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The "blow-off" stage of the Mortgage Finance Bubble led to unprecedented excesses, no doubt about that. Scores of uninformed borrowers with meager incomes and little savings were enticed into the responsibilities of homeownership by a combination of surging home price inflation and offers of ultra-low "teaser" and/or adjustable-rate mortgages with minimal down-payments (compliments of the Greenspan Fed). Many loan originators were enticed into lending to poor Credits for the easy profits garnered by selling these loans to Wall Street (for pooling and securitizing). These pool operators were attracted to these suspect mortgages because of the insatiable demand for higher-yielding "structured" products….

In the context of Credit system blunders, 2006 was a historic doozy. After several years of increasingly egregious excess, the mortgage industry proceeded to open its arms extra wide. The marketplace welcomed millions to refinance problematic mortgages that were in process of payments resets, in many cases significantly higher. Never have so many atrocious Credit risks been offered such a handsome opportunity (to refinance and/or take out second mortgages). Clearly, many slipshod originators catered to these suspect Credits, and this dynamic helps explain why an extraordinarily large number of these ("bottom of the barrel") new mortgages – "Vintage 2006" – have quickly turned delinquent or fallen into default….

A strapped subprime borrower with payments about to reset higher (and with minimal or negative home equity) is at the mercy of the marketplace to refinance and stay afloat. Akin to the leveraged telecom company in 2001/02, the marketplace closing the loan window is immediately catastrophic for the subprime borrower. Again corresponding to the telecom debt bust, tightening Credit conditions quickly lead to escalating Credit losses and only further Credit tightening and losses….

The expectation has been that tightened mortgage Credit conditions would sway the Fed into easing. But today’s comments from Fed officials certainly lead one to believe that they are content to focus more on upside liquidity risks, while allowing subprime excesses to, in the words of Mr. Poole, "come home to roost." Hopefully the Fed demonstrates resolve, as the most problematic systemic fragilities are being exacerbated by ongoing Unlimited Finance available throughout markets in corporate Credits, securities leveraging, and for (over)financing asset markets globally.

Doug Noland is a market strategist at Prudent Bear Funds. Their website is www.prudentbear.com.