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Watchdog Says Fed Paid Too Much In AIG Bailout

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Mark Lennihan

A government audit says the Federal Reserve Bank of New York caved in to pressure from major banks when it bailed out the insurance giant AIG last year. The assessment comes from U.S. Special Inspector General Neil Barofsky, who's looking into how government bailout money has been spent.

Barofsky says the government essentially played a bad game of poker with the country's biggest banks. It agreed to give banks 100 cents on the dollar for what in hindsight were risky bets that the banks had made with American International Group Inc. The report says the government could have played a stronger hand and forced the banks to accept less.

Nariman Behravesh, the chief economist of IHS Global Insight, says the Fed was in a strong position to bargain. "It had the leverage, if you will, to negotiate better deals from these banks." And the report suggests that the fed should have taken a tougher line with the banks. "That's the conclusion of the report", Behravesh says.

But Behravesh says the report misses the bigger picture. "In the midst of a crisis is not really the time to be exercising this kind of tough love on financial institutions that are already reeling, already in trouble," he says.

He adds that at the end of the day, the Fed's approach worked, and the nation was able to avert financial Armageddon.

Administration Response

Administration officials had similar responses. Jake Siewert is a counselor to Treasury Secretary Timothy Geithner, who headed the New York Fed at the time of the AIG bailout.

"If you're steering a boat through a Category 5 hurricane, and you come back ashore and you're happy to be alive again, [it's] not always that constructive to be told, 'Oh, you could have taken a slightly different course,' " Siewert says. "We were just trying to stay alive out there."

Geithner himself addressed the report at a news conference Tuesday.

"The most important thing to understand about this — and this was a tragic failure of our country — is that we came into this crisis without the basic set of tools we needed to help contain the damage caused by hugely costly mistakes in parts of our financial system," he said. The Obama administration has been pushing for broader powers to monitor and intervene in financial firms.

Still, some economists say the government has made some big mistakes with taxpayer money.

Albert "Pete" Kyle is a finance professor at the University of Maryland and has consulted on similar government watchdog efforts.

"This AIG deal is just one example," he says. "In all of these different bailouts, time and time again, the taxpayers have overpaid for securities or offered sweetheart deals to the banks."

Kyle says that when the government has injected money into a bank to prop it up, taxpayers haven't gotten a fair share of the bank's equity, or stock, in return for taxpayer money.

"That was a huge problem," he says. "So, in general, the government should have taken a much bigger stake in the banks than it actually took."

Had the government done that, Kyle says, taxpayers would be getting paid back tens of billions of dollars more as the financial system recovers and the stocks of those big banks rise.

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