Pity poor MBIA Corp. (NYS: MBI) , the sickly bond insurer whose high-profile fight with Bank of America (NYS: BAC) over crisis-era mortgage debt is turning into a classic case of one-upsmanship -- with the much stronger B of A looking a little like a bully as it makes a play for the insurer's outstanding debt in an effort to foil its bid to save itself from bankruptcy.

A premier toxic-loan insurer
In the beginning, MBIA was a simple municipal bond insurer. During the salad days of Wall Street, however, MBIA insured the heck out of subprime mortgage products for many of the biggest banks, but was then downgraded by both Standard and Poor's and Moody's, according to Bloomberg. This effectively took the wind out of its sails and left MBIA in the position of not being able to continue on with its muni business. The company tried to cleave itself in two in an effort to avoid total annihilation by separating the muni arm from the mortgage insurance section, as the collateralized debt obligations they sold on mortgage backed securities began to come due when the MBSes self-destructed.

Several banks, including B of A, sued MBIA over the 2009 split, noticing that such a ploy might very well prevent the insurer from paying up when the piper came calling. In the intervening years, Wall Street big boys such as Morgan Stanley  (NYS: MS) and UBS   (NYS: UBS) have settled with MBIA, receiving money in exchange for promises not to pursue insurance claims against the company. Bank of America, in contrast, has decided to put the insurer's feet to the fire.


B of A and MBIA have been in settlement talks on and off for some time. Nothing has been resolved, however, and the insurer has sued the bank over the quality of the mortgages that it insured in the form of MBSes, upon which it was forced to pay out. Without that money from B of A, MBIA will be in deep trouble, since claims on policies against commercial mortgage backed bonds are coming due in the near future.

But B of A doesn't want to pay. In addition, it is suing the insurer to get back the money it claims MBIA owes it for the insurance on the toxic securities. And now, the bank has offered to buy up as much as it can of MBIA's outstanding debt in an effort to prevent bondholders from accepting new terms that would protect the parent company from bankruptcy if regulators take over its Insurance arm.

Who will blink first?
In this battle, it looks as if B of A may emerge victorious. MBIA is in a weakened position, having paid out billions in settlements with other banks as well as millions more in investor lawsuits. Investors apparently saw the threat as well, sending MBIA's stock plunging. It's hard to blame the bank for wanting to line up with other creditors in the event of a bankruptcy -- and it is taking steps to make sure its position is secure.

Meantime, the insurer turned in a somber Q3 report, showing a profit of $7 million -- chicken feed compared to the $444 million it posted in the year-ago quarter. MBIA puts the blame for this situation squarely on the shoulders of Bank of America, claiming that Countrywide's crummy mortgage portfolio and B of A's refusal to pony up for selfsame loans are at the root of the problem.

The insurer, however, has a couple of rays of hope. For one thing, B of A's ruse won't work unless it is able to buy up a majority of the bonds. Failing that, some have noted that going to court will be chancy for the big bank, since an adverse ruling on successor liability will open up Bank of America to oodles more lawsuits from investors claiming fraud stemming from its Countrywide unit.

For a while, it looked as if the two might kiss and make up. B of A settled similar suits with Assured Guaranty  (NYS: AGO) and Syncora Holdings, encouraging news for MBIA, particularly since it gave legs to the notion that suing banks for dicey MBS products really can work out. Bolstering that idea is the revelation earlier this year of a mortgage fraud database, maintained by Countrywide, which MBIA sought to include in court proceedings. B of A, naturally, pooh-poohed the whole thing, although it has publicly chided MBIA for not paying close enough attention to the quality of the bundled mortgages passing under its nose. This remark would seem to indicate that B of A knew its securities were crap, particularly when it noted that the insurer also ignored input from third-party reviewers -- who, one might assume, noticed the poor quality of said instruments.

How will it all end? We should know soon, as MBIA is asking for the amendment approval by Nov. 21. And so plays out yet another drama featuring the never-ending legacy of the financial crisis.

While the embattled bank fights on, it is also taking steps to bolster its bottom line. To learn more about the most-talked-about bank out there, check out our in-depth company report on Bank of America. The report details Bank of America's prospects, including three reasons to buy and three reasons to sell. Just click here to get access.

The article Bank of America Beats Up Ailing Mortgage Insurer originally appeared on Fool.com.

Fool contributor Amanda Alix has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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