Bond insurer MBIA Inc. (NYSE:MBI) had filed six 'causes of action' against Merrill Lynch (NYSE:BAC) in reference to complicated debt securities the firm had insured on behalf of Merrill, and New York State Supreme Court Justice Bernard Fried has dismissed five out of the six claims.
The one charge MBIA will be allowed to go forward on is for breach of contract, where the judge also said they could seek damages for.
The breach of contract points at the wrapped notes which were alleged to be AAA rated. The judge said, "Plaintiffs may claim that the wrapped notes were not qualified to be AAA rated, as promised, regardless of the label they carried, as a claim for breach of contract."
The insured securities were collateralized debt obligations (CDOs), which had numerous bad mortgages underlying the bond created through them, which while rated AAA, weren't back up with mortgages which warranted the AAA rating, the reason for the lawsuit.
MBIA insured about $5.7 billion in guarantees for the CDOs, which they stand to lose several hundred million as a consequence.
The lawsuit by MBIA sought to have a number of the credit default swaps and other insurance contracts related to them voided.
This could become a big distraction in the industry, and a costly one if MBIA wins the breach of contract suit with hefty damages, as most giant banks were offering these, and the underlying mortgages were overall very risky ones, and what is really on trial is whether the bonds created from the mortgage were awarded a AAA rating in a way to hide that weakness.
If MBIA wins the case in that regard, it'll set a precedent that will cost Merrill Lynch and others a lot of money.
The views expressed are the subjective opinion of the article's author and not of FinancialAdvisory.com
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