Bank of America Corp has agreed to forgive some bad mortgage loans and the government is pushing other lenders to follow suit, but on a scale too small to make much of a dent in the nation's huge pile of bad debt.

Banks want the public relations gains associated with being kind to borrowers, but the losses that would result from wider loan writedowns and loan forgiveness would be devastating to most lenders.

Banks are going to be very careful in how they roll this out, said Matt Burnell, a bank stock analyst at Wells Fargo Securities LLC.

Right now, lenders are focusing on lowering principal payments for the borrowers in the biggest trouble -- those facing ballooning monthly payments as their mortgages reset, who have very little equity in their home, and whose home values have fallen well below the value of the loans.

These borrowers are among the most likely to walk away unless they get some sort of relief. But these borrowers are relatively few in number. Bank of America estimates it will reduce principal on about 45,000 loans.

That's a small number compared with the roughly 12 million U.S. mortgages that are underwater and may enter foreclosure in the next several years, according to estimates by Amherst Securities Group LP in a March 26 research note.

The overall mortgages that may face foreclosure represent about a fifth of home borrowers, Amherst said.

It's just too narrowly constrained to make a big impact, said Dan Immergluck, associate professor at the Georgia Institute of Technology, who specializes in housing finance. I don't want to be too pessimistic, but this is only going to affect a small set of folks.

Lenders have until now mostly modified mortgages through steps like lowering monthly payments and tacking on more principal to the loan. Those kinds of modifications can help banks avoid some painful losses, analysts said.

Lenders modified about 594,095 mortgages in fourth quarter. Most of those modifications were alterations to borrowers' monthly payments.

The entire U.S. mortgage market encompasses $10.8 trillion in debt outstanding, according to a Federal Reserve flow of funds report for the fourth quarter of 2009.

Bank of America announced a plan to cut principal on problem mortgages last week, and the Obama administration announced a $14 billion initiative to help other banks take similar steps.

But these programs are tiny compared to the broader mortgage market, because lenders fear if too many loan values are cut, every borrower could demand a break, analysts said.

This is still rankling some people who are saying 'Why does Joe Blow down the street get help with his principal and I don't?' said Wells Fargo's Burnell.

Bank of America has already seen complaints about its program, according to published reports.

Bank analyst Thomas Brown posted an open letter from an unnamed Bank of America customer to Chief Executive Brian Moynihan on the Web site bankstocks.com.

The letter states the customer will no longer do business with the bank, calling principal forgiveness a despicable solution that rewards irresponsible financial behavior.

LAST RESORT

In the most extreme cases, principal reduction may be the cheapest alternative for the bank, preventing a costly foreclosure.

Wells Fargo & Co (WFC.N), another major U.S. home lender, has only allowed principal reductions in its so-called Pick A Payment mortgage portfolio, acquired as part of the 2008 Wachovia Corp buyout.

We believe we have to judiciously use principal forgiveness to be fair to all American homeowners, said Teri Schrettenbrunner, spokeswoman for Wells Fargo & Co.

The San Francisco-based bank modified 52,600 Pick A Payment loans, with principal reductions totaling $2.6 billion.

JPMorgan Chase & Co, another U.S. home loan giant and rival for Wells Fargo and Bank of America, has sought to reduce monthly payments for customers -- the typical mortgage modification route in the wake of the housing crisis -- rather than cut principal.

A JPMorgan spokesman declined to comment.

But no other banks have announced a mortgage principal reduction program in the wake of Bank of America's Wednesday statement.

Under Bank of America's program, the average principal reduction is projected to be $60,000 to $65,000.

If all 45,000 eligible customers take part in the program, mortgage principal would be reduced by $3 billion.

Anything you can do to slow down the glut of houses in foreclosure is a good thing, said Jefferson Harralson, a Keefe, Bruyette & Woods analyst. It does make sense to make some unusual concessions.

(Additional reporting by Elinor Comlay in New York; Editing by Gary Hill)

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