AIG Bank Clients Got Sweet Payoff, Says TARP Inspector

The first investigation he is undertaking relates to Treasury Department disclosures that the CDS payoffs will help make the taxpayer "whole" for its investment in AIG.

In fact, the Treasury Department believes it will lose $30 billion on the AIG deal, Mr. Barofsky said.

The second investigation relates to a series of documents that have been released regarding the arrangements made to purchase bank assets secured by AIG.

He also said additional documents and facts have "come to light" causing him to review the "extent of the Federal Reserve's cooperation with his office, SIGTARP.

For example, he will testify, "in connection with the recent document productions to this committee, documents have come to light that were not provided to the SIGTARP audit team during the course of the audit."

Besides raising questions about whether the FRBNY acted appropriately in not disclosing the full details of the payouts, Mr. Barofsky will also strongly criticize the role that credit rating agencies played in the events that led to the government's decision to bail out AIG.

"AIG stands as a stark example of the tremendous influence of credit rating agencies upon financial institutions and upon government decision-making in response to financial crises," Mr. Barofsky is due to report.

First, his testimony says, the rating agencies "overrated" the collateralized debt obligations (CDOS) that underlay AIG Financial Products unit's credit default swaps.

Then, once the financial crisis came to a head, the credit rating agencies' downgrades of AIG itself and of the underlying securities played a "significant role" in AIG's liquidity crisis as those downgrades and the related market declines in the securities required AIG to post billions of dollars in collateral that it could not do without government help.

Then, Mr. Barofsky will say, the "threat of further rating agency downgrades due to the onerous terms of the initial FRBNY financing, among other things, led to further government intervention, including the Troubled Asset Relief Program investment in AIG and the necessity to do something with the swap portfolio.

And, he is due to say, the concern about the reaction of the credit rating agencies "played a role in FRBNY's decision not to pursue a more aggressive negotiating policy to seek concessions from counterparties."

In conclusion, Mr. Barofsky will say, "all of these profound effects were based upon the judgments of a small number of private entities that operate…on an inherently conflicted business model and that are subject to minimal regulation."

He adds, "Without drawing any conclusions about the particular actions taken by the rating agencies in the case of AIG, this report further demonstrates the dramatic influence of these entities on our financial system."

Mr. Barofsky will testify that FRBNY executives told him that Timothy Geithner, then president of the FRBNY and now Treasury secretary, "acquiesced" to the proposal by other FRBNY executives to pay off the CDS at par.

Mr. Barofsky then will say, "When asked by SIGTARP if the executives felt they had received their marching orders' from then-FRBNY President Geithner to pay the counterparties par, one FRBNY official responded, 'yes, absolutely.'"

Regarding the value of the securities, Mr. Barofsky will say each collateralized debt obligation paid off had a different value, and some banks benefitted more than others.

For example, the CDOs held by Goldman Sachs had a market value of 40 cents on the dollar, while CDOs held by UBS "had a comparable market value of 71 cents," according to Mr. Barofsky.

The eight AIG trading partners with whom the FRBNY negotiated before breaking off talks and making everyone whole owned CDOs with a market value of 40-to-48 cents, Mr. Barofsky will testify.