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Bernanke: Stagflation a Possibility If Banks Aren't Fixed

UPDATED WITH BERNANKE ON STAGFLATION:

In testimony before the House Financial Services committee underway, Fed Chairman Ben Bernanke just said that stagflation would be a risk if "we don't fix the banking system."

Stagflation, as historians of the 1970s will recall, is a combination of high unemployment and slow or no economic growth combined with inflation, a real witches brew.

It's bad for everyone except holders of long-term certificates of deposit who saw interest rates soar into the high-teens in the '70s, thanks to stagflation.

"It would be very difficult for entrepreneurs to get credit," Bernanke said.

Bachus Hints At Limiting Bank Size

1:23 P.M.: Bernanke just concluded a little debate with Rep. Spencer Bachus (R-Ala.) over the size of banks, with Bachus hinted at limiting their size.

Bernanke was giving Bachus a definition of what it means when the Fed considers a bank or other financial institution -- such as AIG -- systemically important if it were to fail. In other words, it would drag down the system if it goes under.

"One way to prevent that is to not permit a corporation of that size, isn't that right?" Bachus asked.

"That's one way," Bernanke warily allowed, saying he preferred "tougher regulations" and allowing the government to come into a troubled institution before default to help resolve the crisis and possibly to wind down the bank in an orderly way.

Bernanke: Government Needs Stronger Powers To Wind Down Failing Banks

1:23 P.M.: Bernanke said the government needs a better way to wind down failing financial institutions like Bear Stearns, and asked Congress for the authority.

You can read Bernanke's entire testimony here.

"The actions that the Federal Reserve and the Treasury have taken to stabilize systemically critical firms were essential to protect the financial system as a whole, and, in particular, the financial risks inherent in the credits extended by the Federal Reserve were, in my view, greatly outweighed by the risks that would have been faced by the financial system and the economy had we not stepped in," Bernanke said.

"However, many of these actions might not have been necessary in the first place had there been in place a comprehensive resolution regime aimed at avoiding the disorderly failure of systemically critical financial institutions," he said. "The Federal Reserve believes that the development of a robust resolution regime should be a top legislative priority."

On transparency, Bernanke said: "I firmly believe that central banks should be as transparent as possible, both for reasons of democratic accountability and because many of our policies are likely to be more effective if they are well understood by the markets and the public."

-- Frank Ahrens
The Ticker is Twittering!

By Frank Ahrens  |  February 10, 2009; 2:54 PM ET
Categories:  The Ticker  | Tags: Bear Stearns, Ben Bernanke, bailout, inflation, stagflation  
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