American International Group and the Federal Reserve Bank of New York (FRBNY) are at odds concerning whether the insurer has authority to sue banks over virtually worthless mortgages they sold that drove AIG to seek a federal bailout.

The new development is spelled out in a lawsuit AIG filed Friday in the New York State Supreme Court, in Manhattan. 

The Fed had earlier allowed AIG to pursue the lawsuits against the banks even though the defective mortgages in question were contained in a facility known as Maiden Lane II (MLII), which is partially funded by the FRBNY, AIG alleges.

But the lawsuit says the Fed is now supporting the banks by contending that AIG lost its ability to recoup its losses through lawsuits when it turned the securities over to the Fed via MLII.

James Ankner, a spokesman for AIG corporate, says AIG is seeking a declaration from the court that the 2008 contract between AIG and ML II did not transfer to ML II AIG's right to sue Bank of America and other financial institutions for billions of dollars in damages they allegedly caused AIG and its shareholders in connection with the fraudulent sale of residential mortgage-backed securities (RMBS) to AIG. 

Ankner notes that the latest AIG action is part of ongoing litigation. “For the past 18 months, AIG has been pursuing these fraud claims against Bank of America and its affiliated entities,” he says.

AIG's underlying lawsuit alleges that financial institutions that created and/or sold the RMBS provided offering materials that assured AIG that each mortgage loan met certain quality standards.

“In reality, the financial institutions, driven by a single-minded desire to increase their share of the lucrative RMBS market and the considerable fees generated by it, abandoned the stated underwriting guidelines, ignored the represented credit quality metrics, and packed the RMBS with thousands of defective mortgages,” the suit says.

The suit notes that AIG is seeking $10 billion from BankAmerica, formerly Countrywide, labeling it one of the “most blatant offenders.”

AIG's disagreement with the Fed comes as the Financial Stability Oversight Council debates whether to designate the insurer as a systemically-significant non-bank, a move that would keep it under the supervision of the Fed, with even more heightened capital requirements and restrictions.