Congress wants new AIG bailout probe

Congress has new questions almost daily about CEO Ed Liddy's AIG.

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NEW YORK (Fortune) -- The derivatives traders that hit the jackpot with last fall's AIG bailout are getting more attention from the government.

More than two dozen Democrats in Congress called on Thursday for an investigation of the decision to pay in full the holders of credit default swaps written by AIG (AIG, Fortune 500).

The group of 27 legislators, led by AIG critic Rep. Elijah Cummings of Maryland, sent a letter to Neil Barofsky, the special inspector general for the Troubled Assets Relief Program, demanding the investigation.

The legislators say they want to know why AIG's trading partners - a group that includes some of the biggest and most sophisticated financial institutions in the world - were made whole for risky, unregulated trades with scarce taxpayer funds.

"We would like to know if assessments were made of the health and total exposure risks of counterparties, such as Goldman Sachs (which, for example, claimed it had no material exposure to AIG), Barclays (BCS), Deutsche Bank and others," the letter reads. "If such assessments were made, by whom were they made and what were the criteria guiding the assessments?"

Meanwhile, New York Attorney General Andrew Cuomo will subpoena the insurer for information about credit default swaps, the Wall Street Journal reported, as he continues his investigation of the money-losing company's decision to pay out millions of dollars in retention bonuses.

The moves come less than two weeks after AIG tried to defuse questions about who benefited from last fall's federal rescue, by naming the banks and municipalities that received federal funds.

Among the top recipients of the funds were two big Wall Street firms, Goldman and the Merrill Lynch brokerage now owned by Bank of America (BAC, Fortune 500), and a number of large European institutions including Germany's Deutsche Bank (DB) and France's Societe Generale.

AIG was pulled back from the brink of bankruptcy last September thanks to an $85 billion emergency loan from the Federal Reserve Bank of New York. With the tab for that rescue having more than doubled since then, and legislators across the nation wondering how well the money was spent, questions about the AIG rescue have been multiplying.

Among the issues being raised by lawmakers is why the counterparties on AIG's swaps received full payment for positions that were worth considerably less in the market.

"Was any attempt made to renegotiate and close out these contracts with 'haircuts'?" the Cummings letter asks. "If not, why not? What was the benefit of the decision to pay 100% of face value to the American taxpayers who provided the bailout funds and how did it support the goal of ensuring the stability of the economic system?"

Treasury Secretary Tim Geithner pointed earlier Thursday to AIG's sudden, derivatives-fueled collapse as a rationale for the need to create a regulatory system that gives the government more information and greater powers to oversee dark corners of the financial world like the over-the-counter derivatives market.

"The current financial crisis has been amplified by excessive risk-taking by certain insurance companies and poor counterparty credit risk management by many banks trading Credit Default Swaps (CDS) on asset-backed securities," Geithner said in prepared testimony Thursday before the House Financial Services committee.

"These complex instruments were poorly understood by counterparties, and the implication that they could threaten the entire financial system or bring down a company of the size and scope of AIG was not identified by regulators, in part because the CDS markets lacked transparency," he continued.

In response, Geithner proposed that more derivatives trading be moved to exchange-like arrangements that would eliminate the fear that one trading partner might not pay the other.

Earlier this week, Federal Reserve chief Ben Bernanke said that the creation of a strong, unified regulatory system could prevent future AIG-like crises, or at least make it easier for policymakers to deal with those situations.

"AIG highlights the urgent need for new resolution procedures for systemically important nonbank financial firms," he said Tuesday in testimony before the House Financial Services committee.

"If a federal agency had had such tools [in September], they could have been used to put AIG into conservatorship or receivership, unwind it slowly, protect policyholders, and impose haircuts on creditors and counterparties as appropriate. That outcome would have been far preferable to the situation we find ourselves in now," Bernanke added.