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AIG seeks to sue mortgage banks

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American International Group and the Federal Reserve Bank of New York are apparently going to war.

The new development is spelled out in a lawsuit filed by AIG in New York state court that seeks to confirm that it has authority to sue mortgage banks that sold its subsidiaries virtually worthless mortgages whose failure to perform required AIG to seek a federal bailout.

It comes as the Financial Stability Oversight Council debates whether to designate AIG as systemically significant non-bank, a move that would keep it under the supervision of the Fed, with even more heightened capital requirements and restrictions.

AIG is apparently acting because the New York Federal Reserve Bank, which held the securities in a facility known as Maiden Lane II, last month reversed an earlier position and is now aligning itself with the banks that sold the securities backed by the underlying defective securities.

The suit was filed Friday in New York State Supreme Court, in Manhattan.

According to the lawsuit, AIG is suing because the Federal Reserve Bank of New York, which held the securities in a facility, has decided to reverse position and support the mortgage bankers instead of AIG.

The Fed, according to the lawsuit, had earlier allowed AIG to pursue the lawsuits even though the defective mortgages were contained in a facility partially funded by the NYFed.

According to the latest lawsuit, the Fed is now supporting the bankers by contending that AIG has lost its ability to recoup its losses from the issuers of the securities by turning them to the Fed.

Last month, however, the FRBNY publicly reversed itself and provided Bank of America, the successor to Countrywide Financial, with declarations from two FRBNY executives stating, among other things, that AIG transferred to Maiden Lane II through the APA all “litigation claims” relating to the RMBS that Maiden Lane II acquired.

The lawsuit filed Friday alleges that in declarations filed in the court hearing the AIG claims on the securities against Bank of America, one of the declarations further stated, in substance, that the FRBNY had terminated its correspondence with AIG following its receipt of AIG’s written statement that it retained any tort or Securities Act claims because the APA was clear regarding ownership of the RMBS-related claims, and the FRBNY did not wish to renegotiate its terms.

“Not only is that explanation at odds with how sophisticated counsel typically proceed in the face of a written assertion that is allegedly contrary to their position on a matter involving billions of dollars, it is undermined by the fact that the FedNY has now provided Bank of America with declarations from its officers for the very purpose of litigating the meaning of the APA,” the suit stated.

According to the lawsuit, Bank of America contends in current litigation undertaken by AIG regarding the defective mortgages that since AIG had ceded control of the securities by placing them in the so-called Maiden Lane II facility controlled by the NYFed, it had lost its ability to recoup its losses from Bank of America.

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“AIG’s filing relates to AIG’s ongoing litigation against Bank of America in which AIG is asserting that Bank of America defrauded AIG in connection with the sale of certain residential mortgage backed securities,” said James Ankner, a spokesman for AIG corporate.

Specifically, Ankner said, AIG “narrowly” seeks a declaration from the Court that a 2008 contract between AIG and ML II did not transfer to ML II AIG’s right to sue Bank of America and other financial institutions for the billions of dollars of damages they caused AIG and its shareholders in connection with the fraudulent sale of RMBS to AIG. 

“For the past 18 months, AIG has been pursuing these fraud claims against Bank of America and its affiliated entities,” Ankner said in explaining why AIG has taken the latest action.

The suit said specifically that AIG is suing “to eliminate damaging uncertainty recently and unjustifiably created by or on behalf of Maiden Lane II concerning AIG’s ownership of billions of dollars of fraud and other tort claims that exist against numerous financial institutions that made material misrepresentations and omissions in securitizing and marketing to AIG residential mortgage-backed securities between 2005 and 2007.”

The suit alleges that financial institutions that created and/or sold the RMBS provided offering materials that assured AIG that each mortgage loan underlying the RMBS met certain quality standards.

“In reality, the financial institutions, driven by a single-minded desire to increase their share of the lucrative RMBS market and the considerable fees generated by it, abandoned the stated underwriting guidelines, ignored the represented credit quality metrics, and packed the RMBS with thousands of defective mortgages,” the suit said.

“In 2008, when the defective loans experienced unprecedented rates of delinquency, default, and foreclosure, the performance and value of the RMBS plummeted, causing AIG and its subsidiaries great harm,” the suit charges.

The immediate action relates to a suit filed against Bank of America in August 2011. The Fed backed off from its plan to start selling off the securities in Maiden Lane II around that time because the market was not giving the securities a good reception. The market, however, has improved substantially, and the securities in Maiden Lane II were mostly sold off by the Fed in 2012. That’s because the Federal Reserve has made clear it will keep interest rates low for the foreseeable future and the securities offer a far above-market return. However, they are still only fetching about 30 to 50 cents on the dollar, according to an outside data firm that monitors this market.

The suit said AIG sought $10 billion from Bank of America, labeling it one of the “most blatant offenders.”  

The suit charges Bank of America and certain of its affiliates for fraudulent inducement, aiding and abetting fraudulent inducement, negligent misrepresentation, and violation of the Securities Act of 1933. Of the nearly $10 billion in damages AIG is seeking in the Bank of America suit, more than $7 billion relate to RMBS involving Bank of America that AIG later sold to Maiden Lane II.