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Last week’s news from NovaStar confirmed that profitability has vanished across the board for the mono-line subprime originators. An ensuing industry liquidity crisis is feeding a self-reinforcing markdown of distressed loans and originator retained portfolios, with negative ramifications for subprime ABS and securitizations. At the minimum, the specter of rapidly tightening subprime Credit conditions is beginning to foment heightened uncertainty throughout the mortgage finance super-industry. The derivatives market for hedging subprime exposure has badly dislocated, with agonizing pressure to acquire protection (or reinsure/unwind "insurance" previously written) but few willing providers (think panic buying of flood insurance during torrential rains and rapidly rising waters).

It may take some time before mortgage tumult expands to the point of significantly impacting the general economy. However, recognition that the unfolding subprime debacle is an Indictment of Contemporary Wall Street Finance should be more immediate. The almighty Wall Street securitization and distribution machines were directly responsible for millions borrowing more than they could reasonably be expected to ever repay. The issue was never that it didn’t make sense for an individual borrower to bury himself in debt to participate in an obvious Bubble. Instead, it was all about whether scores of such loans could be pooled together and structured in a fashion that ensured that holders made above-market returns for awhile – and, later, with the eventual blow-up, that risks had been spread sufficiently so that nobody suffered too big a hit. We’ll wait to see how effectively risk was dispersed and how well related Credit "insurance" markets function. And let’s see to what extent Wall Street can simply pack up its gear and move it on over to the next nascent Bubble.

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