* US says bank sold toxic loans to Fannie Mae, Freddie Mac
* More than $1 billion losses said to be caused
* Scheme said to begin at Countrywide Financial
* Bank says has acted responsibly to address mortgage issues
NEW YORK, Oct 24 (Reuters) - The United States filed a fraud lawsuit against Bank of America Corp, accusing it of causing taxpayers more than $1 billion of losses by selling thousands of toxic mortgage loans to Fannie Mae and Freddie Mac.
Wednesday's case, originally brought by a whistleblower, is the U.S. Department of Justice's first civil fraud lawsuit over mortgage loans sold to the big mortgage financiers, which were bailed out in 2008.
It also compounds the legal problems that Bank of America Chief Executive Brian Moynihan faces over the second-largest U.S. bank's disastrous July 2008 purchase of Countrywide Financial Corp, once the nation's largest mortgage lender.
According to a complaint filed in Manhattan federal court, Countrywide in 2007 invented and Bank of America continued a scheme known as the ``Hustle'' to speed up processing of residential home loans.
Operating under the motto ``Loans Move Forward, Never Backward,'' mortgage executives tried to eliminate ``toll gates'' designed to ensure that loans were sound and not tainted by fraud, the government said.
This led to ``defect rates'' that approached 40 percent, roughly nine times the industry norm, but Countrywide concealed this from Fannie Mae and Freddie Mac, and even awarded bonuses to staff to ``rebut'' the problems being found, it added.
Defaults and foreclosures soared, yet the bank has resisted buying back many of the defaulted loans from the scheme, which ran through 2009, the government added.
``The fraudulent conduct alleged in today's complaint was spectacularly brazen in scope,'' U.S. Attorney Preet Bharara in Manhattan said. ``Countrywide and Bank of America made disastrously bad loans and stuck taxpayers with the bill.''
Wednesday's lawsuit seeks civil fines, as well as triple damages under the federal False Claims Act, which the government has used several times in recent years against Wall Street.
Lawrence Grayson, a bank spokesman, said in response to the lawsuit: ``Bank of America has stepped up and acted responsibly to resolve legacy mortgage matters. The claim that we have failed to repurchase loans from Fannie Mae is simply false. At some point, Bank of America can't be expected to compensate every entity that claims losses that actually were caused by the economic downturn.''
In February, Bank of America agreed to a $1 billion settlement of False Claims Act allegations over home loans submitted for insurance by the Federal Housing Administration, in a case from the U.S. Attorney's office in Brooklyn, New York.
Since Moynihan's predecessor Kenneth Lewis paid $2.5 billion for Countrywide, the Charlotte, North Carolina-based bank has lost nearly $40 billion on mortgage litigation and investor demands to buy back soured loans, Credit Suisse said on Oct. 5.
Some of these costs related to Merrill Lynch & Co, which Lewis bought at the beginning of 2009. Last month, Bank of America agreed to pay $2.4 billion to settle a lawsuit accusing it of misleading investors about that takeover.
According to court records, Wednesday's case was originally filed under seal in February by Edward O'Donnell, a Pennsylvania resident and former executive vice president at Countrywide Home Loans who had worked there between 2003 and 2009.
In that complaint, O'Donnell said Countrywide and later Bank of America dismissed his ``numerous'' objections to the Hustle, and that he became ``one of the lone voices'' in his division pointing to escalating loan quality issues and defaults.
O'Donnell could not immediately be reached for comment, and his lawyer did not immediately respond to requests for comment.
Bank of America shares closed down 5 cents at $9.31 on the New York Stock Exchange. They have fallen 61 percent since the Countrywide takeover closed, while the Standard & Poor's 500 has risen 10 percent.
Federal regulators seized Fannie Mae and Freddie Mac on Sept. 7, 2008 and put them into a conservatorship.
The mortgage financiers are now overseen by the Federal Housing Finance Agency, and have repaid only about one-fourth of the more than $188 billion of taxpayer funds they have drawn down. Fannie Mae alone has drawn down more than $116 billion.
Wednesday's lawsuit was also brought under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, which was enacted after that decade's savings-and-loan crisis.
It overlaps other cases that federal agencies have brought against Wall Street over the financial crisis, including the FHFA's 18 lawsuits last year over Fannie Mae and Freddie Mac.
These lawsuits covered losses on the sales of roughly $200 billion of securities, including more than $57 billion linked to Bank of America, Countrywide and Merrill.
Fannie Mae and Freddie Mac have in recent months stepped up their own efforts to force Bank of America and other lenders to buy back soured home loans.
Bharara's office has in the last 1-1/2 years brought five civil fraud lawsuits under the False Claims Act over FHA-insured loans against other lenders.
In February, Citigroup Inc settled its case for $158.3 million and Flagstar Bancorp Inc settled for $132.8 million, while Deutsche Bank AG settled in May for $202.3 million. Cases are pending against Wells Fargo & Co and Allied Home Mortgage Corp, Bharara said.
Congressman Barney Frank, who chaired the House Financial Services Committee in 2008, this week said Bank of America should probably be shielded from government lawsuits over Merrill, which it bought in part at federal officials' urging.
He said, however, that the situation could be different for Countrywide because the government did not force that purchase.
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.