Yet another insurance company has sued Bank of America over soured mortgage-backed securities. This time, Allstate brought the lawsuit, alleging that they were misled by Countrywide (now part of BofA) into believing they were purchasing safe securities backed by quality residential loans.

Allstate said that starting in 2003, Countrywide quietly decided to boost market share by approving any mortgage product that a competitor was willing to offer, in a “proverbial race to the bottom.” It said Countrywide then passed on the added risks to investors who bought debt backed by the mortgages.

“Defendants knew the loans offloaded onto Allstate were a toxic mix of loans given to borrowers that could not afford the properties, and thus were highly likely to default,” said the 150-page complaint filed Monday in Manhattan federal court.

Among the defendants are several former Countrywide officials, including long-time Chief Executive Angelo Mozilo.

Allstate is asking for various damages, but basically wants Bank of America to repurchase the securities. This is part of a wave of repurchase asks from insurers, institutional investors, the GSEs and even the Federal Reserve Bank of New York. Earlier this month, the monoline MBIA won an evidence ruling against BofA that will allow them to sample $21 billion dollars in mortgage backed securities they insured, which they want the bank to take back. There are at least a dozen similar lawsuits from insurance companies. In addition, the SEC has subpoenaed several banks on their securitization practices, which is at the heart of the repurchase issue.

The amount of repurchases in this lawsuit, around $700 million dollars, is small. But I’m going to agree with Matt Taibbi on this. At some point, one of these lawsuits will break through – either by investors, foreclosure victims, insurers, or someone else – and this will open the floodgates that could drop one of the major US banks.

I’d bet just about anything that one or more of the big banks — Bank of America, Chase, Wells Fargo, etc. — will be ruined or near-ruined by class-action lawsuits brought either by foreclosure plaintiffs or by MBS investors (there are a number of these lawsuits in the pipe now). The first ruling that declares one of these banks liable for the losses suffered by investors who bought these banks’ fraudulently-packaged mortgage-backed securities is going to send shock waves through the industry.

We saw how during the first wave of the financial crisis, bad news had a tendency to metastasize, compounding the woes of a Bear Stearns or a Lehman Brothers. This is going to get bad for at least one bank, and the most likely candidate is BofA.

David Dayen

David Dayen