Update: Despite the fanfare around the Obama administration’s recent announcement that it will require bailed-out firms Citigroup, General Motors, Bank of America, Chrysler, AIG, GMAC and Chrysler Financial to cut executive compensation dramatically among certain employees, as reported in the New York Times, these pay restrictions don’t address AIG’s failure to pay back its bonuses, as Greg Kaufmann outlines below, or its plan to spend $198 million on bonuses this year.

It was bad enough this past March when–after taxpayers had doled out a mere $180 billion to save AIG and took an 80 percent stake in the company–Americans watched in utter disbelief as the very division responsible for the insurance giant’s collapse received $168 million in so-called retention bonuses.

Now Nightmare on Wall Street continues–coming March 2010 to a theater near you, as AIG plans on upping the bonuses for its Financial Products division to $198 million, bringing the total to $426 million since December 2008.

This was just one of the mind-boggling chapters of the AIG misadventure on display during last week’s House Committee on Oversight and Government Reform hearing with Neil Barofsky, special inspector general of the Troubled Asset Relief Program.

Chairman Edolphus Towns, who has emerged as a leader in trying to uncover what really happened during the financial meltdown, noted that in response to the public outcry over the last round of bonuses, AIG at the time agreed to repay $45 million to the government.

“How much of that really was collected?” asked the chairman.

“As of the conclusion of our audit’s fieldwork in August, $19 million had been collected,” said Barofksy.

If you are hoping for a reason with some semblance of legitimacy, guess again. In fact, AIG just wants to see whether it will get the nearly $200 million this coming year before it makes good on its pledge.

“They want to see what they’re going to be getting after [pay czar Kenneth] Feinberg conducts his review of the $198 million [scheduled for] next March, before they commit, or fulfill their commitment, to pay back the bonuses,” said Barofsky.

Despite the fact that the American people now own 80 percent of AIG, Feinberg can only make a “recommendation” regarding the upcoming bonuses, since these contracts were signed before February 11 and therefore are exempt from any restrictions under the American Recovery and Reinvestment Act (ARRA). It really doesn’t matter one iota whether these bonuses are in the best interest of the public.

“Who could have had the power to insert that provision?” asked Ohio Congresswoman Marcy Kaptur. “It wasn’t in the House bill. How did that get in there?”

“My understanding is that Senator Dodd introduced the amendment,” said Barofsky. “The net effect…is that the TARP does not prohibit these types of bonus payments if the bonus plan was offered prior to that date.”

Maybe it was a fiscally sound move for Dodd, the Senate Committee on Banking, Housing and Urban Affairs chairman who was perhaps looking to replenish his war chest before a tough re-election bid. But it wasn’t so great for the rest of us.

“I think most members of Congress, if you surveyed them, don’t even realize that that provision was in the recovery bill that was passed earlier this year,” said Kaptur. “It takes a lot of power to insert a provision like that that literally puts the firewall up against us going after those bonuses.”

Towns pointed out that while the public and press were focused on the most outrageous of the bonuses–the $168 million in bonuses paid to the failed financial products division–the fact is that after the Fed extended the initial $85 billion line of credit to AIG in September 2008, it “learned that AIG had planned to pay over $1.7 billion in bonuses and retention plans” to its 50,000 employees worldwide.

Barofsky said those were the “approximate” numbers. The AIG compensation structures, he explained, were “a mess so sprawling that even as we concluded our audit late this summer, executives–at the Federal Reserve Bank of New York, at AIG–and the Fed’s consultants still did not have their arms wrapped around the entire AIG executive compensation structure.” In all, auditors have found “more than 600 different programs–some entitled bonuses, some deferred compensation, some, retention plans.” According to Barofsky, AIG never knew where all the money was going, and still doesn’t.

As for the $168 million in “retention bonuses” paid to “essential personnel” who otherwise would have walked out the door and shopped around their golden résumés–former employee AIG Financial Products division–it turns out those particular bonuses weren’t quite so limited in scope.

“I too was left with the impression after the hearings and all the public announcements that these payments were going to those who were necessary and involved, who unwind these complex transactions,” said Barofsky. “And it was one of the things that surprised me the most as I saw the audit work come in: that [bonuses were going] essentially to every single employee at Financial Products.”

Maryland Democratic Congressman Elijah Cummings, who in 2008 wrote and met with AIG for assurances that the bonuses would be limited, said, “AIG was disingenuous at best and outright deceptive at worst…. Somebody simply was not telling the truth.”

One would think that the initial discovery in September 2008 of $1.7 billion in scheduled bonuses might have raised an eyebrow or two at the Fed–or at Treasury–after the next $40 billion was handed over to AIG through TARP in November 2008.

But Barofsky said the Fed was looking at AIG from a creditor’s perspective, and the bonuses were “just a drop in the bucket compared to their overarching concern, which was paying back the debt. They were not concerned.”

Treasury, on the other hand, should have been looking out for the return the American people were getting on their investment. But Barofsky said the agency completely outsourced any oversight responsibility to the Federal Reserve Bank of New York–run at the time by now Treasury Secretary Timothy Geithner. (More on that later.)

“When Treasury outsourced its oversight to the Federal Reserve, Federal Reserve had a far different interest and approach to executive compensation than what Treasury had to do as an investor on behalf of the government people,” said Barofsky.

“There was a breakdown in communications between Treasury and the Federal Reserve regarding AIG’s plan?” asked Towns.

“I think that would be kind to [call it] a breakdown,” said Barofksy. “After Treasury invested the $40 billion, communications were virtually nonexistent.”

That’s why Treasury didn’t know about the $168 million in retention bonuses until two weeks before payment; and even then it took ten more days to get the news to Geithner, according to the audit.

“It was a failure of oversight by Treasury,” said Barofsky. “It was a failure of communications, and it was a failure of management.”

Congressman Dennis Kucinich wasn’t buying the notion that Geithner–who ran the Federal Reserve Bank of New York when this madness began–still didn’t know about the bonuses just four days before they were paid in March.

“Given Mr. Geithner’s heavy involvement in the bailout of AIG, as the president of the Federal Reserve Bank of New York,” said Kucinich, “it’s really hard to believe that he wasn’t informed of the retention bonuses for AIG-FP [Financial Products] employees prior to March 10, especially since they were awarded retention bonuses of $69 million in December 2008.”

Barofsky said there was “no evidence” that anyone informed Geithner of the “size and scope” of the bonuses.

Ranking Member Darrell Issa and his Republican colleagues smelled blood. “So we have a secretary of the Treasury who failed to know what he should have known, failed to do what he should have done and has failed to give us transparency,” Issa said. “I believe that it’s now time for us to bring Secretary Geithner here.”

Kucinich also said Congress should think twice before expanding the Fed’s powers as the single systemic risk regulator, as many–including the Obama administration–propose.

“We better look twice before we consider giving the Federal Reserve any more power,” Kucinich said. “They can’t keep track of small matters, let alone large matters. Time for us to start thinking about changing the direction we have with that institution.”

In the meantime, what to do about the next round of $198 million in retention bonuses? Despite owning 80 percent of AIG, the government has no one on the board of directors and can only offer the aforementioned recommendation. “I think sometimes it’s important for the federal government to recognize the leverage that is associated with having such a significant ownership interest when seeking to renegotiate these payments,” said Barofsky. “We specifically note one opportunity that was lost…was the fact that $30 billion more of taxpayer money was coming down the pike in March of 2009. And this would have been an opportunity to go back and compel a renegotiation.”

Compelling Wall Street to do something with the trillions of dollars we’ve handed them. Now there’s a novel idea.

In two weeks the pay czar will appear before the committee. Stay tuned, and consider letting your legislators know you’re watching.