Massive numbers of foreclosures will reduce the actual, not just the projected, income of lenders. That would have pretty drastic effects of its own.
I agree. It would cause significant pain and a lot of smaller banks would have to give up the ghost and sell their portfolios to better capitalized competitors.
But the best method would be for better-capitalized banks to assess each loan and revalue it, rather than the government decreeing an entire class of lenders absolved from the terms of their contract.