The US government executed an emergency bailout of troubled AIG without sufficient planning, botching its initial $85bn (£50bn) effort to rescue the ailing business and further weakening the multinational insurer's financial position, according to a critical official report into last year's near collapse of the company.
An inspector charged with overseeing the treasury's bail-out efforts concludes today that the intervention by the Federal Reserve and the treasury applied such onerous terms on a loan to AIG in September 2008 that it made matters worse.
The report also questions a decision to pay out $35bn in collateral to "make whole" all of AIG's counterparties on controversial credit default swaps, suggesting that government officials could have tried harder to squeeze concessions from top banks such as Goldman Sachs, Merrill Lynch and Barclays.
The inspector general's findings could prove damaging to the US treasury secretary, Timothy Geithner, who was head of the Federal Reserve Bank of New York which led the AIG bailout efforts. The government intervened when AIG ran into trouble after Lehman Brothers collapsed.
The inspector, Neil Barofsky, who is answerable to Congress, says the government relied on an unsuccessful effort by Wall Street banks to raise a private sector rescue of AIG. When this failed, the Fed had no contingency plan and simply applied the private consortium's terms to an $85bn public loan which carried an interest rate of more than 11% and was in return for an 80% stake in AIG.
"The decision to acquire a controlling interest in one of the world's most complex and troubled corporations was done with almost no independent consideration of the terms of the transaction, or the impact those terms might have on the future of AIG," says the inspector's report.
As AIG's position deteriorated further, the US government had to make two more interventions to prop up AIG, which was crippled by huge contracts written by a financial products arm largely run out of London. The counterparties in these credit default swaps received their total entitlements, avoiding a "haircut" that they would have taken if AIG went bust.
According to the inspector's report, the New York Fed asked AIG's eight leading counterparties to take discounts on their entitlements, but only one bank – UBS – offered to take a reduction of 2%. France's banking regulator, the Commission Bancaire, intervened by informing the Fed that it would be illegal under French law for two banks– Société Générale and Calyon – to take anything below their contractual entitlement.
The inspector general says the banks received an amount "far above" the market value at the time for the swaps and were reimbursed without consideration of the government bailout, without which "they would likely have received far reduced payments as well as the indirect consequences of a systemic collapse".
Critics have suggested that the Bush administration was too soft on Goldman Sachs, the biggest counterparty to AIG, in part because of a close relationship between senior treasury officials and executives at the bank. The US treasury said a decision not to pay counterparties would have led to "defaults and cross-defaults" around the financial system.