AIG Bailout Is Both Criticized and Justified by TARP Report

Congress, journalists and former American International Group CEO Hank Greenberg all agree that the November 2008 deal between the New York Federal Reserve and AIG's creditors was sleazy or just plain stupid. Now the special inspector general for the Troubled Asset Relief Program, Neil Barofsky, has weighed in with his report. It both criticizes and justifies, what happened in those tense, closed-door meetings.

Barofsky's report says that the New York Fed, under then-president Timothy Geithner, gave away too much. The Fed "refused to use its considerable leverage" in negotiating with the creditor banks that were AIG's trading partners on risky investments such as credit default swaps. As a result the banks got a "backdoor bailout" from taxpayers because the TARP money funneled through AIG ended up in the coffers of Goldman Sachs and others.

But a closer look at the report indicates why Geithner and the Fed reached their decision. In any negotiation the one who deals from weakness and has more to lose will come out second. In this case, it was the U.S. Lehman Brothers had already fallen, and AIG was about to topple - taking with it a good part of the country's financial system.

So why weren't the banks willing to negotiate? The simple answer: they didn't have to. Many were an ocean away from America's troubles. Of the eight major creditors, only one, UBS AG, was willing to take a minimal 2 percent off on its debt, and only if AIG's other counterparties would do so.

The hard-nosed and legalistic French regulator, who represented Calyon and Societe Generale, refused to make any concessions. Then Goldman Sachs and the other U.S. banks weighed in. They would not make concessions if foreign banks didn't. They were unwilling to be penalized if foreign creditors got all their money.

The Fed could have forced their hand, but only if AIG went into bankruptcy. And the banks were confident that Geithner and the Fed wouldn't push AIG over the precipice because it had already agreed to AIG's $182 billion bailout two months earlier. So the U.S. was now an AIG creditor and stood to lose billions if AIG went under. Since the Fed's money, and its cards, were already on the table and the banks could see them, it was no surprise that they refused to negotiate.

Barofsky's report cites many more mistakes, but ultimately it comes down to this: Geithner was dealt a losing hand when it came to hardball negotiations with the banks. While the TARP report weakens the treasury secretary's position with the public, he need only worry about one man - his boss, President Obama. And Obama still has confidence in Geithner.