AIG was initially bailed out for $85bn, but the total rescue package eventually cost more than $180bn.
The report said officials at the NY Fed had mismanaged the negotiations with other banks, removing the threat that AIG would go bankrupt, and had bowed to a demand from French regulators that French banks holding AIG's debt insurance be paid in full.
It criticised both the NY Fed and the US Federal Reserve for failing to use their "considerable leverage" to force AIG's partners to accept less than the full amount for the assets.
The document said 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".
As a result, billions more than necessary went to US banks including Goldman Sachs, Merrill Lynch and Wachovia, as well European banks such as Societe Generale, Deutsche Banke and UBS, it says.
William Black, a former federal regulator in Missouri, said told Al Jazeera: "We'll spend more money bailing out AIG alone than the cost of the entire savings loaned back home, which was roughly $150bn.
"This was done with zero transparency and it was done gratuitously. There was not deposit insurance behind AIG. The treasury decided to take our tax dollars and transfer them to AIG's creditors and now the new report shows they transferred it in an immensely stupid fashion."
Barofsky also faults the NY Fed, headed at the time by Timothy Geithner, the US treasury secretary, for refusing at first to reveal which banks had received billions of US taxpayer dollars supposedly intended to save AIG.
The NY Fed released the banks' names and the amount of their payoffs only after politicians demanded greater transparency.
The NY Fed and Federal Reserve Board issued a joint letter to accompany the report.
"We believe that the Federal Reserve acted appropriately in conducting these negotiations and that our negotiating strategy, including the decision to treat all counterparties equally, was not flawed or unreasonably limited," the statement said.
In its written response to the report, the US Treasury Department emphasised that the events "developed extremely quickly" and that officials did not intend to provide further assistance to AIG after the initial $85bn bailout that the report says tied their hands.
"This report overlooks the central lesson learned from [the AIG rescue]", Meg Reilly, a treasury spokeswoman, 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]"
Reilly said the proposed overhaul of financial regulation by the administration of Barack Obama, the US president, would accomplish that goal.