AIG, Countrywide in Legal Feud Over Insurance for Subprime Loans

An AIG unit and Countrywide Financial Corp., now part of Bank of America Corp., have sued each other, alleging breach of contract, in a dispute over insurance losses for subprime mortgage loans now in default.

American International Group Inc.’s United Guaranty Mortgage Indemnity Co. sued Countrywide last Thursday in a California federal court, contending that the lender had misrepresented risks tied to more than $1 billion of mortgage loans that United Guaranty insured.

The case was filed a day after Countrywide sued United Guaranty in California state court in Los Angeles. Countrywide said United Guaranty was trying to get out of its obligations to provide insurance coverage.

United Guaranty provides mortgage insurance, which covers lenders in case a borrower defaults on a loan.

United Guaranty said in its court papers that unlike the traditional use of mortgage insurance, used to facilitate home purchases by responsible borrowers, Countrywide wanted coverage to increase the credit rating of its mortgage-backed securities offerings.

It said Countrywide traded on a long-standing relationship between the two companies to induce it to insure loans it says were too risky and not issued according to proper underwriting standards. It says it has already paid out insurance claims of more than $30 million tied to the Countrywide loans and is exposed to additional claims of “several hundred million dollars more.”

In its lawsuit, Countrywide said United Guaranty “reaped hundreds of millions of dollars” when the real estate market was hot but was now refusing to pay losses on borrowers’ loans as required.

United Guaranty now “faces the reality of steep financial losses because of a significant economic downturn and has announced its unilateral refusal to pay on much of the insurance it sold because it believes it has already paid too much,” the Countrywide lawsuit said.

AIG has received $180 billion in government aid after racking up large losses on a financial product unit’s bets on toxic mortgage assets that triggered credit rating cuts and collateral demands that the insurer could not meet.

AIG is at the center of a political storm over controversial bonuses paid to executives amid the bailout.

In its lawsuit, the AIG division also sued the Bank of New York Trust Co, a trustee for the mortgage-backed securities formed by Countrywide.

A Bank of America spokeswoman declined to comment on the litigation on Friday. The bank bought Countrywide, once the largest U.S. mortgage lender, for about $4 billion in stock last July as the lender’s risky subprime mortgage loan business began to fail.

A spokesman for Bank of New York Trust, part of Bank of New York Mellon Corp, also declined to comment.

An AIG spokesman said Countrywide made misrepresentations and did not follow appropriate underwriting standards, and as a result “exposed us to claims we would not have had to pay out. Now we want the court to order them to make us whole.”

(Reporting by Martha Graybow, editing by Gerald E. McCormick and Tim Dobbyn)