Farrell: RBS and Paulson are Wrong

There are several reasons being given for yesterday's market weakness. John Paulson, who made more last year shorting the housing sub prime stuff than the Vatican, said we're only one third the way through the credit crisis. A strategist at Royal Bank of Scotland feels inflation is going to be a huge problem and the US stock market has a long way to fall.

A response if I may. Goldman Sachs is stitching together a rescue of a defaulted SIV, or Structured Investment Vehicle. These are off balance sheet investment pools that borrow a ton of money and buy ten tons of assets. All well and good if you can sell the assets. Turns out trying to sell sub prime mortgage bonds proved difficult and a lot of SIV's hit the wall. There are over $400 billion of such structures. A lot were set up by banks who took the things back onto the balance sheet. Some had no lineage back to a bigger partner and defaulted. One of those was Cheyne Capital, a $7 billion package of toxic waste. Goldman will have an auction in mid July to restructure Cheyne. The Financial Times quoted a banker yesterday who said trying to solve this issue proved like "nailing jelly to a wall." Forget the details because they are numbingly complex. The point is Goldman has figured a solution and, if this flies, there are immediately $18 billion more lined up and ready to go.

Joe Battapaglia said on Larry Kudlow's show last night this was but a drop in the bucket (See video). With respect for Joe, (and I mean that- have you ever met the guy, he's a defensive tackle size man ... I'm 185 and more a wide receiver, except I'm slow and have terrible hands), I agree this is a drop in the bucket, but it's the first drop and an important one. The solution has to begin somewhere. "A journey of a thousand miles is taken one step at a time." (Mao)

I think we are much further along the solution curve than Mr. Paulson believes. If Goldman is stepping in to risk capital and reputation, I view that as a positive sign and eagerly await the auction as a clearing price for this stuff will be set. I don't think that can happen if we are only one third the way through the crisis.

The RBS analysis is just wrong. Inflation is a lagging indicator and I also can't see inflationary pressures of large consequence while unit labor costs are going down. Seventy percent of the cost of goods is labor, and that's why the killer rise in the price of oil has not (yet) crushed the US economy. The market might go down a ton as RBS suggests. But it won't be for the reasons given.

I think the market went down because of the "Fed Waffle" (coined by Kudlow, all rights reserved). This is a new dance move by the Fed with a quick head fake towards raising rates and an equally quick move back to staying with the status quo. I believe we need a rate increase, I believe the market is disappointed that what looked like leadership from the Fed so quickly evaporated. Mr. Paulson and RBS may be right. I think the market, though, is so wanting direction that even negative, and I hope incorrect, direction attracts followers.