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Milton Ezrati of Lord AbbettNow that the Federal Reserve has launched its third, open-ended, quantitative easing (QE3), investors need to consider the risks. Certainly Fed Chairman Ben Bernanke has. He outlined them recently at the Kansas City Fed’s annual conclave in Jackson Hole, Wyo. There, in addition to providing considerable perspective on the extraordinary steps the Fed has taken since the 2008-2009 financial crisis, the chairman reviewed four critical risks involved in non-traditional policy tools and procedures. He probably could have added a fifth.

Bernanke’s first concern has to do with liquidity. The massive size of the Fed’s quantitative easings, he said, leads him to worry that the markets in which the Fed operates could take on an administered character. That quality could drive out private trading and, with it, the price discovery and liquidity on which markets rely. Bernanke went so far as to say that the lack of a “free-trading” aspect in Treasuries and agencies, to use his words, could erode the lead these markets have offered in pricing and yield, making overall financial markets less efficient as well as weakening the overall effect of future Fed policy moves.

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