A special inspector general said Wednesday that U.S. Treasury Secretary Timothy Geithner was ultimately responsible for a "failure of management" surrounding American International Group Inc. (AIG)'s $168 million in retention bonuses.

Special Inspector General Neil Barofsky, who is responsible for oversight of the U.S. government's financial bailout actions, said Geithner, formerly president of the Federal Reserve Bank of New York and now the top Treasury official, had to answer for a lack of communications between the two agencies over the politically explosive bonuses. But Barofsky also spread blame broadly across the Treasury Department, which he said "outsourced its oversight."

In his testimony before the House Committee on Oversight and Government Reform, Barofsky cited the Treasury Department's inadequate oversight of AIG's compensation plans, the complexity of which bogs down even AIG's human resources officers, he said.

"This was a failure of communications, a failure of management," Barofsky said. He highlighted the fact that the Treasury Department did not find out from better-informed officials at the Federal Reserve Bank of New York about the $168 million of retention payments for employees in the insurance company's troubled financial services division until two weeks before they were issued last March. And even when Treasury Department officials found out about the imminent payments, they did not alert Geithner for an additional 10 days, he said.

Ranking member Rep. Darrell Issa, R-Calif., said Geithner was uniquely positioned to be aware of the impending payments, but did not stop them.

"He failed to know when he should have known, he failed to stop them when he should have at least halted for a review," said Issa. Committee Chairman Edolphus Towns, D-N.Y., asked Barofsky if he would characterize the lack of cooperation as a break-down in communications between the Treasury and the New York Federal Reserve.

"I think that would be kind, to have it as a breakdown," Barofsky said. "Communications were virtually nonexistent."

As guardian of the taxpayer-funded bailout, the Treasury Department had specific responsibilities to oversee executive compensation that the New York Fed did not, Barofsky said. To the New York Fed, the $168 million in retention payments was not significant compared with the size of the government's $180 billion bailout of the insurance company and did not identify it as a politically sensitive issue.

"They didn't think it was that big a deal - $168 million was a drop in the bucket," Barofsky said. "Their concern was paying back the debt. The Federal Reserve was looking at this as a creditor."

In its formal response included with Barofsky's report, the Treasury Department said it intended to implement his recommendations.

"Treasury agrees with the importance of effective communication when various federal agencies have a role in executing TARP programs," wrote Assistant Secretary for Financial Stability Herbert Allison Jr.

Barofsky agreed with lawmakers' comments that "retention payments" paid to AIG administrative employees, including to a file administrator and kitchen assistant, were not necessary to keep irreplaceable employees from resigning.

"Somebody who made the decision to give these bonuses made the decision to make everyone happy and not to act in the interest of American taxpayers," said Issa.

AIG has argued that it had no choice but to pay the bonuses, regardless of employee performance. Barofsky said while his audit concluded the contracts were legally binding, both AIG and Congress lost opportunities to demand renegotiation of the contracts, particularly when the company received additional bailout funds from the government.

"Just because it was a legally binding contract didn't mean there weren't other alternatives," Barofsky said. Currently the government is pursuing other options before AIG's next round of scheduled payments in March 2010, he said.

Barofsky said in any future government bailouts of this magnitude, the Treasury Department should either take on the primary oversight role or establish specific procedures to maintain communications.

There need to policies in place to ensure a "comprehensive and not ad-hoc review of executive compensation and other politically sensitive issues," Barofsky said. He also said he planned to work with "pay czar" Kenneth Feinberg to review compensation packages for the highest-paid executives at seven companies that have received special government assistance.

"That's clearly within our jurisdiction," Barofsky said.

-By Kristina Peterson, Dow Jones Newswires; (202) 862-6619; kristina.peterson@dowjones.com