Hyperinflation or Raising Interest Rates?

There has been ongoing uncertainty about whether the federal reserve would use monetary policy to create one or more of following outcomes to deal with the financial crisis:

1) Allow Hyperinflation – as the fed continues to expand the money supply, long term treasury auctions fail to receive buyers (eg. foreign investors don’t trust they’ll be paid back in non devalued dollars), inflation would naturally occur. 

OR

2) The Federal Reserve will Increase Interest rates (called the "overnight rate") – this will be used to as an indirect means to restrict money supply.  Specifically, banks will receive "increasingly expensive" money and will likely cut off many high risk borrowers/restrict borrowing to only the best candidates.  

The Federal Reserve via Ben Bernanke provides an argument for a slower policy to protect consumers while indicating his preference for option 2):

 

 

Either way, private banks have phenomenal power to shift policy, despite the Fed’s decisions.  In particular, the massive Credit Default Swap market will change the landscape of world economics.  "The value of the credit default insurance market is now much larger than the domestic stock market, mortgage securities market and United States Treasuries market" (source).