Behind closed doors, employees at AIG’s Financial Products division — the very unit whose trading had hastened the insurance giant’s collapse — were defiant, saying they were merely getting what they were due, recoiling at public accusations that they were behind their capitalizing on the company’s massive taxpayer bailout.

It’s worth reading the whole piece to get a full taste of the pomposity inherent in some of these folks, who after all, had recently contributed to the collapse of the global economy. The arrogance award, though, goes to the nameless employee who said this of taxpayers:

To be honest with you, I really hope it blows up. I think the U.S. taxpayer deserves to lose a trillion dollars over this thing for the way they have behaved.

That same guy also had some choice words for the politicians critical of AIG’s dealings:

They only care about the next election, just like we only care about the next bonus. Well, none of them cares about the country, none of us cares about the institution. They really don’t care, and I really don’t care. And frankly, if a trillion dollars gets lost, fine.

It’s unclear whether this particular angry person was aware that he had just conceded precisely how shallow he really is.

President Obama’s economic team is now open to housing the consumer regulator inside another agency, such as the Treasury Department, though they still prefer a stand-alone agency. In either case, they are insisting on a regulator with political autonomy and real teeth so it can effectively enforce rules designed to protect consumers of mortgages, credit cards and other financial products.

Politically, this was probably inevitable. Republicans are unanimously opposed to a new stand-alone agency, arguing that it would represent just another lumbering bureaucracy incapable of tying its own shoes. They fear it would become the EPA of the finance world (i.e., that it would hinder companies’ ability to do exactly what they want). They aren’t going to vote for such a plan, particularly since Sen. Bob Corker (Tenn.) — the Republican leading the negotiations with Banking Committee Chairman Chris Dodd (D-Conn.) — is as adamantly opposed as the rest of his caucus.

Translation: The banks may be unpopular, and they may be the reason that the global economy collapsed, but their influence over lawmakers still ensures that they’ll get most of what they want on Capitol Hill.

That little inconvenience hasn’t dissuaded the Obama administration from proposing a $30 billion small-business loan program using repaid TARP cash. But it does set the White House up for a good deal of criticism from budget hawks. On cue, Sen. Judd Gregg (N.H.), senior Republican on the Budget Committee, issued a statement today reminding Democrats that “TARP is not a piggybank.”

Under the TARP law, repaid TARP funds must be used to reduce the debt — and given that we will have a $1.6 trillion deficit this year and the Senate just voted to increase the debt limit to more than $14 trillion, the requirements of the TARP law should not be changed…

TARP dollars should not be used as a slush fund for the President’s other priorities. The TARP program should end immediately, and, as the TARP law requires, all repaid funds should be used to reduce our staggering debt burden, not used in a way that will add to it.

Gregg would know. He authored the TARP provision requiring any returned funds to go toward debt reduction.

Volcker, of course, will be defending the proposed regulations, which would limit both the size and the trading activities of Wall Street’s largest firms. (After all, he wrote them.) Don’t expect the same enthusiasm from Gerald Corrigan, managing director of Goldman Sachs, or Barry Zubrow, executive vice president of JPMorgan.

The question remains: Can the Democrats pass tighter restrictions on the nation’s banks — a long-term strategy designed to prevent another Wall Street collapse — even as they’re pushing short-term fixes to stimulate the ailing economy?

Rep. Dennis Kucinich (D-Ohio) and Treasury Secretary Timothy Geithner (WDCpix)

To hear Treasury Secretary Tim Geithner tell the tale, the federal officials negotiating the taxpayer bailout of American Insurance Group had no choice but to provide full payment to the company’s trading partners, including Goldman Sachs.

“There was no way, financial, legal, or otherwise, we could have imposed haircuts, selectively default on any of those institutions, without the risk of downgrade and default,” Geithner told lawmakers on the House Oversight and Government Reform Committee last week.

[Economy1]Don’t tell that to Rep. Dennis Kucinich. The Ohio Democrat — who heads the committee’s domestic policy subpanel — says that federal officials had plenty of leverage to push Goldman for a lesser payout, but simply chose not to use it. Indeed, an investigation by his office, Kucinich says, found that Goldman was already preparing to take less than 100 cents on the dollar for the complex, AIG-backed securities it held at the time. He’s charging that Geithner — who headed the New York Federal Reserve when it funneled billions of dollars through AIG to other firms — simply put Goldman’s interests above those of taxpayers.

“There was only one way for Goldman Sachs to get all of the billions they claimed from AIG, and that was if the New York Fed voluntarily agreed to give it to them,” Kucinich, the populist former mayor of Cleveland, said in a little-noticed exchange with Geithner last week. “If the Fed had fought for taxpayers, Goldman would have had to take some losses and the cost to the people could have been minimized.”

Some legal experts agreed. “This ‘legally obligated’ stuff is a lot of nonsense,” said an expert on the Wall Street bailout who wasn’t authorized to speak on the record. “They [Fed officials] are only as legally obligated as they want to be.”

That Goldman is such a powerful player in Washington politics (then-Treasury Secretary Henry Paulson once headed of the firm) could only have contributed to the decision to pay on par, the expert noted. “The idea of imposing a haircut [on Goldman] just kind of wasn’t in the bloodstream of the people involved.”

The controversy stems from the $27 billion the Fed paid in late 2008 to settle roughly $62 billion in insurance contracts that AIG held with a number of large firms. As the mortgage market tanked, AIG had paid out billions to those companies — collateral based on the falling value of the securities. But the banks were all scrambling to cash out on the balance because they were allowed to make more collateral calls as AIG’s credit rating was being downgraded — and because the value of those mortgage bundles was still sinking fast. Effectively, the Fed scrapped the insurance contracts and bought the securities outright. “We paid the fair market value at that time for the assets,” Geithner said last week.

Critics of that arrangement have long wondered why the Fed agreed to pay the full amount, rather than negotiate a better deal for the taxpayers footing the bill. More recently, the scandal has surrounded news that the Fed, at the time, tried to hide those full payments from the public.

The gist of Kucinich’s beef, which focuses just on Goldman’s contract, is more nuanced: Because of a months-long disagreement with AIG over the value of the underlying securities, Goldman took out supplemental insurance policies on $2.5 billion it feared it would lose if AIG failed — much like seniors take out supplemental health policies to cover services that Medicare doesn’t. Goldman executives have said repeatedly that, aided by those policies, the firm was fully protected in the event that AIG went under.

“If AIG had defaulted on its obligations, our shareholders would have been protected against loss because we were fully hedged,” Goldman spokesman Michael DuVally said in an email Friday. “But, because AIG could meet its obligations, it avoided default.”

Left unmentioned, Kucinich says, is that Goldman’s supplementary policies were invalid in the case of a government takeover of AIG — which was the only way the insurance giant was ultimately able to meet its obligations. Translation: After the government stepped in to rescue AIG, Goldman was in a position to lose $2.5 billion, leaving the Fed with a good deal of leverage to negotiate lower payments on behalf of taxpayers.

“The New York Fed had a lot of leverage — a lot of leverage — to negotiate a reduction which would have saved taxpayers billions,” Kucinich told Geithner.

He wasn’t the only lawmaker making a stink about the deal. Rep. Stephen Lynch (D-Mass.) blasted Geithner over the Goldman payments, arguing that Fed officials had “every opportunity” to negotiate a better arrangement for taxpayers.

“The commitment to Goldman Sachs trumped the responsibility that our officials had to the American people,” Lynch said.

Geithner, for his part, fought back against all the critics. The Treasury secretary argued that — because current law doesn’t allow regulators to unwind troubled investment houses the way they can unwind failing commercial banks — officials were left will little choice but to prop up AIG and make good on all of its financial obligations. “We faced a very simple choice: Let AIG default or prevent it,” Geithner said. Allowing the former, he maintained, would have led to an economic collapse much worse than the one that occurred.

“Thousands of more factories would have closed their doors,” he testified. “Millions more Americans would have lost their jobs. The value of Americans’ houses and savings would have fallen even further than they did at that time. People would have rushed to take their money out of banks. It would have brought about utter collapse.”

A March 2009 report from the special inspector general of the Troubled Asset Relief Program indicates that AIG’s trading parties were well justified to fight for full payment on behalf of their shareholders. “[F]rom the counterparties perspective, offering a concession would mean giving away value and voluntarily taking a loss, in contravention of their fiduciary duty to their shareholders,” the report states. “They were contractually entitled to the par value of the [securities].”

But some critics of the Goldman payments have argued that, shareholders or none, the giants of Wall Street should have shown more willingness to absorb the consequences of a financial meltdown caused largely by them.

“Workers around the country are being asked to take pay cuts and accept shorter work weeks so that colleagues won’t be laid off,” former New York governor Eliot Spitzer wrote last year. “Why can’t Wall Street royalty shoulder some of the burden?”

Instead, champagne-sipping Goldman employees are celebrating their bonuses this month.

Kucinich, representing a part of the country decimated by foreclosures in recent years, preferred to focus his criticisms not on the firms, but on the federal officials charged with protecting the public.

“The government gave Goldman Sachs more than Goldman Sachs had any right to expect while at the same time giving no financial relief whatever to millions of Americans facing a foreclosure crisis,” he told Geithner. “If that doesn’t illustrate what the New York Fed thought it was working for — or who it was working for — I don’t know what does.”

During today’s House hearing on AIG’s bailout, a central focus was on why AIG’s counterparties — including giants like Goldman Sachs — were paid in full rather than being asked to take a pay cut, considering the degree of the taxpayer-funded intervention (particularly since no less an authority than Treasury Secretary Tim Geithner has said that those payments were insignificant to the goal of rescuing the larger economy).

Today, Geithner said that officials at the New York Federal Reserve, which Geithner headed at the time, tried to negotiate with those counterparties in an attempt to have them accept less than 100 cents on the dollar.

“Relatively quickly, and not unexpectedly, we discovered that most firms would not, on any condition, provide such a concession,” Geithner said. “One said that it was willing, but only if everybody else would agree to equal concessions on their prices.”

Later in the hearing, Neil Barofsky, special inspector general of the Wall Street bailout, revealed that the one volunteer (of eight counterparties) was UBS, the Zurich-based financial giant. Asked by Rep. Eleanor Holmes Norton (D-D.C.) why UBS might have been willing to make that sacrifice, Barofsky speculated that the firm probably simply recognized that the American taxpayers “had taken the global economy on its back.”

The question is: Why didn’t the other seven firms recognize that as well?

The controversy in recent weeks has centered not on the money that went to AIG, but the money that went through AIG to some of the other Wall Street giants to which AIG owed cash. In the process, AIG paid those firms, including Goldman Sachs, 100 cents on the dollar — an arrangement that some Fed officials lobbied (unsuccessfully) to conceal from the public. Geithner on Wednesday reiterated his earlier statement that although he was head of the New York Fed at the time, he took no part in the decisions surrounding disclosure of those payments. He also defended the decision to allow AIG to pay back Goldman and the others on par, arguing that the only legal way to ask those firms to accept less would be to allow AIG to default — a scenario, he said, that would have devastated the financial sector and the economy as a whole.

The counterparties held insurance entitling them to full or par value of the contract. We could not credibly threaten not to pay. That meant putting AIG into bankruptcy. At the time, we were working desperately to rebuild confidence in the financial system. Any suggestion that we might let AIG fail would have worked against that vital aim. We could not risk a protracted negotiation.

Lawmakers, for their part, were having none of it. Rep. Marcy Kaptur (D-Ohio) implied that finance officials put the interests of Goldman above those of taxpayers. Rep. Dan Burton (R-Ind.) said “it stretches credibility” that Geithner, as head of the New York Fed, wouldn’t have been involved in the disclosure discussions. Rep. Stephan Lynch (D-Mass.) wondered why officials “scalped” the shareholders of Bear Stearns, but made sure to pay off Goldman in full. Rep. John Mica (R-Fla.) simply asked Geithner to resign.

The hearing, called by Democrats, highlights the pickle facing the White House in a tough election year. In short, the Obama team chose Geithner because, as a friendly face to Wall Street, he could step into the Treasury spot without scaring the hell out of the banks. (Indeed, the markets soared when the country learned of Obama’s choice.) But he hardly fits the populist image that the administration is hoping to resurrect after the special Senate election in Massachusetts last week — a wake-up call to Democratic leaders who are scrambling to reframe their message before November.

Two questions for the White House: (1) Can you keep Geithner in place and still create the impression among disgruntled voters that you’re serious about taking on Wall Street? And (2) if you choose to replace Geithner, who could fill the office and be the face of populism without causing the markets to tank?

Yesterday, Grassley was at it again, asking Kenneth Feinberg — executive pay czar for the Troubled Asset Relief Program — for details of yet another enormous AIG severance deal, this one to Suzanne Folsom, the company’s former chief compliance and regulatory officer. AIG announced last month that Folsom left “to pursue other opportunities.” She was reportedly given more than $1 million in the process.

Grassley wants the details surrounding Folsom’s windfall, including “copies of all severance plans or arrangements signed by Ms. Folsom.”

You can already hear the complaints from Wall Street: Who cares about $1 million in this universe of billion-dollar payouts and trillion-dollar leverage arrangements? But that, of course, is precisely the sentiment that led to the historic bank collapse.

Over the weekend, Bernanke won the endorsement of Sens. Chris Dodd (D-Conn.), who chairs the Banking Committee, and Judd Gregg (N.H.), senior Republican on the Budget Committee. That was on top of Senate Majority Leader Harry Reid’s (D-Nev.) approval announced a few days earlier. And this morning, Sen. Max Baucus (D-Mont.), who heads the Finance Committee, added his name to the list of supporters, arguing that, faced with the greatest economic turmoil in generations, Bernanke’s decision-making “brought us back from the brink of economic disaster.”

I have full faith he will continue to use his post as Chairman of the Federal Reserve to create jobs, help middle class families and continue to get our economy back on track.  These past two years have revealed flaws in our regulatory system that must be addressed with strong and comprehensive regulatory reform.   It is clear that we face many serious challenges moving forward which is why I will vote to confirm Chairman Bernanke for another term.

Bernanke’s term expires at the end of the month.

Yet, according to Reuters, that’s precisely what has happened.

Geithner, Reuters says, “has expressed some skepticism behind closed doors about the broad bank limits proposed on Thursday by his boss, President Barack Obama, according to financial industry sources.”

The sources, speaking anonymously because Geithner has not spoken publicly about his reservations, said the Treasury chief is concerned the proposed limits on big banks’ trading and size could impact U.S. firms’ global competitiveness.

Some economists are already doubting the effectiveness of the proposed reforms to prevent the types of lending that led to the economic collapse. That failure is all but guaranteed if even the administration’s own finance officials aren’t on board.

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