The biggest story in banking and real estate over the course of the last year has been home and commercial mortgages and what has been deemed “the lending crisis.” The recent recession we find ourselves in owes a lot to people who have become “upside down” on their mortgages – meaning that they owe more on their homes or other properties than they are worth.

How did this happen? The main culprit is a boom in real estate values which caused home and building prices to rise, coupled with easy credit given away by lenders to borrowers who were left in the lurch when real estate values dipped. The final piece of this “perfect storm” which led to a national and global financial crisis was the prevalence of ARM loans; variable rate mortgages which were given to borrowers who either didn’t understand them or purchased properties which they couldn’t afford once their low monthly mortgage payment grace period ended and their higher payment period began. Whether the government who encouraged and allowed these loans or the lenders who issued them are to blame is not as important as figuring out how to clean up the mess.

A recent policy change is aimed at alleviating some of this current crisis in mortgages, however. Federal bank regulators have recently issued guidelines to banks to keep loans on their books as “performing” even if the value of the properties associated with these loans are lower than the loan amounts. The number of these underwater real estate loans is enormous and the hope is that banks will restructure these loans rather than foreclose on them. Some critics say that this move, which is mainly directed at commercial loans, is only going to prolong the problem rather than solve it, though.

The recently released guidelines, issued by the Federal Deposit Insurance Corp.(FDIC), the Federal Reserve, and the Office of the Comptroller of the Currency, provides guidelines for financial institutions working with commercial property owners who are having difficulties with cash flow, lowered property values, or difficulties in selling or renting their properties. For these borrowers, the guidelines point out; restructuring is often in the best interest of both the lender and the borrower.

This is not a change in the current rules, but instead is described as a more explicit explanation of current ones. This clarification is being issued in response to a barrage of questions directed at federal agencies in recent months involving the skyrocketing number of problem loans. Regulators have shown concern, however, that increasing issues with commercial real estate might work against economic recovery if left unchecked and allowed to continue to rack up record amounts of losses under these new rule “clarifications.” Other experts, such as FDIC Chairman Sheila Bair, feel that reworking the terms of commercial loans could actually help banks to avoid further losses.

Whether you side with the detractors or the supporters of these new rules, a few grim facts are certain:

• About $770 billion of the $1.4 trillion commercial mortgages that will mature in the next five years are currently underwater.

• More than 106 banks have failed this year – the most since 1992.

Something had to be done to slow the downslide in the mortgage industry, and this recent change in policy could prove to be a wise move over the long term. If successful, these new guidelines should help all of the banks who are carrying the hundreds of billions of dollars worth of loans which are coming due but cannot be refinanced because the value of those properties have fallen below the loan amount. Many of these properties are still generating enough income to service their loans and therefore should stay on the books.

Despite this philosophical change, however, some still say that this practice of continuing commercial mortgages which are undervalued may make things worse in the long run by prolonging the problem, rather than confronting these problem loans as soon as possible before they grow worse. Only time will tell which approach is more prudent.

written by REI Circle (www.reicircle.com)