Yesterday, Bank of America finally took a painful step regarding their mortgage portfolio. They realized that they are going to have to write down principal balances on some of them. B of A is the first “too big to fail” bank to take this step although some smaller institutions have already started doing this.

Now, don’t pick up the phone to pester Customer Service about it just yet. This program is only open to a limited number of qualifying homeowners who have option ARM, 2-year hybrid, or certain types subprime mortgages. Most of these were in fact written by Countrywide. This is estimated to be only about 45,000 loans total.

One interesting detail is that this plan was developed in cooperation with the Commonwealth of Massachusetts (did you know that Massachusetts wasn’t just a “state”?). Was there perhaps some legal arm-twisting? Will homeowners outside Massachusetts be able to take advantage of this program?

Right now, B of A has some huge image problems when it comes to distressed properties: it’s difficult to make a short sale work, and sometimes there are difficulties after closing; they have a reputation for foreclosing on the wrong address; I still see many listings that require pre-approval with B of A before you are allowed to place a purchase offer on one of their properties (right, because they will be so much better a judge of this buyer’s ability to pay than they were of the previous owner); they are also one of the culprit banks I see destroying neighborhood housing values by pricing foreclosures at absurdly low levels. In short, they are one of the reasons Alan Greenspan calls our housing prices “fragile”.

The bottom line: I hope my fears are unfounded and that Bank of America does this right. More, I hope they realize that they can take care of a lot of future balance sheet pain by writing down principal widely in areas that have been hard hit by housing value declines.