Watchdog: Fed Used Flawed Strategy in AIG Bailout

WASHINGTON, Nov. 16, 2009— -- The Federal Reserve last year "severely limited" the chance to save taxpayer money by using a flawed negotiating strategy in discussions with AIG's business partners, a government watchdog said in a report released today.

Ultimately, 16 of AIG's counterparties -- financial institutions in the United States and abroad that had deals with the insurance giant -- received $62.1 billion in taxpayer money after the Fed paid them full value for their credit-default swaps.

In his new audit, Neil Barofsky, the special inspector general for the $700 billion financial bailout, said the Federal Reserve Bank of New York "made several policy decisions that severely limited its ability to obtain concessions from the counterparties."

The Fed's initial rush last fall to save AIG -- and thereby avoid a widespread market meltdown -- "was done with almost no independent consideration of the terms of the transaction or the impact that those terms might have on the future of AIG," Barofsky said.

Without the threat of a possible AIG bankruptcy, the Fed, led at the time by current Treasury Secretary Tim Geithner, then had less leverage in negotiations with banks and other institutions that had credit-default swaps through AIG.

But still, Barofsky found, the Fed did not use what leverage it did have. For instance, the watchdog said, the Fed did not use its "considerable leverage" as the regulator for some of these banks, nor did it treat AIG's counterparties differently, even though some banks were based in the United States and some overseas.

"These policy decisions came at a cost," Barofsky stated in the report. "They led directly to a negotiating strategy with the counterparties that even then-FRBNY President Geithner acknowledged had little likelihood of success."

At one point in the discussions last November, one of the counterparties, UBS, conditionally accepted a 2 percent cut in what it was owed -- a "haircut" -- but since negotiations with the other counterparties proved fruitless, the Fed paid all of them in full. Societe Generale received $16.5 billion in payments, Goldman Sachs $14 billion, Deutsche Bank $8.5 billion, and Merrill Lynch received $6.2 billion. Another 12 institutions received a total of $16.9 billion.