New York Fed Protects Bank of America From Big, Bad AIG

Just when investors thought the lawsuits over the shoddy mortgage loans and mortgage-backed securities plaguing Bank of America (NYSE: BAC  ) might soon become merely a bad memory, a nasty bit of news showed up. A recent article in The New York Times reports that last summer, the Federal Reserve Bank of New York, unbeknownst to almost everybody, absolved B of A of liability in some MBSes it sold to AIG (NYSE: AIG  ) , which were then purchased by the FRBNY.

Secret meetings, ongoing lawsuits
These securities were part of the AIG bailout, and they became one of the ingredients in the Maiden Lane II portfolio. If this sounds familiar, that's because these documents were aired in a New York courtroom as part of the lawsuit filed against the New York Fed in an effort to sustain its right to sue B of A over those shaky MBSes.

According to AIG's suit, however, the FRNBY somewhat mysteriously told Bank of America last December that AIG had sold its litigation rights along with the securities. Meanwhile, a 2011 lawsuit filed by the insurer against B of A regarding $10 billion of toxic MBSes -- $7 billion of which were tucked into Maiden Lane II -- is still pending.

For its part, Bank of America has asked a Los Angeles federal judge to dismiss AIG's claim, saying that the insurer "long ago signed away" litigation rights during the bailout. But AIG states that it never explicitly signed away those rights -- and as it turns out, "long ago" was actually last July.

A good deal for B of A?
Since the New York Fed sent a letter to AIG in October 2011 upholding the insurer's right to pursue claims on those securities, AIG seems to have a valid point. As the article point out, however, the FRBNY began telling B of A another story last December, releasing the bank of liability, while asking nothing in return. Why would the Fed make such a deal with the bank, knowing the pending litigation? Did the New York Fed also make promises to other banks such as Goldman Sachs (NYSE: GS  ) and JPMorgan Chase (NYSE: JPM  ) , which AIG may also be planning to sue? 

On the surface, this looks like a favorable outcome for Bank of America. Taking that $7 billion claim off the table should make investors happy and save the bank some cold, hard cash. After all, it was a very big deal in August 2011 when AIG first filed the $10 billion lawsuit, causing the bank's shares to tank until Warren Buffett stepped in with a $5 billion infusion to calm the waters.

But there was another element, as well. A ruckus ensued when it was discovered that the bank knew the lawsuit was coming, but never mentioned it in Securities and Exchange Commission filings or investor reports. This apparent lack of transparency seemed to upset investors concerned about these kinds of lawsuits, and it's not hard to understand why: How can investors know the extent of the risk if the bank doesn't divulge that information?

Here, again, there seems to be some skullduggery, just as B of A has begun to repair its reputation. Will this issue put the big guy's stock back in the doghouse, as investors wonder what else they haven't been told?

It remains to be seen whether or not the FRBNY actually had the authority to wave its magic wand in this manner. If it sticks, it could be good news for JPMorgan and Goldman, as well as B of A. If not, it could be better news for AIG.

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