US central bank denies bubble as it widens wealth inequality

March has been an up-and-down stretch for the stock market, but it is turning into a month of milestones nonetheless. The bull market reached its fifth anniversary last weekend, and if the trend continues this week, on Saturday it will become the fifth-longest bull market since 1928.

Already, it’s the fourth-strongest bull, with a gain of more than 172 percent in the Standard & Poor’s 500-stock index.

Perhaps most significantly, Federal Reserve figures released this month show that levitating stock prices were the primary cause of a surge in total household wealth to $80.7 trillion in 2013 — the highest level in American history,  even after inflation is taken into account.

All of this is undoubtedly reason for celebration, especially for the affluent households that hold the bulk of the wealth and have benefited most from the stock market’s big rebound. But for anyone with even a modest stake in the market — as well as for Janet L. Yellen and the other Fed policy makers who are at least partly responsible for the market’s rise — the startling increase in asset prices also raises difficult questions.

For market strategists, chief among them may be this: How will the bull market respond as the Fed throttles its accommodative monetary policy?

When the Federal Open Market Committee meets on Tuesday and Wednesday, with Ms. Yellen at the helm for the first time, policy makers are expected to discuss how to proceed with the tightening of monetary policy without causing serious problems for financial markets.

In December, the Fed began to wean the markets off the extraordinary monetary stimulus that has swelled the central bank’s balance sheet above $4.1 trillion from a relatively meager $869 billion in August 2007. The central bank has been gradually reducing its monthly purchases of Treasuries and mortgage-backed securities; it is expected to continue holding interest rates near zero for many months, and it may try to more clearly signal its intentions to the markets. It is reining in its stimulus program, not ending it.

Unleashing that policy in the first place had powerful effects, which the central bank has acknowledged. After the stock market hit bottom, Ben S. Bernanke, then the Fed chairman, and other Fed officials said repeatedly that by bringing down bond yields and making credit more available, they hoped to increase the appeal of riskier assets like stocks, stimulating the economy. By the Fed’s own criteria, the economic recovery is still incomplete. But the restoration of prices to their pre-financial-crisis levels has already occurred in many asset categories, and then some.

(As big as the stock market rally has been, it’s far from the strongest or the longest we’ve seen. The rally from Dec. 4, 1987, to March 24, 2000, has a lock on first place in both categories, with a gain of 582 percent over that period, according to figures from the Bespoke Investment Group going back to 1928.)

Central bank policies that lead to higher stock prices can distort financial markets, said Joseph G. Carson, director of global economic research at AllianceBernstein.

“Household debt and corporate debt have been reduced sharply,” Mr. Carson said. “But the Fed has effectively moved the debt onto its own balance sheet. It’s crucial that they unwind it, but the question is, how?”

The Fed has helped to sustain the bull market in stocks, and because home values have also risen in the last year, many middle-class people have begun to spend more freely, spurring short-term economic growth, he said. But one effect of Fed policies has been to widen wealth inequality. That’s because the wealthy hold a high proportion of their assets in the stock market and benefit when the market rises, he said.

What’s more, stock market prices have increased far more rapidly than housing prices, and the net worth of most Americans is heavily concentrated in the value of their homes. In a note to clients, Mr. Carson pointed out that average home prices rose roughly 10 percent in 2013 while the S.&P. 500 index surged more than 30 percent, disproportionately benefiting those who held stock. And, of course, those with neither home equity nor financial assets fell further behind those who own both.

The Fed’s report, “Financial Accounts of the United States,” broke down the figures this way: While the total value of real estate in the United States increased $2.3 trillion, the total value of stocks grew by $5.6 trillion.

Even if such issues provide a subtext for Fed discussions, the direct effects of Fed policy on the stock and housing markets may not be an explicit part of the Fed’s agenda this week.

That’s partly because Congress didn’t include financial asset prices in the Fed’s mandate, which is “to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” Those stable prices referred to items like cars, food and shoes, not to financial assets like stocks and bonds, whose price levels fall outside the Fed’s traditional purview.

Still, the Fed closely monitors financial market price levels, and it has taken on growing responsibility for maintaining the stability of the entire financial system. In congressional testimony, Ms. Yellen has said that the central bank needs to “attempt to detect asset bubbles” in both the stock markets.

There may not be full-blown bubbles at this moment. But valuations have become much less attractive as prices have risen. Richard W. Fisher, president of the Federal Reserve Bank of Dallas, is among those who have argued vigorously that the Fed needs to cut back sharply on its monetary stimulus because it has, in his view, been feeding speculative bubbles.

In a speech in Mexico City on March 5, Mr. Fisher said, “There are increasing signs quantitative easing has overstayed its welcome: Market distortions and acting on bad incentives are becoming more pervasive.” He listed a series of stock valuation measures and said they were “at eye-popping levels not seen since the dot-com boom of the late 1990s.”

Mr. Fisher’s view appears to be a minority one at the Fed, but he makes some telling points. Certainly, as the stock market reaches ever more impressive milestones, it’s important, as he says, to monitor market indicators very carefully, “to ensure that the ghost of ‘irrational exuberance’ does not haunt us again.”

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