By Aruna Viswanatha

Jan 17 (Reuters) - Banks are testing U.S. authorities' use of a once-obscure statute to bring more cases tied to the financial crisis, arguing the government is twisting the law beyond what it can do.

In a motion to dismiss a federal case alleging mortgage misconduct, Wells Fargo said late Wednesday the government was essentially trying to argue that the bank defrauded itself under one of the laws at issue, FIRREA.

Bank of America is also fighting a recent lawsuit from the U.S. Attorney's Office in Manhattan alleging some $1 billion in losses to Fannie Mae and Freddie Mac, partly by arguing those institutions also don't qualify as affected firms under FIRREA.

Courts are expected to weigh in later this year on the issue in both cases. If they side with the banks, it could limit a key Justice Department tool promoted as a way to bring big civil cases against misconduct that fueled the 2007-2009 crisis.

FIRREA, or the Financial Institutions Reform, Recovery, and Enforcement Act, is a federal civil fraud statute passed in the wake of the 1980s savings-and-loan scandals. It covers fraud affecting federally in s ured financial institutions.

While it has only appeared in a few dozen cases, its low burden of proof, broad investigative powers and long statute of limitations encouraged the Justice Department to dust it off for potential cases, especially after criminal inquiries failed to yield major prosecutions.

The DOJ, led by the Manhattan U.S. Attorney's office, has used the statute in big bank cases in the past year, including against Citigroup, Bank of New York Mellon, and in the $25 billion settlement with five top banks that resolved allegations of mortgage servicing abuses.

While those cases resulted in settlements, rulings in the cases against Bank of America and Wells Fargo could lay out clear markers of just what is covered by the law.

'WILDLY EXPANSIVE READING'

The U.S. in October sued Bank of America, accusing it of violating FIRREA and other laws when it caused taxpayers more than $1 billion in losses by selling thousands of toxic mortgage loans to the government-sponsored Fannie and Freddie.

When Bank of America filed a motion to dismiss the case in late December, it said the government was turning the law on its head.

The alleged fraud was directed at Fannie and Freddie, which are not themselves federally insured financial institutions, the bank said.

The DOJ's allegations instead hung on other federally insured institutions that were preferred Fannie and Freddie stockholders who suffered losses as a result of the loans. "This interpretation ... is limitless and absurd," the bank said.

"This is a wildly expansive reading...(the law) was not intended to increase civil penalties for all fraud that, through intermediaries, might remotely touch a financial institution..." it said.

Bank of America also said the Justice Department did not describe a scheme to defraud, as the statute requires, but only that Countrywide violated contracts with Fannie and Freddie.

Oral arguments on the motion are scheduled for April 18.

'AFFECT YOURSELF'

In seeking to defeat an October lawsuit that alleges more than 10 years of misconduct related to government-insured loans, Wells Fargo too attacked the Justice Department's theories under FIRREA.

The original complaint did not specifically identify a federally insured financial institution, the bank said in its Wednesday filing.

"The United States has now tried to cure this defect by alleging that Wells Fargo is the 'federally insured financial institution' that was 'affect ' by Wells Fargo's own alleged violations...No court has accepted this 'affect yourself' theory of liability, and it is wrong."

The DOJ built its case against Wells Fargo in part through information gleaned from four FIRREA subpoenas, according to court documents. The law allows civil prosecutors to obtain information prior to filing a lawsuit, which most civil laws don't allow.

The bank also argued it was already absolved of much of the liability through an earlier $25 billion, multi-bank deal.

The government has until Feb. 13 to respond to Wells Fargo's motion. 

(Additional reporting by Nate Raymond)

Follow us on Twitter @ReutersLegal | Like us on Facebook