The AIG-Bank of America lawsuit over mortgage backed securities fills me with the least rooting interest of any possible lawsuit. For me it’s like watching Notre Dame play Ohio State. I don’t really care who wins. But that AIG lawsuit was critical to the larger mortgage mess. For the first time, an investor in mortgage backed securities sought a repurchase fee far higher than what other investors had sought. On a face value of $35 billion, AIG wanted $10 billion. This made the $8.5 billion BofA settlement with all their Countrywide MBS investors look ridiculous, and the same for the “global settlement” with state Attorneys General, over all banks, with a rumored price tag of $20-$25 billion. AIG’s suit showed the serious liabilities the banks had with their improper securitizations, and as a result BofA’s shares dipped about 20%. This was the main cause.

It turns out that BofA knew about the AIG lawsuit since January.

Top Bank of America Corp lawyers knew as early as January that American International Group Inc was prepared to sue the bank for more than $10 billion, seven months before the lawsuit was filed, according to sources familiar with the matter [...]

The bank made no mention of the lawsuit threat in a quarterly regulatory filing with the U.S. Securities and Exchange Commission just four days earlier. Nor did management discuss it on conference calls about quarterly results and other pending legal claims.

The SEC’s rules for litigation disclosure are murky, and some lawyers said Bank of America may have been justified in not revealing AIG’s lawsuit before it was filed. The bank’s litigation disclosures are in line with those of many rivals.

But other lawyers said banks have an obligation to disclose legal threats that could have major consequences.

“Publicly owned companies are supposed to disclose material threatened litigation under generally accepted accounting principles,” said Richard Rowe, a former director of the SEC’s Division of Corporation Finance, who was commenting generally and not specifically about Bank of America.

Every quarterly earnings statement and public comment from banks in the post-bubble period contains some discussion of a reserve fund for mortgage losses and liabilities. They always attach a dollar amount to it. If BofA knew about an AIG lawsuit seven months ago that would reshape the extent of their mortgage liabilities, and chose not to reveal that information, that’s a serious error. Is it criminal? Hard to say. The SEC has requested more disclosure on these matters. But if I were a BofA shareholder, I’d be mighty unhappy today.

The bigger issue this highlights is the massive credibility gap the banks have on their mortgage liabilities. The sums they throw out to cover repurchases are ridiculously low. AIG exposed this with their lawsuit. How many other banks know about pending litigation and aren’t revealing it?

The lack of disclosure is a symptom of the general head-in-the-sand attitude from the banks toward their mortgage problems. This has been the case since the bubble popped.