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Robert Lenzner

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Bernanke's QE1 and QE2 Pushed Stocks Skyward

Posted: 01/22/11 08:47 PM ET

No doubt about it, Fed Chairman Ben Bernanke's use of well over $2 trillion in Fed funds did help push higher the price of many securities, especially those in natural resource or commodity businesses -- increasing the paper wealth of the investing class. A related goal was to buttress the rate of inflation and defeat the fear of a deflationary spiral, a double dip in economic activity. Credit Bernanke hugely for the rise of share prices from a despairing time.

Indeed, the market ONLY rallied after Bernanke's August 27 speech to central bankers where he promised the Fed would "do all that it can to ensure continuation of the economic recovery." His method? "Additional purchases of longer-term securities."

And this followed 2009's injection of $1.5 trillion on mortgage backed securities in a QE1 manoevre that enbaled the mortgage sellers to turn around and buy the safer Treasuries that financed Obama's deficit.

And, as those treasuries went up slightly in price, so too did their yields go down, encouraging other investors to buy equities.

Now comes my friend the admirable Barry Ritholtz of fusioninvest.com, who goes so far as to suggest that the Fed action to pour money into the financial markets has "distorted the stock market."

We're not sure the "distortion" is right, but I suggest we wait until the summer, when the $100 billion a month transfusion of cash by the Fed's purchase of Treasuries and mortgages will end. If stocks tumble, I guess we'll need another "distortion, QE3.

I have been curious myself how those $100 billion injections of buying power in fixed income securities them translate practically speaking into market participants using the Fed's money by pushing up stock prices. And I mean to get to the nitty-gritty bottom of it.

One major unexpected result of QE2 has been the failure of the Fed's attempt to lower interest rates to stimulate activity in the housing market by means of cheaper mortgage rates. On the contrary, the interest coupon on mortgages has risen along with the interest costs of Fed borrowings.

So strike one Bernanke victory for higher stock prices, and one defeat in money markets, where the attempt to stimulate the purchases of homes through lower interest rates backfired. On balance, we have to admit the nation is better off. But, hold your breath come June 1 that the stimulus from QE2 will be enough to keep the economy growing and employment gaining.
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