updated 11/16/2009 7:32:33 PM ET 2009-11-17T00:32:33

Officials managing the multibillion dollar bailout of insurance giant American International Group Inc. bungled the first rescue and may have overpaid other banks to wind down AIG's business relationships, a government watchdog says.

The Federal Reserve Bank of New York — headed at the time by now Treasury Secretary Timothy Geithner — paid AIG's business partners face value for securities so they would cancel insurance-like contracts AIG had written and ease the firm's liquidity crunch. But at least one of those partner banks would have canceled the contracts for less, according to a report Tuesday from Neil Barofsky, the Special Inspector General for the $700 billion financial bailout Congress approved last October.

The report says New York Fed officials mismanaged the negotiations with other banks, removing the threat that AIG would go bankrupt and bowing to a demand from French regulators that French banks holding AIG's debt insurance be paid in full.

The initial bailout "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," the report says.

As a result, billions more than necessary went to U.S. banks including Goldman Sachs Group Inc.; Merrill Lynch, now part of Bank of America Corp.; and Wachovia, now part of Wells Fargo & Co.; and European banks including Societe Generale, Deutsche Banke, UBS and Calyon, it says.

Barofsky also faults the Federal Reserve for refusing at first to reveal which banks had received billions of American taxpayer dollars supposedly intended to save AIG. The Fed released the banks' names and the amount of their payoffs only after lawmakers demanded greater transparency.

In its written response, the Treasury Department emphasized that the events "developed extremely quickly" and that officials did not intend to provide further assistance to AIG after an initial $85 billion bailout that the report says tied their hands. But AIG's total bailout package eventually amounted to more than $180 billion.

"This report overlooks the central lesson learned from the" AIG rescue, Treasury spokeswoman Meg Reilly said in a statement. "The lesson is that the federal government needs better tools to deal with the impending failure of a large institution" in times of crisis.

She said the Obama administration's proposed overhaul of financial regulation would accomplish that goal.

Copyright 2009 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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