The Federal Reserve Bank of New York used a weak negotiating strategy that failed to wring concessions from AIG trading partners last year, allowing them to reap nearly $30 billion in payments from U.S. taxpayers, a government audit report said on Monday.

The New York Fed had little room to maneuver after bailing out American International Group in September but failed to use what leverage it had when it later cut a deal with AIG counterparties, according to the report by the Troubled Asset Relief Program's special inspector general.

This resulted in the New York Fed paying full market value for assets underlying credit default swaps written by AIG to banks such as Goldman Sachs , Societe Generale , Merrill Lynch and Deutsche Bank , 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, TARP Inspector General Neil Barofsky said in the report.

RESCUE HURT POSITION

The report said that in the rush to rescue AIG -- just two days after the failure of Lehman Brothers -- the New York Fed adopted terms that were based on an aborted commercial rescue effort. This would necessitate another bailout just weeks later.

The New York Fed last November created a special purpose vehicle, dubbed Maiden Lane III, to buy collateralized debt obligations from the banks to avoid what it considered a greater threat -- AIG credit downgrades that would necessitate the posting of hundreds of billions of dollars in additional collateral or risk another debilitating collapse.

Negotiations for discounts over two days with eight U.S. and European institutions proved fruitless.

Barofsky criticized the New York Fed, headed at the time by now-U.S. Treasury Secretary Timothy Geithner, for insisting that all banks be treated equally in negotiations and that it would not treat domestic banks differently from foreign institutions.

UBS was willing to negotiate a modest 2 percent discount, but all of the others refused. The French bank regulator would not allow SocGen and Calyon make any concessions, making it impossible for the Fed to treat banks equally if it were to try to wring concessions out of U.S. firms that by that time had received taxpayer capital injections.

SocGen was the largest beneficiary of the Fed purchases, receiving $6.9 billion in direct payments from the Fed, in addition to $9.6 billion in collateral payments from AIG.

The New York Fed and Federal Reserve Board, in a joint letter accompanying the report, said that the terms of their $85 billion bailout to AIG were appropriate given the severity of the crisis at the time and defended their efforts to obtain concessions from AIG counterparties.

We believe that the Federal Reserve acted appropriately in conducting these negotiations and that our negotiating strategy, including the decision to treat all counterparties equally, was not flawed or unreasonably limited, the letter said.

Leaning on domestic institutions only would have been a misuse of our supervisory authority and provided an advantage to foreign institutions, the Fed said.

The U.S. Treasury, in its response, said failure to pay some of AIG's creditors could have precipitated the event that government officials were trying to prevent -- a debilitating AIG bankruptcy.

Herbert Allison, the Treasury assistant secretary who heads TARP, said the central lesson to be learned from the AIG experience is that the federal government needs better tools to deal with the impending failure of a large institution in extraordinary circumstances like those facing us last fall and called for approval of an Obama administration proposal for authority to step in and shut such firms down.

(Reporting by David Lawder; Editing by Phil Berlowitz, Gary Hill)

Timothy geithner Goldman sachs Aig