Systemic Signal in the Prime RBMS Markets?

Recently, one of my investment advisors brought to my attention the sixth month drop in the PrimeX Index ARM 2.  He wondered if this was going to create a problem in the markets? I asked him how he stumbled across this item, and he pointed me to Zero Hedge's post on the topic. Today, there's been a second post.

What does all of this mean? What is the PrimeX index?

As far as I can tell, PrimeX (created by Markit) is a CDS built up from tranches of AAA (Prime) Residential Mortgage Backed Securities (RMBS).  There are restrictions on the type of RMBSs that can into a tranch destined for this index.  These include first mortgage, high FICO (730+), LTV below 73%, owner occupied (85-90%), among others.  You can find a summary of the types on page 12 here and details in the Prime X Rules Documentation here (Section 3.2 on pages 3-4).

The CDS (Credit Default Swap) provides insurance for holders of Mortgage Backed Securities, allowing those holders to lay off risk to someone else (buy the CDS) or allow those betting against RMBS (betting on defaults) to place their bets (sell the CDS).

Today, the Prime X indexes dropped 1-2% each.  Here's today's data.

11-Oct-11 Overview
Index	Series	Coupon	RED ID	Price	Factor
PRIMEX.ARM.1	1	0.0442	7B579YAA3	99.812	0.408221747
PRIMEX.ARM.2	2	0.0458	7B579YAB1	89.042	0.436699618
PRIMEX.FRM.1	1	0.0442	7B57AKAA1	103.833	0.468172369
PRIMEX.FRM.2	2	0.0458	7B57AKAB9	93.875	0.488982221

Yesterday, these prices were 100%+, 90%+, 104%+, 94%+.

For another data point, here's an article in which Barclays recommends buying MREITs because they are cheap.  Meanwhile, you have Zero Hedge's comment about a Barclays trader blasting Bloomberg with a message about not understanding "the sudden hate for the sector" and recommending some buying.  So, Barclays seems to have a uniform message about pushing RMBS in various capacities (on the Buy side of CDS and on the Buy side of MREITs), or at least, as Tyler Durden of Zero Hedge puts it, they are unable to pinpoint what others may have already.

So, the downward trend continues in insurance designed to hedge against RMBS risk.

Is this a systemic signal for the housing market, especially in the Prime space?  Should we expect another shock in the next 3-6 months?

Also, in my internet hunting around, I found an article by Gillian Tett of the Financial Times written back in 2006 and about "The Dream Machine: The Invention of Credit Derivatives".  It contains statements about how derivatives should soften financial shocks as they spread risk (Ha, that didn't work).  The most interesting part of the article (it is long) was the discussion of how the banks justified derivative use, as offsetting risk on their books, thereby, allowing higher leverage ("calorie-free chocolate: almost too good to be true").

Here's the thing, based upon descriptions in that article and thinking about issues raised here, I am wondering how much of the Prime Mortgage risk was pulled back into the banks and/or won't stay offloaded because the CDS market will fail.

Are we set for another drop after all?