Kass: Subpar Subprime a Growing Problem

That fungus of subprime credits is now clearly not only among us but it is now upon us, and the implications for a tightening in mortgage credit will likely serve to contribute to the second leg down in housing over the balance of 2007.

The tidal wave of liquidity and cheap borrowing over the last seven years -- which has permeated the mortgage, private-equity and stock markets -- has created an attitude toward risk-taking unlike almost anything ever seen before.

Except for a brief period in late 1999-early 2000, the spread of risk taking to risk aversion has never been wider. Like eight years ago, this condition has produced a market that is currently priced for perfection, poorly positioned for any unpleasant surprises.

We entered 2006 with most investors holding the highest degree of confidence in rising prices for their homes. As it turns out, homeowners were materially disappointed last year.

We enter 2007 with investors having the highest degree of confidence in rising prices for their stock holdings. They too might be disappointed as the year progresses when the hidden fragility of an overpriced, overleveraged world will soon be revealed.

I have written that "in time we will undoubtedly see a mean reversion in home prices, interest rates, credit spreads (and losses), corporate profit margins ... and in the world's equity prices."

Last night's subprime mortgage news that credit losses are skyrocketing is the first shot across the bow of the boat called market optimism.

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