Scared yet? Sure, but don't panic

In sobering testimony to the Senate Banking Committee, Fed chair Ben Bernanke says the credit crunch and inflation are both key concerns.

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By Paul R. La Monica, editor at large

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NEW YORK ( -- This is one of those days you probably wished you stayed in bed.

GM (GM, Fortune 500) is suspending its dividend and cutting jobs. Investors are speculating about more bank failures and appear to lack faith in the government's "rescue" plan for Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500). Inflation at the wholesale level grew at its fastest clip in 27 years. The dollar hit a new low against the euro.

Gold, the ultimate safe haven in times of turmoil, is nearing $1,000 an ounce again, a level it hasn't seen since the height of the Bear Stearns-inspired market fears back in March.

(Note to all the gold bulls who've been e-mailing me about my last gold column...yes, it looks like I may wind up being wrong about gold not getting back to $1,000. I clearly underestimated the fear in this market and put too much faith in the dollar.)

And Federal Reserve chairman Ben Bernanke didn't help matters Tuesday morning. Stocks plunged at the open ahead of his testimony to the Senate Banking Committee and actually fell further once his prepared remarks were released. (Stocks actually moved higher later in the day though following a surprise drop in the price of oil.)

The big problem appears to be that Bernanke pretty much admitted that the Fed has a lot of fires to put out and that it can only do so much at one time.

In what qualifies as the understatement of the year, Bernanke said that "financial markets and institutions remain under considerable stress."

He added that "healthy economic growth depends on well-functioning financial markets" and that "helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve."

Those statements would suggest Bernanke will keep interest rates low to address sluggish growth.

But he also talked about inflation and the weak dollar - to combat those problems, he'd have to raise rates.

In other words, Bernanke confirmed Wall Street's worst fears. The financial markets are a mess. Inflation is a problem. And he can't tackle both at the same time.

Trying to solve the crisis of confidence in the credit markets with continued low rates probably will make the inflation problem worse while raising rates to tackle oil and the dollar could lead to a further deterioration in the health of banks and other financial institutions.

So with the market down sharply once again on all this bad news, what is the average investor to do? Is it time to run and hide?

The temptation is to panic. But that is the worst possible thing to do as it is just fueling more selling and a sense of impending doom. Just look at what's happened with the banking sector.

The collapse of IndyMac late Friday sent a lot of otherwise rational people into a tizzy.

Despite assurances from the Federal Deposit Insurance Corp. that the overwhelming majority of banks are safe, investors still pummeled bank stocks yesterday and today as wild, unsubstantiated rumors circulated on trading desks about more failures.

Now don't get me wrong. I'm not suggesting that the banking sector is healthy or that the stocks are worth buying - even at these depressed levels.

But the sell-off seems to be overdone. Shares of banks like National City (NCC, Fortune 500) and Washington Mutual (WM, Fortune 500) were crushed Monday on no news, just speculation.

Nonetheless, it's understandable why the market is in such a dreary mood.

After all, you have to dig deep into Bernanke's testimony to find any good news. He said the Fed expects the housing market and economy to "bottom out and begin a slow recovery as credit conditions gradually improve" over the next two years.

And 2010 is a long time away for people facing foreclosure, rising gas prices and higher food prices at the grocery store.

So even though I still think investors should try and keep a level head and not overreact, it's getting tougher and tougher by the day to expect that the markets and economy will significantly improve any time soon. This downturn may last longer than past recessions have.

Issue #1 - America's Money: All this week at noon ET, CNN explains how the weakening economy affects you. Full coverage.

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