Fed Caved to Bank Demands in AIG Bailout

NEW YORK (TheStreet) -- The Federal Reserve Bank of New York, headed then by now-Treasury Secretary Timothy Geithner, caved into demands by trading partners of AIG(AIG Quote) that they be paid in full for complex securities they had insured with the company, the Wall Street Journal reports.

The actions saved some of the world's biggest banks from potentially large losses, a government audit finds, the Journal reports.

The audit, conducted by the special inspector general for the Troubled Asset Relief Program, faulted the New York Fed for not using its leverage as the regulator of some of these banks to get them to accept lower prices for more than $60 billion in credit-market bets, the Journal notes. These bets were tied to souring mortgage-linked securities that had fallen in value.

The Associated Press reports that at least one of those partner banks offered to canceled the contracts for less, according to the special inspector general report, meaning officials may have spent billions more than necessary to cancel debt insurance contracts with the banks.

The banks that were paid off in full included Goldman Sachs(GS Quote), Merrill Lynch, now a unit of Bank of America(BAC Quote), and large French banks Societe Generale and Calyon, the report said. The French banks were represented by the French bank regulator in negotiations with the New York Fed last November, the report said.

"The refusal of the FRBNY and the Federal Reserve to use their considerable leverage as the primary regulators for several of the counterparties, including the emphasis that their participation in the negotiations was purely 'voluntary' made the possibility of obtaining concessions from those counterparties extremely remote," Neil Barofsky, the special inspector general, said in the report.