THERE is nothing sublime about the subprime mortgage market. Tales of woe regarding the US housing market are in the news frequently these days. As reported by Bloomberg last week, unsold homes (inventory) in the United States are at the highest level ever, some 4.4 million.The statistics might be derived from those that are selling these homes because they can no longer afford the mortgage, or the bankruptcy receiver is liquidating property is in default, or the family needs to relocate.

The reason is irrelevant. Real estate in some parts of the US may be offered at fire sale prices, but currently there are fewer buyers these days qualifying for mortgages. Finance institutions of all types have had to tighten their information gathering and credit requirements, primarily imposed by defaults in the sub-prime mortgage market.

On Wall Street, firms such as Bear Stearns, are wrestling with coverage of huge investment losses due to wrong way bets on this market. Yet, they are only one of thousands of participants in the US mortgage market, estimated in the trillions of dollars. While these are interesting news stories for residents of Bermuda, it would hardly appear to affect anyone here, would it?

How does a mortgage market operate and what is a sub-prime loan?

To understand a little of mortgage financing and securitisation, we should compare the mortgage process between the two countries. There are differences.

Bermuda first: You are your family have reached an important milestone. You have been looking for a house for several years. You've pooled your money for a small down payment; filled out your mortgage application; provided all of the income, employer and good credit verifications.

Your job has not been going well lately, but you still think you will buy that cool car sitting on the auto lot — to celebrate right after you get your house, but you aren't going to put that on your credit history.

Today is House Reality Day. Congratulations says your friendly loan officer! Welcome to Sea Shore Bank.

"We have finished our credit approval process on your personal credit history and we are willing to loan you 95 percent of the appraised value of your home.

"Here is your adjustable-rate mortgage agreement, your payment plan, your check to the attorney handling the closing, and the proverbial keys to a home of your own.

"On signing this contract, you agree to our loan conditions, including origination fees and closing costs estimated at four to five percent of the loan. You will make your payments on time each month. Late payments will automatically be assessed a penalty, except for extenuating circumstances.

"Any problems with meeting your obligation should be brought to our attention immediately, so that we can work with you for quick resolution."

You feel great knowing that you will have a long relationship with your mortgage officer; she treats you like a friend! In a perfect world, this is the finest level of service an institution can provide.>

United States: John and Lynn Smith (our pretend couple) couple decide to purchase a home. They shop various web-site and physical mortgage companies (or in this incredibly competitive market an independent mortgage broker) to receive pre-approval. They finally settle on Street Smart Strategy Mortgages because the broker requests minimum credit, income and expense documentation while promising to turn the process in a day.

For starters, the couple has less-than-solid work history: he is a self-employed finish carpenter, starting a small construction business; she has on surface appearances, a decent bookkeeping position, although persistent rumours within her company indicate her job may be "offshored".

The third-party verification forms go out, mailed to friends (also with small businesses) who obligingly sign that the income stated on the application is indeed correct. What is carefully omitted from the application are dunning letters from US Internal Revenue Service, levying penalties and interest for back taxes owed, and a couple of maxed-out credit cards.

They fall in love with a great two-storey, three bedroom and bath en suite home; make an offer that is accepted by the seller, subject to mortgage financing in place. They are approved but are given a higher than usual mortgage interest rate due to the shaky credit rating.

The title search and sales closing (with no closing costs or origination fees) happens in a matter of days. They are now proud owners of a home, but those monthly payments are going to be a hurdle even in the best of times.

The broker notes that their documentation is a bit sketchy, but that "they are good for the money". Their loan package receives a mediocre credit score and is placed in the high risk sub-prime category.

They get the keys; their broker has a big commission pay-day; their loan is bundled with the rest of the Street Smart Strategies Mortgages for the week and sold into the secondary mortgage market in some form of another security .

And the Difference is: In Bermuda, your mortgage remains in the banking house, the relationship and the service domiciled right there for the life of your loan.

In the United States, your loan may leave the bank that day, owned by investors in Eastern Wyoming. Minimal service is provided long distance by a voice in India.

No one knows who you are; many investors own a piece of your loan. They care only about maintaining cash flow and keeping non-performing loans from drilling a hole in their profit picture. Remotely, they will foreclose instantly on non-compliance.

Relatively, there are millions of securities and transactions traded every day in capital markets that leverage off bundled mortgages; derivatives, mutual funds, pension funds, hedge funds, real estate investment trusts (REITS) and so on.

And that is the difference in sophisticated markets. Mortgages are not a contract between the local bank and the person(s) contracting for the mortgage.

Mortgages are converted like a frog into a prince into an extremely liquid, marketable security with one very important caveat; the underlying value of this new security is derived from the value of the original mortgage.

Next week: Sliced, diced, drawn, and quartered. Personal individual mortgages becomes unrecognisable, hard to value, and extreme liquid as they are layered into various new security offerings.

Note: This is a hypothetical picture of this very complex market. Each financial institution may handle their mortgage loan portfolio or price it differently than stated. This article is not intended to be a complex in-depth quantification of financial securitisation, rather a general overview. Capital markets evolve and change rapidly, there may even be newer more innovative products sold as you read this.

Martha Harris Myron CPA CFP is a Senior Wealth Manager at Argus Financial Limited. She specializes in investment advisory services with objective comprehensive financial solutions for private clients planning for retirement and lifestyle transitions. DirectLine: 294 5709 Confidential email can be directed to marthamyron@northrock.bm

The article expresses the opinion of the author alone. Under no circumstances is the content of this article to be taken as specific individual investment advice, nor as a recommendation to buy/ sell any investment product. The Editor of the Royal Gazette has final right of approval over headlines, content, and length/brevity of article.