The biggest U.S. banks will provide about $25 billion in relief to distressed homeowners, as state and federal officials hold lenders responsible for taking illegal shortcuts during foreclosures and for other deceptive practices.
The settlement announced on Thursday seals more than a year of negotiations after evidence emerged late in 2010 that banks robosigned thousands of foreclosure documents without properly reviewing paperwork.
The Obama administration hopes the settlement will open a new avenue for housing relief because it will force the banks to write down mortgages at a time when roughly one in four borrowers owe more on their mortgage than their home is worth.
Principal reductions have been done on a voluntary basis by banks, often on a limited basis.
The deal resolves civil government lawsuits over faulty foreclosures and servicing misconduct.
The banks involved in the deal are Bank of America Corp, Wells Fargo & Co, JPMorgan Chase & Co, Citigroup Inc and Ally Financial Inc.
Although the deal with 49 states is the largest joint federal-state settlement ever obtained, the amount is miniscule compared to the declines in home values and the banks still face a host of other mortgage-related lawsuits.
"The bottom line about this settlement, is it's okay, it's a step forward, it's a step in the right direction. But let's not kid ourselves, there's a hell of a lot more that needs to be done," said Ira Rheingold, executive director of the National Association of Consumer Advocates.
The deal does little to ease bank investor fears, industry analysts said.
"We believe any initial euphoria over the deal will quickly fade as investors realize the flood of additional mortgage-related litigation that the major banks face," said Guggenheim Partners analyst Jaret Seiberg in a note on Thursday.
The U.S. Justice Department, the Department of Housing and Urban Development, and a handful of state attorneys general announced the deal at a news conference in Washington. Some large states, such as California and New York, joined at the last minute.
"This historic settlement will provide immediate relief to homeowners - forcing banks to reduce the principal balance on many loans, refinance loans for underwater borrowers, and pay billions of dollars to states and consumers," said HUD Secretary Shaun Donovan.