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I turned out that lighttpd mod_proxy wants to get the whole response before it starts sending it back to client. A bug has been reported in their trac about it a long time ago.
I don't want to wait for ffmpeg to finish transcoding before the music starts streaming to my phone, so I tried stunnel.
kippo ~ # emerge -av stunnel
If you get errors emerging stunnel about groupadd switch -r not existing, you need to update sys-apps/shadow
kippo ~ # emerge -av shadow
Add your tunnel to /etc/stunnel/stunnel.conf
[subsonic] accept = 44300 connect = 10.10.10.10:4040
Start the daemon
kippo ~ # /etc/init.d/stunnel start
Open iSub and now the streaming starts right away. Yay.