WASHINGTON (AP) — Officials handling the multibillion dollar bailout of insurance giant American International Group Inc. mismanaged an initial rescue attempt and may have overpaid other banks to wind down AIG’s business relationships, a government watchdog says.

The Federal Reserve Bank of New York — headed at the time by now-Treasury Secretary Timothy Geithner — paid AIG’s business partners full face value for securities so they would cancel insurance contracts AIG had written in order to ease the firm’s liquidity crunch. But at least one of those partner banks offered to canceled the contracts for less, according to a report Monday from Neil Barofsky, the Special Inspector General for the $700 billion financial bailout Congress approved last October.

That means officials may have spent billions more than necessary to cancel debt insurance contracts with banks including Goldman Sachs Group Inc. and others, the report says.

AIG, a financial services conglomerate that was the world’s largest insurer, was considered so interconnected with other companies that its failure could upend the global financial system. As it teetered last fall, officials decided to save the company with billions of taxpayer dollars and government guarantees to prevent deepening the spreading financial crisis.

After several bailouts, AIG now holds government commitments worth up to $180 billion — more than any other company. The Treasury Department owns nearly 80 percent of the company.

Critics have long argued that AIG’s trading partners should have been forced to take less than 100 percent of the value of their contracts with AIG. They note that the protection AIG offered — in the form of complex products called credit-default swaps — was unregulated and that AIG’s trading partners knew the risks and should have to assume some losses.

Officials, however, have said they feared that underpaying AIG’s business partners would cause the company’s credit to be downgraded, which also could have sparked AIG’s collapse.

The new report faults the New York Fed for decisions that “severely limited its ability to obtain concessions” from other banks. In particular, it says, officials refused to use their regulatory power over American banks like Goldman and Merrill Lynch, now part of Bank of America Corp., to force them to take concessions.

A French regulator had refused to accept concessions from the Fed for $20.8 billion worth of securities held by Societe Generale and Calyon, and New York Fed officials did not want to treat the U.S. banks differently. But the report points out that American banks already were benefiting from the financial bailout — Goldman, for example, had recently received the Fed’s OK to become a bank holding company as a way to boost assets — and all the banks receiving AIG rescue funds benefited from the billions the U.S. already spent on AIG.

The New York Fed also weakened its bargaining position by refusing to threaten that AIG would go bankrupt after an initial $85 billion bailout proved too small to save the firm, the report says. Furthermore, negotiators led by Geithner told the banks that any concessions would be purely voluntary, the report says.

The result, the report says, was a weak negotiating strategy with little chance of success in obtaining concessions from the banks. It says the initial bailout “was done with almost no independent consideration of the terms of the transaction or the impact that those terms might have on the future of AIG.”

The report says at least one bank, Germany-based UBS, told the New York Fed it would accept less than face value to cancel the contracts, as long as the other banks did so as well. The other banks refused to take less money “voluntarily,” it says.

As president of the New York Fed, Geithner signed off on many key decisions concerning AIG’s bailouts — including the move to pay in full for securities held by other banks, the report says. Also involved were officials from Treasury and the Federal Reserve.

The report says Geithner denied that officials intended to give other banks a “backdoor bailout.” Yet it says decisions Geithner approved — “indeed, the very design” of AIG’s rescue — meant that billions of taxpayer dollars were “funneled inexorably and directly” to other banks.

It acknowledges that officials had good reasons to save AIG, and were appropriately reluctant to break contracts the company had with other companies. But it says those decisions “came with a cost — they led directly to a negotiating strategy that even ... Geithner acknowledged had little likelihood of success.”

In a joint response, the Fed and New York Fed argue that they acted to protect AIG’s customers, whose insurance policies, annuities and retirement plans would have been threatened if the company failed — not just the banks with which AIG had business relationships. They defend the terms of the first bailout and the decision to pay off other banks.

“Our negotiating strategy, including the decision to treat all counterparties equally, was not flawed or unreasonably limited,” they wrote.

In its response, Treasury emphasizes that the events “developed extremely quickly” and that officials did not intend to provide further assistance to AIG after the initial $85 billion bailout that the report says tied their hands.

“This report overlooks the central lesson learned from the” AIG rescue, Treasury spokeswoman Meg Reilly said in a statement. “The lesson is that the federal government needs better tools to deal with the impending failure of a large institution” in times of crisis.

She said the Obama administration’s proposed overhaul of financial regulation would accomplish that goal. The new rules would give regulators the power to unwind large financial firms whose failures threaten the financial system. The process initially would be funded by taxpayers.

Barofsky faults the Federal Reserve for refusing at first to reveal which banks had received billions of American taxpayer dollars supposedly intended to save AIG. The Fed released the banks’ names and the amount of their payoffs only after lawmakers demanded greater transparency.

Barofsky had earlier asserted that taxpayers are unlikely to recover the money spent rescuing AIG. Officials from Treasury and the Fed say they still hope the money will be repaid.

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AP Economics Writer Martin Crutsinger in Washington contributed to this report.