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New York Sets Hearing To Review Fraud Claims By Bond Insurers

Published Friday, 28th January 2011 01:48 am - © 2011 Dow Jones

By Katy Burne


NEW YORK -(Dow Jones)- New York State lawmakers have scheduled a public hearing next month to gather information on whether certain banks intentionally defrauded bond insurers about the creditworthiness of subprime-mortgage-backed securities.

Leading the charge is Joseph Morelle, member of the New York State Assembly and chairman of its standing committee on insurance. He held a hearing in mid-December on the demise of those so-called monoline insurers at the hands of mortgage-related deals.

"We don't want to get ahead of ourselves," said Morelle in an interview Thursday. "But if there was an effort to mislead people underwriting these insurance policies, that is obviously problematic."

So far, the insurance committee is calling on bankers, insurance executives and other expert witnesses to testify voluntarily at the Feb. 16 hearing in New York City. It does have the power to subpoena firms, however--something it has used infrequently in the past.

The list of invitees has not yet been finalized, according to Morelle's office.

The hearing puts a new spin on the dispute between banks and monoline insurers. Up to now, banks have agreed to repurchase certain securities where they were not represented properly in documentation, and in some cases have compensated investors.

Bank of America Corp. (BAC) in particular has been faulted for the way it represented certain securities. Earlier this month, the firm wrote a $3 billion check to settle claims from government-sponsored entities Fannie Mae and Freddie Mac in connection with mortgages originated by Countrywide Financial Corp, which BofA purchased in 2008.

BofA is dealing with private investors and monolines separately. The firm increased its capital reserves at the end of the fourth quarter to $5.5 billion, partly to set aside an additional $1.1 billion for those claims. It added that future claims could leave it on the hook for another $7-10 billion--the upper range of its forecast.

New York lawmakers' decision to up the ante could discredit even that estimate. Morelle said while the committee is part of the legislature and has no law-enforcement powers, it could take the matter up with the State Attorney General and the New York State Insurance Department.

The Insurance Department is already considering a formal investigation into whether banks committed insurance fraud by misrepresenting material facts on structured-finance deals, as first reported by the Wall Street Journal last month. It is acting on a series of referrals from different monolines.

"If someone did something akin to calling in insurance when their house was already on fire, and didn't acknowledge their house was already on fire, that's a problem," said Morelle.

A key part of the monolines' case is proving that the banks had intent to defraud them. Prosecutors would need to show that bankers who created the residential mortgage-backed securities knew they were violating their own underwriting guidelines, and then purposefully disguised the risks when passing the securities on to be insured.

Insurance fraud is a criminal offense punishable by significant fines and/or imprisonment.

-By Katy Burne, Dow Jones Newswires; 212-416-3084;

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