Panic is sweeping the subprime mortgage sector and threatening to move up the food chain to larger integrated banks, after the bankruptcy of 22 lenders over the last two months.

The real panic began in February when Britain’s largest bank by market value, hsbc, announced that it had fired the head of its North American operations after its bad-mortgage-related debt rose to $6.8 billion and that it was setting aside a total of $10.5 billion to cover U. S. bad home loans.

The fear then intensified when New Century Financial, the second biggest subprime lender in America, failed. The crash seemed to catch almost everyone by surprise, including banking giant Goldman Sachs, which had extended New Century Financial’s line of credit, set to expire on February 15, to May 14 even after New Century Financial warned that it would have to restate its financial filings for the first three quarters of 2006.

New Century Financial, which owed $23 billion to lenders, watched its stock plummet from $66 to its current rate near zero; a plunge that was only quickened when the New York Stock Exchange halted trading of its shares in early March.

California’s ResMae Mortgage has now also filed for bankruptcy as $7.7 billion worth of defaulting mortgages finally took its toll on the lender, while San Diego’s Accredited Home Lenders has warned that bad debts are becoming a rising percentage of its portfolio.

Meanwhile, Washington Mutual, the nation’s largest savings and loan, told analysts that its subprime loan portfolio was performing “exceedingly poorly” and would significantly affect its earnings.

“We believe we are in the early stage of a correction in this market and that the market will eventually implode,” said Paulson & Co., a New York-based fund that manages $11 billion.

What does this subprime fallout mean for the average homeowner or purchaser? “Essentially the subprime mortgage industry—which lends to consumers with credit issues—is gone,” and those lenders that remain are tightening their lending standards, says msn Money’s Bill Fleckenstein.

In other words, a whole segment of the U.S. populace will no longer qualify for home loans.

But the damage may not just be contained to the subprime sector. According to Fleckenstein, “Alt A lenders”—companies that lend to people one step above “subprime”—will be the next section within the mortgage industry to collapse.

Taken together, Fleckenstein says that subprime and Alt A lending comprises approximately 40 percent of the market.

Any ideas about what happens to housing demand when 40 percent of borrowers can no longer qualify to purchase homes? For starters, a good guess would be that the number of home sales will also drop by something near 40 percent.

If 40 percent sounds drastic, consider that new home sales had already dropped 11 percent and 20.1 percent from 2006 in December and January respectively—and that was before this subprime meltdown began.

But it is not just home sales that will be affected.

As demand slows, expect home valuations to fall. “Real-estate prices will go down 40-50 percent in bubble areas,” says commodities guru Jim Rogers. “There will be massive defaults. This time it’ll be worse because we haven’t had this kind of speculative buying in U.S. history.”

This is very bad news for the U.S. economy. As former Federal Reserve Bank Chairman Alan Greenspan warned on March 15, “[I]f [home] prices go down, we will have problems.” He also said he expects subprime mortgage defaults to ripple through the economy.

The housing market and the related construction industry is one of the biggest, if not the biggest driver of the economy. The ability of “anybody with a pulse” (and probably their dog too) to get a loan is what drove the real-estate market. The ability of people to refinance and cash-out home equity also fueled consumer spending and the economy. But now a huge segment of prospective home buyers can no longer qualify for a mortgage to purchase a home, and home prices are stagnating and falling in many areas.

“It’s going to be a disaster for many people who don’t have a clue about what happens when a real-estate bubble pops,” said Rogers.

Think of this as “the leading edge of the storm,” says Lou Ranieri, who is considered by some to be the father of the mortgage bond market. “If you think this is bad, imagine what it’s going to be like in the middle of the crisis.”

For information on how to prepare for the coming financial storm, read “Storm-Proof Your Financial House.”