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Weak Wealth Effect Blunts Fed Stimulus For Stocks, Housing

Federal Reserve stimulus has buoyed home and stock prices, but that won't generate as much an economic bounce as wealth gains once did, according to a recent study.

The financial crisis eroded the so-called wealth effect that Americans feel from rising property and stock values, producing a weaker spending boost, said Credit Suisse analysts Neal Soss and Henry Mo.

That makes the 7% yearly increase in the Case-Shiller home price index and the near-record high of the Dow Jones industrial average less encouraging.

From Q1 1993 to Q3 2012, a 100% housing wealth gain translated to a 3.3% increase in household consumption, down from 5% during Q1 1993 to Q1 2007, Mo said. Similarly, a 100% rise in stock wealth meant a 1.1% consumption gain, down from 1.5%.

Those data suggest a sharp drop in the wealth effect over the past five years.

Consumption is more sensitive to housing wealth than it is to stock wealth because the former is less volatile, they explain. Both fall far short of disposable income's effect: A 100% income gain leads to a 99% spending rise.

The significantly reduced housing wealth effect since 2007 may have three causes: Gains are seen as less permanent, gains are merely restoring previous declines, and fewer equity withdrawals are putting less money in consumers' hands.

That suggests housing's wealth effect won't return to its prior level until home prices fully recover, Mo said, adding that it could take at least five years.

Fed Chairman Ben Bernanke noted the wealth effect when an nouncing the latest round of bond purchases in September. But Credit Suisse's findings imply the Fed must orchestrate an even steeper rally in house and stock prices for a given pickup in the economy.

"You'd have to keep the easy monetary stance longer," Mo said.

Central bank policymakers are actually becoming more squeamish over the current $85 billion a month in asset purchases and are debating whether it should be trimmed or stopped altogether. But Bernanke last week forcefully backed the stimulus measures. Vice Chair Janet Yellen on Monday fully backed the Fed's aggressive policy.

Housing will still have a significant wealth effect over the medium term, Credit Suisse says. Its analysis suggests a recovery in home prices back to their 2006 peak should boost consumer spending by about $93 billion.

But 2013 price gains are unlikely to offset the payroll tax hike's impact on spending, it added.

Rental Impact The housing rebound's spillover economic benefits were already looking weaker, given the high demand for rentals.

Construction of the average single-family home creates more jobs than a multifamily unit. Apartment dwellers also tend to spend less than homeowners.

There is a "growing misconception" about housing's wealth effect, RBC Capital Markets economists said in a research note. Not only is it not generating much of one now, housing also is still an impediment to consumer credit.

Homeowner equity is stuck far below the average seen before the housing crash, despite the improvement in prices since then.

"(T)he only people benefiting from a true wealth effect associated with that increase are the people who bought their houses recently," RBC said. "For the rest of us, many remain underwater."