JJC:   Don't be fooled by the rally in the banks today. I believe that these stocks are in real trouble, and obvious trouble, courtesy of the friends at the Federal Reserve... who are all back in their ivory tower who are thinking about raising rates to fight inflation... something that I think could utterly wreck nearly every major bank out there... especially ones choking on home equity loans, which are defaulting quicker than I can down a cheap bottle of scotch on a linoleum floor on a big down day...

Everyday, we get more and more awful data from the financials... Yesterday, it was LEH... WM... Today, it's UBS. The housing crisis is so bad that now we're hearing that JPM is suddenly troubled by the losses by the BSC bond portfolio it bought, even after those gigantic loan guarantees from the Feds... That is new news by the way...

We are now more than a year into the crisis, and what are we hearing from our nation's financial leaders... the men who are supposed to save us from financial catastrophe?... Here's Ben Bernanke (Fed Chairman) yesterday... "The risk that the economy has entered a substantial downturn appears to have diminished over the last month or so"...

Really? Is he seeing the same things I'm seeing? Do we inhabit the same universe?...

Honestly, this guy is sounding like Herbert Hoover every day... Seriously, here's Hoover in 1930 (just before the Great Depression)... "I am convinced that we have now passed the worst, and with continued unity of effort, we shall rapidly recover." These quotations, to me, are both interchangeable...

I hope that, this time, it isn't equally as catastrophic.

After a period where it seemed like the Fed was no longer asleep at the wheel, I'm once again convinced that they are beginning to unlearn what I thought they had learned the hard way... through almost $500 billion in losses that I firmly believe could have been avoided, had the Fed taken swift action...

The worry for them, once again, unbelievably... inflation. The same excuse they used to avoid dealing with the problem when it first surfaced... But, and I'll say this real slow for the benefit of the Fed and the Treasury Department for that matter... You cannot fight inflation, and stop a housing depression at the same time... You can't be worried about both simultaneously. If they continue to take the... let-them-have-their-cake-and-eat-it-too approach, our economy is headed straight for the financial guillotine...

Last year was the year to cut rates big!... And let people re-finance their mortgages and give the banks a chance to play the yield curve to rebuild capital... a la 1990... a scenario we've outlined repeatedly on Mad Money...

We all know the story... we know what they did... They blew that chance to avert the crisis because they were worried about, yes, inflation... Bernanke and the rest of the Fed... You see, they're trying to take a middle road that does not exist... They have no conviction, and maybe no idea of the consequences of their actions... They just keep vacillating, putting out different stories, giving different speeches... failing to fix inflation or the housing-induced recession... but they don't get it...

If they want to fight inflation... if that is Bernanke's chief goal, then here's what he needs to do...

Frankly, he needs to destroy the economy, in order to save it...

He needs to make people so poor, that they can't afford to pay for gasoline, because this particular strand of inflation is energy-based, not wage cost or housing-related.

Now the government could take care of a big chunk of food inflation by killing that nasty and stupid ethanol mandate, where we trade 30% of our corn... what the animals eat... chicken, beef... for 3% of our gasoline... That's right. And I believe that federal policy... mandated by the President and supported by congress... is causing the real inflation for food... That's why the July 4th barbecue is going to be so tough... the same with Father's Day...

And, at the same time, we have the Federal Reserve that's noodling on whether to raise rates and level the economy to fight that inflation...

All right, if they urged the elimination of corn-based ethanol, they would do more for the cause of lower inflation than they would by raising rates... and they'd also have the added advantage of not increasing the likelihood that you'd lose your job.

What we have now is a choice. And it's a choice neither the Federal Reserve nor the Treasury Department seems willing to make... They can either cut down inflation and take in exchange what I expect to be a severe recession... absolutely maul American businesses... so they will use less energy... brutalize the American homeowner, so he can't pay his mortgage... and then merge all the banks, as they start to fail, under the weight of all these defaults...

Or they can solve the housing conundrum first, and put the rate hikes in a drawer until we're finished.

You see, they're trying to do both, but that's simply impossible. They want to be tough on oil-based inflation, which won't work... and bet that the housing depression is over. That's a bad bet.

These problems have to be tackled sequentially or they won't be tackled at all... One or the other... they've got to pick. I hear them all day on our network... they're saying both.

There have been some benefits from their indecision for Cramericans... the bull market in energy and energy-related stocks that have to go higher with the commodity. If Bernanke wants to raise interest rates to kill that, and to create mass unemployment, that's his prerogative. It seems he can't make up his mind.

It shouldn't be this way... these guys are supposed to be clued in... but it is. And it has been... We can't keep denying the obvious. They haven't been able to choose between trying to stop oil inflation, and trying to combat house price depreciation, and that's the most dangerous non-choice of all.

So we have a nonsensical policy that seeks to create inflation and kill it at the same time... one that I believe will result in the worst alternative... both inflation and recession.

The Bottom Line!:      I'm convinced that, as long as Bernanke and Paulson think they can take on oil-based inflation with higher interest rates, and the housing crisis, at the same time... with lower interest rates... we're in trouble. I think we'll be better off when they recognize that you have to cure one before you can cure the other. They should stop speaking out of both sides of their mouths. And speaking as someone who doesn't want to see the economy devastated... with millions of people losing their homes, and millions more losing their jobs... I prefer if they cure housing first.