The Weak Link

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Orange County. The collapse of Mexico. The Latin American chaos of the early 1980s. These were all reasons for the Fed to give the stock market a break. Of course, the Fed didn't mean to set a match under the market. It was just a byproduct of a policy meant to stabilize the financial system.

What's our catalyst this time? I think it's a couple of guys named

Long Term

. Neither will ever per se collapse, just like Orange County didn't or Brazil or Argentina for that matter. But the crippling of these two institutions are at the heart of the chaos this time.

We all know the story of Long Term Credit Bank. This is the test-case bank, the one that the Japanese are using to build a blueprint to wiping out their banking problems. The slowness with which this situation is being solved has the world on edge, but the need to give Japan some breathing room if they solve this, including pressure off their currency through a cut in our rates, makes a ton of sense.

In fact, it's not LTCB that worries me. It's

Long Term Capital

that is the weak link in the U.S. system. We don't know who is invested with these guys -- is it brokerage houses? Individuals? We will never know. But just going by what's been made public, whoever invested with it has to take a hit unless Long Term Capital bounces back tomorrow. Maybe that's the hit that has all of the brokerage house stocks so jittery, because maybe they have money with these guys.

But the Long Term Capital situation could lead to everything from layoffs at brokerage houses to shortfalls at

Toll Brothers

(TOL) - Get Report

(which I am short). Here's why. Long Term Capital makes its living by borrowing huge amounts of money to take advantage of discrepancies in various markets. Again, we know from public reports that Long Term had investments that blew up in Russia. But we also know that it was a large player in the mortgage market. I am sure it was a huge customer of securitized mortgage pools, most of which have been devastated by prepayments caused by the shockingly low long-term rates.

Many firms ran along the lines of Long Term Capital, meaning they bought this kind of paper by the billions, borrowing massively to enhance the returns. These clients generated huge fees for the investment banks that pooled this stuff. You take out those clients, you have a lot of high-paid salespeople and traders who have nothing to sell and no place to go with it. They go from being players to being overhead.

This chain reaction, which I saw when the junk market dried up with the

Milken

fiasco and the stock market with the '87 crash, is very hard to stop once it starts. The immediate problems are of the bonus variety: Nobody who deals with this stuff can expect much of a bonus at this point, which doesn't sit well with those who borrowed a lot of money betting the good times would continue.

That's the Toll Brothers problem.

But then there is the problem of a dramatic loss of liquidity in the fixed-income market. If you can't create these giant pools, you can't help lending institutions that layoff these loans because they don't want all of that exposure. So the institutions will be reluctant to loan. If institutions are reluctant to loan, clients will be reluctant to build or buy. Prices come down, projects get canceled and

GDP

gets affected. Fast.

That's why this stuff leads right to the Fed. That's why a rate cut is coming, maybe not this month, but sometime soon, because the Fed knows more than anyone that once this chain reaction starts, one rate cut alone won't stop it.

James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com.

At the time of publication, the fund was short Toll Brothers, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to TheStreet.com at

letters@thestreet.com.