TARP watchdog: Fed mishandled AIG

The top government watchdog over the $700 billion financial rescue package sharply criticized the Federal Reserve for mishandling the bailout.

Neil Barofsky, the special inspector general over the Troubled Asset Relief Program (TARP), said in a report that the central bank, and particularly the Federal Reserve Bank of New York, made a series of missteps in the initial bailout and during negotiations over settling AIG’s contracts for complex financial derivatives.


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Barofsky said the initial amount of money and the high interest rate Fed negotiators agreed to “inadequately addressed AIG’s long-term liquidity concerns, thus requiring further government support.” The federal government committed more than $180 billion to the insurance firm that was crippled from poor investments and trades in credit default swaps, one form of financial derivatives.

Barofsky said that the New York Fed’s negotiating strategy regarding credit default swaps “offered little opportunity for success.” The report details how Fed officials contacted eight of AIG’s counterparties to the financial deals by telephone over a two-day period, attempting to persuade them to accept less than the full value that they were owed.

But Barofsky concluded that the central bank sharply limited its negotiating position. Among other steps, Barofsky said the central bank refused to treat the counterparties differently, giving each an effective veto, and also refused to use its leverage as a regulator to compel the better terms. One of the eight counterparties had said it would accept marginally less than the full value.

In the end, AIG’s counterparties, some of the biggest American and foreign banks, received billions of dollars from the U.S. federal government. Those transactions weren’t disclosed to the public until March 2009.

“By providing AIG with the capital to make these payments, Federal Reserve officials provided AIG’s counterparties with tens of billions of dollars they likely would have not otherwise received had AIG gone into bankruptcy,” Barofsky concluded.

Federal Reserve lawyers responded to the report by saying that the central bank’s actions, “was designed to prevent a system-wide collapse and achived that end.” They said the negotiating strategy, “was not flawed or unreasonably limited.”

Herbert Allison, assistant Treasury secretary, defended the government, saying that it had to take steps to allow AIG meet its financial obligations. “The government could not unilaterally impose haircuts on creditors, and it would not have been appropriate for the government to pressure counterparties to accept haircuts,” Allison wrote.