I wouldn’t touch financials with a barge pole. I think Laszlo Brinyi is right: ‘avoid financials.’ So, I agree with you – no financials. But, paired trades might be a way to reduce risk from going long or short.

This sort of a relative-value hedge trade is the sort of thing hedge funds were invented to o. But, now it seems they are more bent on taking on risk.

As for WFC, they seem mighty confident — dividend increase and all (not that I’d buy them outright here). Let’s see if there is any substance to that.

On a stand alone basis, I don’t think any financials are good risk adjusted investments here. That seems to fit well with your credit deflation thesis. As a paired trade though, identifying the bad and the not as bad could be a profitable stategy.

That said, financial companies are black boxes. It’s hard to say what is lurking on or even off a balance sheet. Even WFC looks vulnerable as they have a huge exposure to California real estate via home equity loans. Their latest earning “beat” looked like smoke and mirrors to me – extending the term of delinquent to 120 days from 90 days.

As for Northern Rock, we are now seeing that Northern Rock’s loan book was not that good to begin with. Although they fell because of liquidity constraints, I would argue that they would be in dire straits today had they not failed in 2007 as the Chancellor’s additional funding has demonstrated.