Housing Collapse Squishes Bear

This just in: The housing bubble wasn't just making mad funny money for the likes of Pulte Homes (NYSE: PHM), Toll Brothers (NYSE: TOL), or lenders such as Countrywide Financial (NYSE: CFC) and the 81 unsuccessful lenders listed on the mortgage "Implode-O-Meter."

The risky mortgages that drove the mania were also prime ways for Wall Street to cash in on the greedy and naive. And now that the air is escaping and credit is being crunched, we're seeing the results. Bear Stearns (NYSE: BSC) is feeling the pain, beginning with a 32% drop in earnings that the company blamed on bad performance in its fixed income segment. You know things are bad when the outfit is forcing its 10-month-old, poetically named hedge fund, the High-Grade Structured Credit Strategies Enhanced Leverage Fund, to dump billions (WSJ subscription required) in mortgage-backed securities. Note the name, folks. "High-Grade Structured Credit." Sounds like the fellows at Bear were drinkin' too much of their own Flavor Aid.

Of course, the Stearns bears aren't the only ones getting bitten. Things are bad all over. Lehman Brothers (NYSE: LEH) and Goldman Sachs (NYSE: GS), which did OK otherwise, had lousy results from the many-faceted mortgage biz.

Sure, it's easy enough to see the problem now. You only need to follow the money trail for what passed as a viable business model for a few years: Crummy loan broker handed money to bad credit risk (often with ginned-up financials). Loan originator held nose, got compliant appraiser to OK the inflated price, then flipped loan to Very Clever Men on Wall Street.

Very Clever Men bought toxic-waste loans, chopped them into bits, recombined them into tranches of varying yields -- differentiated by risk -- and sold these, now marked with disturbingly sanguine credit ratings, to eager bagholders across the world who were hungry for yield and oblivious to the hidden time bombs within. Along the way, marking mortgage "securities" to market, booking illusory profits on unpaid interest from option ARMs, taking inadequate reserves, and other accounting hocus pocus helped many companies in the food chain post record "profits."

It was a perfect perpetual motion machine, until it stopped swirling. When non-performing loans and foreclosure rates climbed, the apparatus started to grind, smoke, and hiss.

Now that the machine is breaking down, I suggest investors (not to mention taxpayers) continue to follow the money. Who stands to continue losing as the quick-flip housing culture slows the flow of mortgage-backed securities, as well as dampening consumer spending?

Who will benefit from the Democratic-proposed bailout plans for those who signed on for homes they couldn't afford? Will "foreclosure relief" -- as I'm sure it will be called -- really save the poor, huddled masses? Or is it just a way of making sure that Wall Street banks (big donors to both parties) can be assured that their fancy loan derivatives don't get even more toxic, and even less profitable?

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At the time of publication, Seth Jayson had no positions in any company mentioned here. See his latest blog commentary here. View his stock holdings and Fool profile here. Fool rules are here.