At NY trial, Assured says Flagstar must pay for shoddy mortgages

* Bond insurer sued bank for breach-of-contract

* Flagstar says due diligence firms gave loans high marks

* Bench trial in federal court expected to go two weeks

By Nate Raymond

NEW YORK, Oct 10 (Reuters) - Flagstar Bancorp Inc had to know by 2009 that hundreds of loans it originated didn't meet underwriting guidelines when it sold $900 million in mortgage-backed securities to investors, a lawyer for a bond insurer said on Wednesday.

At the start of a civil trial over Flagstar's mortgage securities practices at the height of the housing boom, Assured Guaranty Ltd lawyer Jacob Buchdahl said the bank misrepresented the quality of home loans packaged together as investments.

Buchdahl said Troy, Michigan-based Flagstar was required to buy back mortgages that did not comply with standards for the investments, but did not do so.

"The defendant Flagstar failed to live up to its promises," he told U.S. District Judge Jed Rakoff in Manhattan. The judge is hearing the case without a jury.

The case, filed last year, is one of the first to go to trial over claims tied to the bundling of mortgages that were sold to investors. The collapse of these securities when the housing market cooled has been blamed in part for the financial crisis.

Assured, like other bond insurers, guaranteed the Flagstar securities. The insurer was forced to pay up when the asset values fell amid the housing meltdown.

The case is expected to test insurers' ability to recover damages in the dozens of similar cases against banks. Assured has sued for breach of contract and is seeking $108 million from Flagstar.

Buchdahl said a mortgage underwriting expert will testify about a review of 800 loans included in the two Flagstar offerings. The review found 610 instances of misrepresentations, according to Assured.

But Veronica Rendon, a Flagstar lawyer, attacked that analysis and contended that the loans were made through "quality and sound underwriting."

Those earlier loan reviews went through a "tighter process with greater control" than one conducted by the trial expert Assured hired for the lawsuit, Rendon told the judge.

Also, due diligence firms hired by Assured when the securities were issued in 2005 and 2006 gave the loans high marks, she said.

Assured's losses can be attributed to the decline in housing values, she said, as homeowners decided to walk away from their mortgages rather than make payments on underwater properties.

"As Bill Clinton said in his successful campaign against President George Bush, 'It's the economy stupid,'" Rendon said.

The trial is expected to last two weeks.

The case is Assured Guaranty Municipal Corp v Flagstar Bank, FSB in U.S. District Court for the Southern District of New York, No. 11-2375.

(Reporting By Nate Raymond in New York; Editing by Martha Graybow, Bernard Orr)

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