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It was just a few weeks ago that American Home Mortgage (AHM), the nation's tenth largest mortgage lender, assured investors its .70 cent quarterly divided was safe and the company's future was secure, despite a withering credit crunch precipitated by rising defaults among residential home buyers. Then, last week, AHM stunned investors by not only canceling the promised divided but doing so after the ex-dividend date -- dividends which had been paid to investors were actually taken from their accounts! An eerie silence fell; trading was halted pending news. When the news finally came, late at night, it was grim: AHM was kaput, toast, bankrupt.

Today, the mortgage lending sector continued to simmer in the foul perspiration of investors crushed hopes and withering retirement accounts. More lenders jumped on a madly careening roller coaster ride, one claiming that it had stopped all lending, only to announce a few hours later that it had restarted lending. As I watch this sector unravel, lenders and investors alike who are caught in this growing web of intrigue are looking more and more like patients in a 17th insane asylum, counting scraps of worthless paper and imagining themselves living the good life reserved for kings and feudal land barons.

Early today, strange price gyrations began to wave a wicked spell on the common stock of Luminent Mortgage Capital (LUM). Previously, LUM's management had gone to great lengths to assure investors that the $.32 dividend was "safe" and LUM had plenty of capital to meet its needs. This morning, it felt like a weird cloud of deja vu hung over LUM's discussion board on Yahoo Finance. Unfortunely, that was a premonition. The stock took a nosedive...at $3.75, it looked like a bargain to me. But then the NYSE halted trading on pending news, and a familiar silence fell upon one of the few remaining bright stars in the MREIT sector. Trading never resumed, and after the market closed, LUM announced, among other things, that it had suspended its promised dividend and now faces an avalanche of margin calls.

LUM's supporters are right for the most part when they say that LUM and AHM don't have much in common. Their business models are different; yet, they are both passengers on a sinking Titanic whose destruction is being driven by a frantic panic selling that prompted Jim Cramer to shout "This is Armageddon!" when he melted down into state of apoplexy during a televised interview last Friday.

The entire mortgage lending sector appears to be caught in a downward spiral of self-destruction. Yes, it's bad news that a couple of million Americans with appetites bigger than their pocketbooks took out ARMS which are now resetting and they cannot afford to pay. But that news is not so bad that it should send the whole mortgage industry crashing down in a pile of worthless rubble. The real culprit here, I believe, is fear and panic selling, not the underlying fundamentals. If your portfolio is truly worth a million dollars, but panic selling forces a margin call, and if there are no buyers, you are going to be toast when you liquidate, no matter what the true book value of your stock might be.

Tomorrow, LUM's grim pronouncement will likely trigger more panic selling across the sector, depressing stock prices further and probably prompting more margin calls. Intervention by the Fed, or perhaps a divine force, is a necessity or the crisis could spread to other credit sectors, producing dire consequences not only for investors but the global economy.

Until calm heads wade back into the fray and begin to prevail, the mayhem will get uglier as we torpedo toward rock bottom. However, I do believe that we will hit that bottom, sooner than later. Some MREITS will survive the immolation. Those that do will make savvy, bottom fishing investors a lot of money down the road. The trick is second-guessing how bad the calamity will get, which firms will survive, and where the bottom actually is. Those who have a tolerance for that kind of risk, and who make the right picks, will make a lot of money when the dust settles. Those who make the wrong choices will be bagging groceries or driving taxi cabs.

Disclosure: I am long in several mortgage REITs and bottom fishing in a limited way and with great caution. I am short nothing. I currently have no position in LUM, and I have not owned or shorted LUM previously.

Source: Luminent Mortgage Capital: Another MREIT Bites the Dust?