New Century's collapse is not a surprise. It's the system's logic working.

When risk is removed from those who create it, it doesn't disappear. It accumulates where nobody wants to look.

New Century Financial filed for bankruptcy this week. It's the largest originator of subprime mortgages in the United States. The market is reacting as if this is an isolated event — a player with bad practices that found the natural outcome of its bad decisions. It isn't. It's the first visible point of a structure that distributes risk in ways that make invisible who carries it.

The subprime mortgage origination and distribution model works like this: a bank or finance company originates a high-risk loan, packages it with others in securitized instruments and sells it to institutional investors. Whoever originated doesn't keep the risk. Whoever bought the instrument has exposure to the loan pool, but no visibility into the individual quality of each one. The result is that the incentive for the originator isn't to qualify borrowers well — it's to originate maximum volume before selling. When incentive and risk are in different places, the system produces exactly what's happening now.

What happens next depends on how much of this risk is distributed in instruments the market still believes are safe. Subprime mortgage CDOs are in the portfolios of pension funds, European banks and sovereign funds that probably don't know the risk they bought is greater than the ratings indicate. The problem with opaquely distributed risk is that when it starts to manifest, nobody knows where it is. And the contagion mechanism isn't the credit directly — it's the uncertainty about who has what.

Leo Bentier