Wall Street Whispers - The Selloff - TheStreet

NEW YORK (

TheStreet

) -- The stock market's decline since the end of the first quarter has revealed two things about what's going on in the financial system.

First, investors are finally starting to realize that there is no quick and dirty solution to the country's financial woes: The

mortgage reckoning

is finally coming to pass, and its effects continue to ripple relentlessly.

Second, an inevitable showdown between traditional money managers and the high-tech, hot-money profit-chasers is coming. The latter are obviously driving the much of the market action these days, with their strategies becoming available on a do-it-yourself basis ever more frequently and thereby threatening fee revenue of fund managers large and small.

Those two items are the cause and embellishment of Tuesday's stock sell-off, much like many other days in recent weeks.

The Reckoning

The math is fairly simple: There was an estimated $10 trillion worth of value in U.S. residential mortgages before the subprime market began to deflate.

Use any deflation metric you'd like, but using one benchmark measure -- the Case-Shiller home-price index -- about 30% of that value has been lost. Let's say the $3 trillion hit is shared among the four major parties with skin in the game -- the lenders, borrowers, investors and average citizens who live in America.

Moody's estimates that banks have taken about $436 billion worth of writedowns through the first quarter, mostly made up of residential mortgages gone bad. The ratings agency predicts another $300 billion will be recorded before the storm has passed.

Borrowers have seen home-price declines of varying ranges, depending on the part of the country one lives in. Yet, the 12-month rolling average of median existing-home prices is 15% lower than the median price at the height of the market in 2007, according to the National Association of Realtors. The Mortgage Bankers Association and independent economists expect home values to continue to sink through 2012.

Investors have also faced a range of disappointments. According to the KBW Bank Index, bank stocks are down 61% from their five-year peak in February 2007. Yet some investors have been wiped out, and others, who bought at the market low in March 2009 and held onto those investments, have made a killing, even with the recent selloff factored in.

Fannie Mae

(FNM)

and

Freddie Mac

(FRE)

have been bailed out to the tune of $145 billion to date, and there's sure to be more losses attributed to those mortgage-finance giants as the situation plays out.

In other words, when the country goes through a massive devaluation of an asset that's key to everyone's finances and well-being, there will be long-lasting implications.

The government has attempted to reduce or mask the costs through housing initiatives and bailout programs, but at the end of the day if buyers think homes are worth "X" less at the bottom of the market than they were at the top, "X" amount of dollars will be lost by someone. Slowly but surely,

banks have started feeling the pain

of loan losses again. And the Obama administration can't hide those losses within Fannie and Freddie forever. Meanwhile, homeowners have been suffering all along.

Combine housing with the ripple effects of lower household wealth, less consumer spending and confidence and heightened unemployment, and there's an argument to be made that the true impact of the crisis has yet to be fully felt.

The Profiteers

In the midst of all the market tumult, speculators and momentum chasers have had more to gain than long-term investors.

The prospect that banks might collapse in the fall of 2008, and then again in March 2009, ultimately brought periods of unbridled jubilance at the realization that the government would support the financial system and that banks were not only staying alive but would end up heartily profitable. Such volatility is the grass upon which the market bulls feed nowadays.

While the moneyed set of high frequency traders, market-makers and hedge funders have been able to "game the system" using a combination of technical analysis, and quick execution technology, fund managers have been left in the dust. With their promises of safety and assured returns left unfulfilled, investors have fled to greener pastures -- whether a safer money-market fund, or risk-takers who have proven their ability to stay ahead of the game.

Meanwhile, the growing dominance of exchange-traded funds and hedge-fund replication tools has provided Average Joes a method to take matters into their own hands, rather than rely on the "expertise" of money managers who have failed them miserably in the past.

For the moment, it appears that the

fast-money set

is winning out while the buy-and-holders of yore

lick their wounds

. (For references, see the action in

Procter & Gamble

(PG) - Get Report

shares on May 6, and the

investor who got flash-crashed

.)

It will be interesting to see which group prevails in the end, especially given the potential for technology and information-sharing to level the playing field even further in the years to come.

-- Written by Lauren Tara LaCapra in New York

.