Federal Reserve officials missed opportunities to minimize taxpayer exposure during the bailout of American International Group (AIG), according to the latest report by Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program.

Officials cost taxpayers “tens of billions of dollars” because they failed to use their “considerable leverage” in negotiating AIG’s responsibility to pay out contracts as the government scrambled to stabilize a panicked financial system last fall, Barofsky said in the report.

The report falls short of charging Federal Reserve officials with intentionally structuring the AIG bailout to benefit the failing companies’ counterparties.  It pointed out then-New York Fed President Timothy Geithner, the current Treasury secretary, and its general counsel denied the counterparty payment were a “relevant consideration for the AIG transactions.”

“Irrespective of their stated intent, however, there is no question that the effect of FRBNY’s decisions — indeed, the very design of the federal assistance to AIG — was that tens of billions of dollars of Government money was funneled inexorably and directly to AIG’s counterparties,” said Barofsky.

“It's very easy to say with 20/20 hindsight that there was a better deal available but it's hard to refinance your house when it's on fire,” said a Treasury official. 

The report charges the Fed’s strategy to secure discounted payments to those counterparties “offered little opportunity for success.”

Geithner was uncomfortable with interfering with the sanctity of AIG’s contractual obligations and concerned that a counterparty discount would signal a Fed pullback from government support of the gigantic insurer, said Barofsky. 

“Although these were certainly valid concerns, these policy decisions came with a cost — they led directly to a negotiating strategy with the counterparties,” said Barofky. 

Herb Allison, Treasury’s assistant secretary for financial stability, said the report focuses only on the New York Fed’s negotiating strategy. “What must be remembered is that the decision by the government not to let AIG go bankrupt meant that AIG had to meet its contractual obligations,” said Allison in a letter to Barofsky.

"This report overlooks the central lesson learned from the unprecedented steps taken to support AIG. The lesson is that the federal government needs better tools to deal with the impending failure of a large institution in extraordinary circumstances like those facing us last fall,” said Meg Reilly, a Treasury spokesperson.  “It is for these reasons that the Obama Administration has proposed a regulatory reform agenda that includes giving the government the emergency authority to resolve a significant, interconnected financial institution.”

The report offers little on what the government stands to lose in AIG. “It is difficult to assess the true costs of the Federal Reserve’s actions until there is more clarity as to AIG’s ability to repay all of its assistance from the Government,” said Barofsky.