The New York Times “Investors Sue Countrywide Over Loan Modifications” reports that hedge fund Greenwich Financial Services claims it would lose money if Bank of America (BAC) modified Countrywide mortgages. The modifications result from a settlement with 11 state attorneys general based on Countrywide’s deceptive loan practices. Greenwich further claims that the trust agreements require Countrywide to buy back any modified mortgages at face value.

Countrywide said that the plaintiff is trying to unlawfully “assert the rights of the trusts.” Countrywide claims to be acting in the best interest of the trust investors, adding: “Loan modifications have been occurring for decades without objections or challenges, so we are especially troubled at the timing of this complaint. We are confident any attempt to stop this program will be legally unsupportable.”

I wrote that Greenwich first threatened a lawsuit in "Hedge Funds Threaten to Block Mortgage Modifications". The interesting question in the suit is whether the investors and trust are the same entity. I’ll have to leave that up to the lawyers. But it does show that Congress will have to clarify the legal landscape. In extraordinary times Congress can override legal contractual remedies for the common good. Either way, right now Bank of America appears to be trapped between the government and an aggressive investor.

The monolines are taking a different track against mortgage originators. Ambac (ABK) and MBIA (MBI) are suing for false warranties and requesting that mortgages in trusts they insured be repurchased. It seems that this is a more straightforward path. The political tide is running against Greenwich.

Disclosures: Author is long ABK, BAC and MBI.