NEW YORK (Reuters) - A Manhattan judge indicated Monday he was "troubled" by how the U.S. government applied a rarely used law in a suit against Bank of America Corp (BAC.N) over the sale of toxic mortgages to Fannie Mae FNMA.OB and Freddie Mac FMCC.OB.
The hearing before U.S. District Judge Jed Rakoff marked a challenge of the U.S. Department of Justice's bid to bring fraud lawsuits against Wall Street banks under a powerful law enacted following the savings and loan scandals of the 1980s.
Rakoff held off on a ruling, saying he would issue a decision by May 13 on whether to dismiss the lawsuit, which blames Bank of America for more than $1 billion in losses incurred by Fannie and Freddie.
The federal government seized Fannie and Freddie and placed them into conservatorship in 2008.
The lawsuit, filed in October, accuses Bank of America of engaging in a scheme to defraud Fannie and Freddie through a program started at the former Countrywide Financial Corp, which the bank acquired in 2008.
That program, called "Hustle," was intended to speed up the processing of mortgages by cutting protections against fraud, resulting in problem loans nine times the industry standard, the Justice Department said.
The lawsuit relies in part on the Financial Institutional Reform, Recovery and Enforcement Act of 1989 (FIRREA), which allows the government to seek civil penalties against anyone who commits a fraud "affecting a federally insured financial institution."
The law has a low burden of proof, strong subpoena power and a long 10-year statute of limitations.
But in a trio of cases, banks including Bank of America, Bank of New York Mellon Corp (BK.N) and Wells Fargo & Co (WFC.N) have argued that the law cannot apply when the only financial institution affected by a fraud was the institution that allegedly committed the fraud.
U.S. District Judge Lewis Kaplan rejected that argument on Wednesday in allowing the Justice Department to move forward in lawsuit accusing Bank of New York Mellon of overcharging clients for trading currencies.
Kannon Shanmugam, a lawyer for Bank of America, urged Rakoff not to adopt Kaplan's reasoning. The "most natural reading" of FIRREA was that the fraud had to be committed by someone other than the bank itself, he said.
Rakoff, while saying he was "not particularly overwhelmed" by a different argument Shanmugam was making related to the fraud claims, appeared open to the lawyer's view on FIRREA.
"I'm more troubled, not withstanding Judge Kaplan's opinion, by the affecting argument," Rakoff said.
The lawsuit additionally asserts claims under the False Claims Act against Bank of America, which the bank is also seeking to dismiss. Rebecca Mairone, a former Countrywide executive, has also moved for dismissal.
Lawrence Grayson, a spokesman for Bank of America, declined comment. A spokeswoman for Manhattan U.S. Attorney Preet Bharara, whose office is handling the case, did not respond to a request for comment.
The case is U.S. ex rel. O'Donnell v. Bank of America Corp et al, U.S. District Court, Southern District of New York, No. 12-01422.
Editing by Edmund Klamann