Question about banks selling toxic mortgages?

"So you have banks committing fraud by paying moody's which states that the mortgages are AAA "
That never happened. Moody's rated bonds AAA because they thought the credit risk was AAA.

"what is toxic about the mortgage? "
"Toxic" in the case of securities means that there is no functioning market for the security, not that the security itself is a problem.

"Are the banks selling the mortgage for higher price than it's worth"
It was never about banks selling mortgages; it was about banks selling mortgage backed securities. In some case, the AAA stuff was unfunded super senior tranches of CDO's that you didn't have to buy. The CDO originator paid you to take on super seniopr risk and you didn't have to put up a dime.

"what makes the mortgage toxic?"
Lack of a functioning market. I would say Alt-A and other nasty subprime mortgages are pretty toxic these days.

"Is this done when the bank is about to default and know it and know they are going to need to be bailed out?"
No

" in this case the bank knows it's going under so when they do the people are left with no home I'm assuming? "
Of course not. If you have a mortgage with Bank A which goes bankrupt, your mortgage is a valuable asset of the bank. You keep paying on the mortgage and one day you get a letter (or maybe even not depending on the terms of your mortgage) that says that your mortgage is owned by someone else and there is possibly a new place to send payments to.

The mortgage back securities that were the problem were structured products like CDO's. The issue was that nobody understood the risk of the more senior tranches very well.