NEW YORK (Bloomberg) — The Federal Reserve "severely limited" its ability to save taxpayer money during the bailout of American International Group Inc. by refusing to compel banks to accept concessions, said a chief Treasury watchdog.

The Fed didn't use its "considerable leverage" as regulator of several banks that bought protection from AIG to force them to take reduced payments on the derivatives, Neil Barofsky, special inspector for the Troubled Asset Relief Programme (TARP), said yesterday in a report.

"These policy decisions came with a cost — they led directly to a negotiating strategy with the counterparties that even then New York Fed President Geithner acknowledged had little likelihood of success," Barofsky said.

Timothy Geithner, now Treasury secretary, was among officials who took over negotiations with the banks from AIG in November 2008.

The Fed contacted eight of AIG's biggest counterparties by telephone and attempted to negotiate discounts over two days, Barofsky said.

UBS AG, the Zurich-based bank, was willing to make a two percent concession, he said.