Corrects the bailout figure in paragraph 5 to $180 billion

WASHINGTON - The top two U.S. financial officials told lawmakers angry over bonus payments to AIG executives that the government needs authority to shut down troubled institutions like the giant insurer to avoid future bailouts.

U.S. Treasury Secretary Timothy Geithner, testifying before a key U.S. House of Representatives committee, took the lead in calling for new powers to take over big non-bank financial companies that run amok.

Federal Reserve Chairman Ben Bernanke strongly backed Geithner at the House Financial Services Committee hearing, calling American International Group Inc a poster child for the need to update financial regulation.

Geithner and Bernanke appeared before Congress a day after the Treasury secretary formally unveiled the government's latest financial rescue plan -- a program aimed at absorbing up to $1 trillion worth of toxic assets keeping lending frozen.

They were joined by New York Federal Reserve Bank President William Dudley, who said he was confident that AIG would eventually repay the taxpayers for a bailout worth up to $180 billion. However, Dudley declined to rule out the possibility that more funds might need to be put on the line.

AIG ran a respected global insurance company but also had a division dealing in derivatives contracts. The division -- which has been likened to a hedge fund grafted to the insurer -- suffered huge losses when the U.S. housing sector imploded and put the whole firm at risk of collapse.

AIG highlights the urgent need for new resolution procedures for systemically important non-bank financial firms, Bernanke told the House committee.

Lawmakers are still fuming over the payment of some $165 million in bonuses to executives at AIG.

Geithner called the bonuses deeply troubling and said he had demanded AIG reduce future bonus payments by hundreds of millions of dollars.

Anger over the AIG bonuses erupted on Capitol Hill last week, and the House passed legislation that would claw back almost all of the money paid out. The Senate has yet to act.


Geithner, Bernanke and Dudley argued that saving AIG was the right thing to do because its global reach meant its failure might severely damage the world economy.

Conceivably, its failure could have resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income and jobs, Bernanke said.

Geithner was harsh in his description of the London-based AIG financial products division that had become a counterparty on derivatives contracts to major financial institutions and other entities around the world. Those contracts went bad.

This division was an unregulated entity operating in unregulated markets, he said. The problem is that there is no legal mechanism for winding down a non-bank financial institution like AIG, the Treasury secretary said.

Geithner said Congress should grant the government new authority to make loans to a troubled institution, buy its obligations, take over its liabilities or possibly take an ownership stake in it while it regains its footing.

House Republican leader John Boehner told reporters the Treasury's request for authority to shutter non-bank financial firms sounded like an unprecedented grab of power.

Democrats were more supportive, although the No. 2 Democrat in the House said he wanted to move forward with care.

I'm not prejudging the issue; I'm just saying at this point in time I want to look at it more carefully, House Majority Leader Steny Hoyer of Maryland told reporters.


The proposal sketched by Geithner would enable the government to step in to act as a receiver for troubled non-banks.

In that capacity, it would gain sweeping powers like the right to sell or transfer assets of non-bank financial institutions that get in trouble. The government would also get the authority to renegotiate contracts, including pacts with employees, and to halt the termination of contracts if necessary.

In effect, the government would be able to deal with non-banks in the same way that the Federal Deposit Insurance Corp (FDIC), a banking regulator, does with banks when it steps in to shut them down.

The FDIC will typically run a seized bank until it gets it in shape to reopen under new ownership or to be taken over by another, healthy bank.

FDIC Chairman Sheila Bair has hinted that her agency might be able to take on such a role for non-banks as well, leaving room for debate over where such powers should rest if lawmakers approve them.

(Additional reporting by Alister Bull, David Lawder, Corbett B. Daly, Karey Wutkowski and Susan Cornwell; Editing by Dan Grebler)