in an interview taped Friday to be aired this weekend on C-SPAN.

Goolsbee, who also teaches economics at the University of Chicago, sought to put in sharp relief the differences between the two candidates on issues such as tax policy, healthcare, trade and efforts to kickstart the ailing economy. At the same time, he sought to tie McCain’s economic proposals to those of President George W. Bush.

“The contrast couldn’t be greater with the approach of McCain, which is the same as the Bush approach that ‘hey, we’re in trouble so let’s cut taxes for the highest income people and the biggest corporations and hope it trickles down’,” Goolsbee said.

The message is one the Obama campaign, and Democrats more broadly, are expected to hammer Republicans on ahead of November’s elections. Polls repeatedly show the economy continues to be the number one concern for voters, an anxiety reinforced by data released Friday showing the nation’s jobless rate at a five-year high and home foreclosures at record levels.

Goolsbee’s comments came after a week in which Republicans used their national convention in Minnesota to criticize Obama’s economic proposals, particularly his plan to cut taxes for families making less than $250,000 a year.

“I will keep taxes low and cut them where I can. My opponent will raise them. I will open new markets to our goods and services. My opponent will close them. I will cut government spending. He will increase it,” McCain said Thursday evening during his acceptance speech.

Goolsbee said McCain’s comments were untrue, and independent analyses of the two candidates’ proposal suggest there are stark differences between their tax proposals. Obama’s tax plan would generally aim to cut taxes for lower- and middle-income groups, particularly those families making less than $250,000 a year.

“For the vast majority of people, those making less than $150,000 a year, there would be substantial relief,” Goolsbee said.

Critics say McCain’s plan, on the other hand, would do more to help the wealthy and businesses. The nonpartisan Tax Policy Center found that McCain proposals would cut taxes for the wealthiest 1% in 2012 by an average of $126,902 when compared to current law. He favors reducing the corporate tax rate to 25% from 35%, as well as exempting assets under $5 million from the estate tax.

“It’s a totally different philosophy,” he said. “The Obama philosophy is Bush tried what McCain is doing and it didn’t work. Let’s try something different, let’s try to give the relief and job creation to ordinary Americans and McCain is on the other side.

Goolsbee said both candidates will have to deal with growing budget deficits when they take office, as well as the ongoing turmoil in the credit and financial markets. He acknowledged that Obama’s proposals are unlikely to balance the federal budget over the next four years — a promise McCain has made but which Goolsbee derided as bereft of specific details — but said they would slow and then start to reduce the federal deficit during an Obama presidency.

“Let us not get on the McCain-Bush approach which is let’s have multi-trillion dollars in additional tax cuts for very high income people and corporations and let’s promise to balance the budget sometime in the future with spending cuts that we never specify,” Goolsbee said.

Finally, Goolsbee also defended Obama’s position on trade agreements, which have come under fire from Republicans as being protectionist. The senator from Illinois has said he opposes aspects of pending agreements with Colombia and South Korea, and has suggested he wants to renegotiate portions of the landmark North American Free Trade Agreement. Goolsbee, defending those positions, said Obama favors free trade agreements in principle, but only if they are adequately enforced and include labor and environmental protections for U.S. companies and workers.

“Not supporting flawed agreements, and not supporting the passage of new flawed agreements, is completely different and it’s completely inaccurate to describe that as being in favor of erecting tariff barriers and for building a moat around the country,” Goolsbee said. “That is the accusation John McCain is leveling and it’s just completely false.” –Michael R. Crittenden

As bad as the August jobs report was, it doesn’t appear to be a game changer for the Federal Reserve and interest rate policy.

That’s largely because, as dismal as the state of the labor market was last month, the drop in hiring fits within the central bank’s pre-existing outlook. Over recent weeks policy makers have been arguing with a fairly steady voice that after a relatively resilient start to the year, the second half of the year would be when the economy faced one of its most challenging periods.

Fed officials expect that with government stimulus efforts now expended, the ongoing impact of the housing and credit market troubles, coupled with slowing overseas activity, will reduce the economy to a negligible if not negative pace over the final six months of the year, before a recovery starts in 2009. As they’ve made this argument, they’ve also signaled that the current stance of monetary policy is unlikely to change.

In a speech Thursday in Utah, Federal Reserve Bank of San Francisco President Janet Yellen said she was expecting “decidedly subpar” activity for the remainder of the year. She also expects to see an eventual moderation in price pressures on the back of weaker commodity prices and slower growth, but she explained the environment is not one she sees as leading to a change in what’s now a 2% overnight target rate. She said “easing rates further is not likely.”

Against that outlook, the 84,000 drop in August payrolls, reported Friday, along with the sharp and unexpected rise in the unemployment rate to 6.1%, from 5.7%, is unwelcome, but not particularly surprising.

“This report does not really change anything from the standpoint of the economic landscape or the policy outlook,” said Morgan Stanley forecasters. “Labor market conditions continue to deteriorate — but the pace of deterioration still does not appear to be as severe as in a typical recession,” they told clients in a note.

And in this instance the bond market seems to be on the same page as Fed officials, booking only a very short-lived rally on the bad data before fading back to relatively modest gains. That led Miller Tabak strategist Tony Crescenzi to observe the expectation of a tough economic environment is an idea “already partly priced into the financial markets.”

There’s one way the jobs report may rattle policy makers. With the unemployment rate moving to a five-year high of 6.1% in August, that level is now beyond what policy makers had forecast as recently as July. In their regular report to Congress then, the central bank’s official expectation for the unemployment rate had it ranging between 5.5% and 5.7% this year, and between 5.3% and 5.8% next year.

But even on that front, it seems like Fed officials’ views have already moved on. In a speech Wednesday Boston Fed President Eric Rosengren said “economic headwinds have not subsided as hoped” and “further increases in the unemployment rate are possible.”

The primary test for policy makers as time moves forward is how much weakness they’ll be willing to tolerate before deciding to act. Key in all of this will be the inflation outlook: Most policy makers expect already uncomfortable price measures to worsen a bit more, and then move toward more favorable levels as the decline in oil prices and slower growth leave their mark.

Lower inflation gives the Fed the latitude to cut rates. But it remains unclear how weak the economy would have to get before officials decide monetary policy needs to offer more support to the economy, in the form of lower rates. –Michael S. Derby

Economists and others weigh in on the jump in the unemployment rate to 6.1% and the 84,000 job losses reported in August.

A roundup of economic news from around the Web.

Federal Reserve policymakers often are separated along a spectrum that places the hawks, who are more concerned about inflation than growth, on one end and doves, who worry more about growth than inflation, on the other. The two extremes on that spectrum spoke today, but their caws and coos sounded a relatively similar song.

Fisher

Dallas Fed President Richard Fisher, who as a voter on the rate-setting FOMC has dissented from every rate move that he has had a say in this year over inflation concerns, spoke to the Greater Houston Partnership, while San Francisco Fed President Janet Yellen, who isn’t an FOMC voter this year but is characterized as dovish, spoke to a community leaders luncheon in Utah. Both discussed the economic outlook.

The two presidents used nautical themes to illustrate the economy’s current path. “Regrettably, the nation’s economy has been in rough waters for over a year now,” Yellen said, while Fisher declared: “Having sailed the economy along for years in a tranquil following sea, we are now navigating Force 10 conditions.”

They agreed that as consumer spending becomes tepid and the economy continues to deal with the fallout from the credit crisis and housing downturn, growth will be weak into 2009. Both officials said that while inflation has run higher than the Fed would like, the coming slowdown and a resultant drop in commodity prices could reduce price pressures.

However, their major difference was the degree of confidence in that scenario. Yellen portrayed easing price pressures as the most likely outcome of the current situation. She pointed to contained inflation expectations, little evidence of rising wages and the likelihood that commodity prices will drop further. “If commodity prices keep falling — or even if they remain at current levels — the Fed’s objective of promoting both price stability and full employment will become more readily achievable,” Yellen said.

Yellen

Fisher said that the view espoused by Yellen is one possibility, but posited another probable scenario, where price pressures felt recently by producers are passed through to consumers. “After companies have had their margins gutted by dramatic rises in their cost of goods sold, one can envision them being a little skeptical about the durability of recent price retrenchments in the commodities markets and taking advantage of every opportunity to buy protection from being victimized again,” he said. He was less convinced that inflation expectations are firmly anchored.

“While it seems pretty clear that economic momentum is slowing, the jury is out on whether lesser momentum will be sufficient to translate into relief on the price front over the intermediate to longer term,” Fisher said. “In East Texas parlance, ‘It might could, but it mightn’t'; it most definitely has not thus far.”

Both speeches indicated that the Fed remains in a difficult position, but the forecasts for weak growth and remaining inflation pressures suggest rates aren’t likely to move in any direction in the near future unless the landscape changes substantially one way or another in the coming months.

Fisher made clear that despite differences among Fed officials they have the same goal of noninflationary employment growth. “Neither I nor what commentators describe as my ‘less hawkish’ or ‘dovish’ colleagues feel that this convenient nomenclature does justice to our approach to policy,” he said. “The one thing we do not wish to become are pigeons.” –Phil Izzo

Amid concern that banks have been using the European Central Bank as a storehouse to dump risky mortgage-backed-securities, the ECB Thursday announced the first major change in its operational framework since market turmoil began last summer.

Trichet

The bulk of the changes are aimed at discouraging banks from dumping hard-to-sell asset-backed-securities at the ECB. After February next year, for example, the central bank will cut 12% from the value of asset-backed securities that it takes as collateral in exchange for short-term loans, up from as little as 2% before.

ECB policymakers have been particularly concerned that banks are increasingly bundling risky mortgages together in products designed for the sole purpose of getting central-bank funds. To curtail banks’ impulses to create and submit such products, the central bank will impose an additional premium of 5% on asset-backed securities that — because they have never traded — are hard to value.

In a move that surprised markets, the ECB also said it will impose an extra 5% penalty on unsecured bank bonds. “Under the former system, bonds issued by banks and nonfinancial corporations were treated equally in terms of haircut,” wrote Bank of America economist Gilles Moec in a note to clients. Thursday’s change “means that the ECB now considers that, on average, banks are more at risk than non-financial corporations.”

While these and other changes fell short of the most drastic steps the ECB could have taken — which would have included banning asset-backed securities altogether — Mr. Moec says “the changes should still be painful for a number of banks in the euro zone. The average refinancing cost for banks in the euro zone will probably increase … Furthermore, they will probably postpone further any fundamental recovery on the ABS market.”

The ECB did cut the banking sector some slack, delaying the changes until February 1, 2009, to avoid exacerbating tensions that typically arise in the inter-bank lending market around the turn of the year, when banks are squaring their books. ECB President Jean-Claude Trichet said the changes would only affect a “small fraction” of the more than one trillion euros of assets banks submit as collateral each year. Asset-backed securities amounted to 16% of the collateral in 2007.

In a nod to the fact that markets remain off kilter and banks reluctant to lend to one another for longer periods of time, Mr. Trichet also said the central bank is renewing a batch of extra longer-term loans it extended to banks earlier this year. Two three-month loans of 50 billion euros each and one six-month loan of 25 billion euros now mature early next year, instead of later this year. –Joellen Perry

Standard & Poor’s foresees the trouble in the housing market continuing, which could lead to more credit rating cuts for homebuilders in the next year as production levels fall and credit remains strained.

Associated Press

In an industry-wide report card, analysts at the firm said if prices continue to fall as expected and homebuilders continue posting huge write-offs, rating cuts were likely to continue. S&P lowered its credit ratings on seven homebuilders in the last three months, and had cut 11 in the preceding quarter.

But the firm also noted that the large drop in housing starts — down 65% from a high two years ago — may not be as distressing as some have said. While the cutback is unprecedented and hit some builders hard, the note found a silver lining saying, the current supply of new unsold homes would be “significantly larger if homebuilders, and more recently construction lenders, had not pulled back to the extent that they have.”

“The drop in starts, while generally greeted with displeasure by the media, is actually a positive sign,” it continued. “The pace of housing starts must move closer to the current, much lower pace of housing sales to avoid exacerbating current inventory oversupply conditions.”

Large homebuilders — like D.R. Horton Inc., Lennar Corp. and Pulte Homes Inc. — have cut back production to levels last seen in 2000 and 2001, while others have retreated as far as 1994. The drops have caused earnings to fall for the builders, but may spell relief in the future as the market works to correct itself.

The current oversupply is weighing heavily on builders, especially as new orders and closings continue to fall. And while a lifeline from the government - in the form of the Housing and Economic Recovery Act of 2008 – could aid some buyers, the S&P remained unconvinced of its value. –David Benoit

A roundup of economic news from around the Web.

The following is the full text of ECB President Jean-Claude Trichet’s introductory statement to the press, following the European Central Bank’s decision to hold interest rates steady:

Ladies and gentlemen, the Vice-President and I are very pleased to welcome you to our press conference. We will now report on the outcome of today’s meeting of the Governing Council, which was also attended by Commissioner Almunia.

On the basis of our regular economic and monetary analyses, at today’s meeting we decided to leave the key ECB interest rates unchanged. The information that has become available since the last meeting has confirmed that annual inflation rates are likely to remain well above levels consistent with price stability for a protracted period of time and that upside risks to price stability over the medium term prevail. While the growth of broad money and credit aggregates is now showing some signs of moderation, the still strong underlying pace of monetary expansion points to continued upside risks to price stability over the medium term. The latest economic data also confirm the weakening of real GDP growth in mid-2008. This reflects partly an expected technical reaction to the strong growth seen in the first quarter as well as dampening effects from global and domestic factors, including direct and indirect effects from high commodity prices. In this environment, it remains imperative to avoid broad-based second-round effects in price and wage-setting. In full accordance with our mandate, we emphasize that maintaining price stability in the medium term is our primary objective and that we are resolute in our determination to keep medium and long-term inflation expectations firmly anchored in line with price stability. This will preserve purchasing power in the medium term and support sustainable growth and employment. On the basis of our assessment, the current monetary policy stance will contribute to achieving our objective. We will continue to monitor very closely all developments over the period ahead.

Allow me to explain our assessment in greater detail, starting with the economic analysis.

According to Eurostat’s first estimate, following strong quarterly growth of 0.7% in the first quarter, euro area real GDP contracted by 0.2% in the second quarter of 2008. In terms of quarter-on-quarter growth, private consumption declined by 0.2% and there was a perceptible weakness in investment, which fell by 1.2%. Growth in both euro area imports and exports declined by 0.4%.
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