Richard Whalen

In the movie, “It’s a Wonderful Life,” small town banker Jimmy Stewart faces a run on his bank and uses the money intended for his honeymoon to give the townspeople what they need to sustain them and quell the panic -- one of countless scenes during the Great Depression.

I am amazed that our media has given so little attention to Federal Reserve Chairman Ben Bernanke’s semi-annual Congressional testimony, February 28, in which he warned that small banks might go under as the sub prime mortgage and housing scandals worsened. He told the Senate Banking Committee: “I expect there will be some failures….Among the largest banks, the capital ratios remain good and I don’t anticipate any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system.”

That’s OK – right? It’s only small banks that will fail. How many? Bernanke didn’t say.

Question: are we in a recession or are we going for the big “D”?

Some analysts believe that some of the huge writedowns in the value of bank assets related to subprime mortgages may have gone too far and accounting rules may be forcing banks to put artificially low values on little-traded assets when they mark them to market. The inability to value such assets on the basis of actual trades, Bernanke confessed, is “one of the major problems that we have in the current environment. I don’t know how to fix it. I don’t know what to do about it,” reported *Bloomberg.com *this week.

These assets are mostly complex derivatives that were never intended to be traded. These were devised by banks using endless supplies of surplus dollars.

The international media, specifically Europe, has been all over Bernanke’s statements as the dollar fell to a new record low against the Euro on February 29, which soared to levels above $1.52 for the first time while the dollar’s overall value on its trade-weighted index also hit a record low.

The *London Times *reported last week: “Leading U.S. shares sank by 2 percent or more in morning trading. Equity markets in Europe also endured still more steep losses, with London’s FTSE 100 index ending the day down 110.8 points or 1.8 percent.”

Despite Bernanke’s rejection of suggestions that the U.S. economy could succumb to a bout of 1970s-style stagflation, some observers warn that the main conditions are in place:

• The world price of oil, which had been expected to level off or decline by late winter, instead soared back above $100 a barrel. Dollar-priced commodities are higher.
• Slower economic growth was supposed to restrain other prices, but inflation in January accelerated. U.S. consumer price inflation for the month hit 4.3 percent, exceeded only by China, the Czech Republic, Russia, Turkey, Indonesia, Pakistan, Colombia, Venezuela and Egypt – odd company for the world’s only superpower.
• U.S. wholesale prices rose by 7.4 percent in the year to January, according to the Economist, the largest increase since 1981.
• Significantly, starting a trend, food and energy prices jumped in January. In reaction, the Conference Board’s index of consumer confidence plunged by 12.3 points, to 75.0, its lowest level in five years.

The sharp slowdown in the economy since the New Year has been consumer-led as consumers have decided en masse to put their credit cards away and cut back on their purchases of gasoline.

So, stagflation is a reality and GDP growth is flat. The U.S. economy is weakening, but the inflation rate is rising. Credit has tightened further, despite the Federal Reserve’s unprecedented January 1.25 percent rate cuts, which are expected to continue. Spreads between risk-free Treasury bonds and AAA-rated corporate bonds widened to the highest level since the 2002 corporate scandals.

But let’s be of good cheer. John Crudele, writing in the New York Post, has a brilliant solution: “Save the dollar” Fire Bernanke!” And despite his 80 years, he advocates bringing back “the legendary Paul Volcker, who successfully led the Fed during the inflation-wracked 1970s and 1980s.”

I am with you, John.