Dear FDIC: I Want a Better Mortgage, Too

In real estate, you typically see cycles between buyer's markets and seller's markets. But the credit crunch has brought a new term to the forefront: a borrower's market.

The Federal Deposit Insurance Corporation, which is responsible for insuring bank deposits across the country, announced yesterday that thousands of IndyMac borrowers who are delinquent or in default on their mortgage loans could expect to see their loan terms modified in the near future. According to the FDIC, the modifications are designed both "to achieve affordable and sustainable mortgage payments for borrowers and increase the value of distressed mortgages by rehabilitating them into performing loans."

As a homeowner, that sounds like a nice deal to me. Sign me up.

So much for fiscal responsibility
But no, I won't qualify for this help, and you probably won't either. In order to get help from the FDIC -- help that as taxpayers, you and I are paying for -- two things have to be true:

• Borrowers have to have overextended themselves on their mortgage loans, most likely by either pulling out too much of their equity via refinancing or by getting burned by an adjustable-rate mortgage.
• The bank where the loan was taken has to have been so badly mismanaged that it gets taken over by the FDIC.

Talk about a strange set of incentives. You don't just get rewarded for being personally irresponsible; you also benefit when your bank acts irresponsibly.

A sweet deal for borrowers
Now this isn't the only case in which mortgage borrowers have seen their loans modified favorably. Since last year, mortgage lenders with high concentrations of loans in hard-hit areas, including Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC), Washington Mutual (NYSE:WM), and Countrywide Financial, have been adjusting loan terms to give borrowers a better chance at paying them off.

But the terms on the FDIC's modifications are pretty nice. Loan rates will be capped at the going rate for fully conforming loans -- currently 6.5%. Given that most of these borrowers couldn't dream of getting such a mortgage right now, this is a great deal for them.

Nevertheless, if that rate reduction isn't enough to make the mortgage affordable for a given borrower, then an even sweeter deal is available. The FDIC can offer an even lower rate for up to five years, which will then slowly adjust back upward to that 6.5% rate.

The lesser of two evils
Although the modifications represent a windfall for troubled borrowers, the FDIC is making the best of a bad lot. As FDIC Chair Sheila Bair explained in comments about the program, the FDIC has recovered less than a third of book value on nonperforming loans, while recoveries on performing loans have been much higher, at over 87%. Clearly, there's plenty of incentive to make every effort to turn bad loans into good ones -- or at least ones where homeowners can actually afford their payments.

It's all part of the painful process of deleveraging the economy. For investment in housing, that process promises to be long and drawn-out, involving give and take among borrowers, financial institutions, and the federal government. The main question for investors, however, is whether the trend toward less leverage will spread further beyond the financial industry. Look at some non-financial companies with high debt-to-equity ratios:

Source: Motley Fool CAPS.

As Motley Fool Inside Value lead analyst Philip Durell has explained, the debt-to-equity ratio isn't always a perfect measure of whether a company is overleveraged. But in general, with debt a necessary component of business operations throughout the economy, an already iffy business environment can ill afford to see contraction in corporate lending capacity. With many banks already straining to raise needed capital, however, leverage remains a threat to future economic growth.

For more on the housing crisis, read about:

• Why it's still going to get worse.
• How one stock guru predicted the mortgage crisis.
• What you can do with your own mortgage.