From Salon (Registration/SitePass Required):
Wanna raise hackles on Wall Street? Sneak up behind an investment banker and whisper the words “systemic risk.” As in: The miseries currently being experienced by subprime mortgage lenders are causing enough problems in derivatives trading markets so as to send a destabilizing jolt through the entire universe of high finance.
The response most likely will be a snort of derision, but underneath the sneer might lie a shudder, because the way Wall Street works has changed so much, so fast, over the last 10 years that no one really knows what’s going to happen when the markets get seriously tested. All anyone can do is look at each new blip in the markets and wonder: Is this the tipping point? Is this the moment we will look back upon and pinpoint as the day it all went to hell?
It has been clear for more than a year that Wall Street hedge funds have been betting on trouble coming in mortgage lending markets. Whoever made those bets is probably doing quite well right now. And maybe that’s where it will end — in a perfectly balanced market, someone will profit from someone else’s woes, and so it will go, forever more. Some optimists predict that there will be a period of consolidation in the sub-prime mortgage lending industry, the weak players will get eliminated, and the overall market will be stronger in the end.
Or perhaps economic historians will one day look back and trace this sequence of events:
The rise of credit derivatives allowed banks to sell off the risk of being caught holding the bag for bad loans. This emboldened them to move aggressively into riskier and riskier sub-prime loans. But the subsequent collapse of the housing market led all too naturally to a flock of bad credit risks coming home to roost. That, in turn, has made it harder to buy insurance, because there’s a chance that the sellers of protection might actually have to pay up, rather than just get fat off their premiums. And so the entire system started to get stressed…