UPDATE 2-NY Fed failed to negotiate AIG concessions-audit

* NY Fed failed to wring AIG counterparty discounts-audit

* Initial bailout, weak strategy hurt Fed bargaining-audit

* Fed says acted appropriately in AIG situation (Adds details, Treasury response, background)

By David Lawder

WASHINGTON, Nov 16 (Reuters) - 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 (AIG.N) 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 (GS.N), Societe Generale (SOGN.PA), Merrill Lynch (BAC.N) and Deutsche Bank (DBKGn.DE), 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.