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We’ve definitely reached a critical point worthy of the question: Can "structured finance," as we know it, survive the California and U.S. mortgage/housing busts? I don’t believe so. For one, the historic nature of the Credit Bubble virtually ensures the collapse of the Credit insurance "industry" (companies, markets, and derivative counter-parties). The mortgage insurers are now in the fight for their lives, while the "financial guarantors" today face an implosion of their "structured Credit" insurance business. Worse yet, major problems in municipal finance (certainly including California state and municipalities) are festering and will emerge when the economy sinks into recession. It is worth noting that California revenues were $777 million short of expectations during the first fiscal quarter (see "CA Watch" above).

Returning to the vulnerable CDO market, some key dynamics are in play. With California now at the brink, uncertain but huge losses are in the pipeline for jumbo, "alt-A," and "option-ARM" mortgages – loans that were for the most part thought sound only weeks ago. The market began to revalue the top-rated CDO tranches this week, a process that should only accelerate. "AAA" is not going to mean much. If things unfold as I expect, a full-fledged run from California mortgage exposure could be in the offing. And as the dimensions of this debacle come into clearer market view, the viability of the Credit insurers will be cast further in doubt – with ramifications for Trillions of securities and derivatives. General Credit Availability would suffer mightily.

With global equities markets in melt-up mode, it might seem absurd to warn that a troubling global financial crisis is poised to worsen. But Structured Finance is Under Duress. The entire daisy-chain of liquidity agreements, securitization structures, Credit insurance and guarantees, derivatives counterparty exposures and, even, the GSEs is increasingly suspect. Trust has been broken and market confidence is not far behind.

The big global equities and commodities surge over the past few months certainly has been instrumental in counteracting what would have surely been a problematic "run" from the leveraged speculating community. How long this spectacle can divert attention from the unfolding mortgage/CDO/"structured finance" debacle is an open question. I can’t think of a period when it has been more critical for stocks to rise - and rise they have. Yet I suspect recent developments will now encourage the more sophisticated players to begin reining in exposure.

The nightmare scenario - where the market abruptly comes to recognize that the leveraged speculating is hopelessly stuck in illiquid CDO, ABS, MBS, derivative and equities positions - doesn’t seem all that outrageous or distant this week. Unfortunately, today’s Ponzi-style acute fragility (as was demonstrated this summer in subprime, asset-backed CP, SIVs and the like) and speculative dynamics dictate that he who panics first panics best. I don’t expect the sophisticated players to hang around and wait for securities to be properly priced and the full extent of illiquidity and the unfolding Credit debacle to be recognized. And while Bubbling markets do delay the inevitable reversal of speculative flows from the leveraged speculating community, they only compound the risk of an inevitable ravaging run from illiquidity. We’ll see to what extent the Fed is willing to spur increasingly destabilizing global stock market speculation and dollar liquidation in false hope that lower rates can somehow mitigate Structured Finance Under Duress.

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