Kass: Subprime Fungus Will Spread

This column by Doug Kass was originally published on Feb. 15 at 9:27 a.m. EST on Street Insight. It's being republished as a bonus for TheStreet.com and RealMoney.com readers. For more information about subscribing to Street Insight, please click here.

Wednesday saw another large mortgage bank, Silver State Mortgage, cease originating subprime loans. Silver State Mortgage was, according to National Mortgage News, one of the fastest-growing wholesale lenders in the country.

The relatively healthy subprime originators, like Washington Mutual's(WM Quote) Long Beach Mortgage, are downsizing around the country faster than you can say BBB-minus.

In a related note, Standard & Poor's might have been reading my story from last week as they downgraded ratings on 18 securities from 11 mortgage-backed bond issues and put on review a number of other bonds sold by units of Goldman Sachs(GS Quote), Lehman Brothers(LEH Quote), Barclays Capital, Countrywide Financial(CFC Quote) and New Century Financial(NEW Quote) on Wednesday.

Many in the media (from Jim "El Capitan" Cramer to Sir Larry Kudlow to Bob Pisani) have opined that the bears "don't understand the conditions under which real estate markets collapse, and these conditions (suggestive of a broadening credit problem) are not present." And, in a series of perfunctory conference calls over the last week, the leading brokerages have supported their case that there will not be a credit contagion emanating from subprime lending and that the brokerage exposure will be contained and limited, even though none of the banks disclosed their involvement in the subprime market (as agents and as principals).

It appears that the principal reason these observers are ignoring the subprime problem and its ramifications is that the equity markets are ignoring them. Ergo, it must not be a problem. This is the definition of a Goldilocks mindset (see no evil, hear no evil), not a Goldilocks scenario.