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The Federal Reserve Bank of New York's effort to recover taxpayer money used in bailouts during the crisis may be at odds with its mission to ensure the stability of the financial system.

The New York Fed, which acquired mortgage debt in the 2008 rescues of Bear Stearns Cos. and American International Group Inc., joined a bondholder group including Pacific Investment Management Co. that aims to force Bank of America Corp. to buy back some bad home loans packaged into $47 billion of securities, people familiar with the matter said this week.

Concern that Bank of America may be forced to buy back soured mortgages helped send its stock down almost 5 percent in the last two days, wiping out $5.92 billion of its market value. The decline runs counter to the Fed's goal of strengthening the banking system after the worst crisis since the Great Depression.

"This is an inherent conflict," said former Atlanta Fed research director Robert Eisenbeis, now chief monetary economist at Cumberland Advisors Inc. in Sarasota, Florida. "They're transferring the loss from what would have been Bear Stearns through the Fed to the originators of the mortgages. That's an odd chain, and I don't know how you manage that."

The bondholder group that includes the New York Fed sent a letter to Bank of America and Bank of New York Mellon Corp., the trustee for the bonds created by Bank of America's Countrywide Financial Corp. unit, saying that Countrywide failed to service the loans properly, according to a statement this week from their lawyer. The statement didn't name the firms.

Preventing Collapse

Countrywide's servicing failures, including insufficient record keeping, may open the door for investors to seek repurchases, said Kathy Patrick, the bondholders' lawyer at Gibbs and Bruns LLP in Houston. Patrick represents investors who own at least 25 percent of so-called voting rights in the deals and stand to recover "many billions of dollars," she said.

The Fed has no choice except to shield the assets it acquired as it stepped in to prevent a collapse of the financial system, said Joseph Mason, a finance professor at Louisiana State University in Baton Rouge.

"The New York Fed is, acting along with other institutional holders, trying to preserve the value of their securities holdings," Mason said. "To act otherwise would be inappropriate and would be viewed as a waste of the government's money that was invested in this bailout."

The Federal Reserve System, made up of 12 regional banks plus the Washington-based Board of Governors, works with other regulators to ensure the safety and soundness of the financial system.

Wall Street Banks

The New York Fed plays a key role because it oversees many of the biggest Wall Street bank holding companies, including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. Bank of America, the largest U.S. bank by assets, is based in Charlotte, North Carolina, and overseen by the Richmond Fed.

The Dodd-Frank Act enacted this year expanded the Fed's authority by giving it responsibility for overseeing non-bank financial firms deemed "too big to fail" because their collapse might pose a risk to the system. Those may include insurers such as New York-based AIG and Fairfield, Connecticut- based General Electric Co.'s GE Capital unit.

The Fed's effort to avoid losses on mortgage securities originated by Countrywide and then bought by Bear Stearns creates "a vicious circle," Cumberland's Eisenbeis said.

"It all comes about because of the Fed's unwillingness to impose losses on creditors" when it bailed out Bear Stearns. Had the New York Fed let the investment firm collapse, "then we wouldn't have this problem," he said.

Investor Rights

New York Fed spokesman Jack Gutt declined to comment. In August, he said that the institution was involved in "multiple efforts related to exercising our rights as investors," which would "support our primary goal of maximizing the value of these portfolios on behalf of the American taxpayer."

The Fed's actions during the crisis have brought heightened scrutiny from Congress, which approved legislation that will require government audits of the bailouts and force the central bank to reveal recipients of emergency credit.

The Fed owns assets from the Bear Stearns and AIG bailouts in three holding companies. The New York Fed, which has policies to manage conflicts of interest between its multiple units, created its Special Investments Management Group in January to oversee the assets.

Maiden Lane

Maiden Lane LLC, named for the street bordering the New York Fed's Manhattan headquarters, bought about $30 billion of Bear Stearns assets that JPMorgan didn't want when it acquired the company. Maiden Lane II and III were created to hold the assets from AIG's rescue. BlackRock Inc., the world's biggest money manager, was hired to manage the assets and is also part of the bondholder group.

"This is a highly unusual position that the Fed has put itself in," said Sylvain Raynes, a principal at R&R Consulting in New York and co-author of "Elements of Structured Finance," which was published in May by Oxford University Press. "They made their bed and now they have to lie in it."

Efforts to recoup losses from soured mortgages that spawned the credit crisis come amid probes of the wave of foreclosures that followed.

Attorneys general in all 50 states are investigating whether loan servicers have improperly foreclosed on homes, contributing to concerns that banks will be forced to buy back billions of dollars in loans from investors because of faulty paperwork.

Potential Impact

New York Fed President William Dudley said this week that the Fed is working with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. to review foreclosure practices and "evaluate any potential impact on the housing market, financial institutions and the overall economy."

Future losses from forced repurchases of soured U.S. mortgages whose quality failed to meet sellers' promises will likely total $55 billion to $120 billion, JPMorgan analysts John Sim and Ed Reardon said in an Oct. 15 report. The $47 billion of Countrywide securities affected by the bondholder letter represents the current face amount of the debt, not the potential recovery for investors.

The intensification of bondholder efforts to get banks to repurchase loans "suggests that the fallout from the credit crisis is far from over," said Brian Yelvington, head of fixed- income strategy at Knight Libertas LLC in Greenwich, Connecticut, citing the "the huge amount of mortgages that might be involved."

Conflicting Goals

The Fed isn't the only one in the group to face conflicting goals in trying to get banks to absorb losses.

BlackRock Chief Executive Officer Larry Fink said in response to a question on an Oct. 20 conference call about the letter to Bank of America that his firm's "No. 1 job is to be a fiduciary for investors." At the same time, Bank of America is New York-based BlackRock's third-largest shareholder, according to data compiled by Bloomberg based on filings, and Fink's firm oversees a range of assets that would likely be affected by weakened banks.

Bank of America Chief Executive Officer Brian T. Moynihan said this week that the company will "defend" its shareholders against unfounded claims.

The Standard & Poor's 500 Index fell 1.6 percent on Oct. 19, the day that Bloomberg News reported that the Fed was part of the group seeking to force banks to buy back loans, on concern other banks might also be at risk. It was the index's biggest drop since August.

Reaction Overdone

Fink said in a Bloomberg Television interview that the market reaction has been overdone as bond investors won't be able to prove "that large" of a number of repurchases are required and because some banks' reserves are "probably adequate."

Government-controlled Fannie Mae and Freddie Mac, which the U.S. has been supporting with almost $150 billion of capital to help stabilize the housing market and protect investors in their debt from losses, face a similar dilemma as they try to shift their losses to lenders.

Freddie Mac also joined the bondholder letter, and about 53 percent of Bank of America's $12.9 billion of outstanding repurchase requests stem from loans directly owned or insured by Fannie Mae and Freddie Mac, according to the company.

"The losses are extraordinary, and we owe it to the American taxpayer to find out where these losses are coming from," Edward J. DeMarco, the Federal Housing Finance Agency's acting director, told lawmakers last month.

The New York Fed's participation in bondholder campaigns increases the chances banks will be forced to repurchase loans, said Raynes of R&R Consulting.

"It's like having a big gorilla in the room," Raynes said. "It's a big advantage if you are dealing with people. It's like being sued by the government -- it does make a difference."