* Lawmakers challenge Geithner’s credibility over AIG

* One Republican calls for Geithner to resign

* Former Treasury chief Paulson backs AIG rescue

* Republican says Geithner’s defense ‘strains credulity’

(Adds testimony by special inspector general, analyst quote)

By Glenn Somerville and David Lawder

WASHINGTON, Jan 27 (Reuters) - U.S. lawmakers on Wednesday challenged Treasury Secretary Timothy Geithner’s credibility after he said he was not involved in AIG’s decision to withhold details on $62 billion the bailed-out insurer paid to banks.

Geithner held his ground at a hearing, however, insisting the government-funded rescue which cost more than $180 billion had been necessary to avert an economic collapse.

Big taxpayer-funded bailouts for AIG and other financial institutions at a time of soaring unemployment have angered voters. Economic worries helped put a Republican into a Senate seat long-held by Democrats in Massachusetts last week, serving notice to lawmakers facing reelection in November.

“Why shouldn’t we ask for your resignation as secretary of the Treasury?” Florida Republican John Mica demanded. “I think you’re punting the blame ... I believe we’re not getting the whole story.”

The populist backlash has heaped pressure on Geithner and threatened to scuttle Ben Bernanke’s bid for a second term as chairman of the Federal Reserve -- the U.S. central bank. Both men are architects of the financial rescue.

“It was a circus and what I saw I thought Geithner handled it well and that the adults on Capitol Hill will recognize that,” said Kevin Krueger, an analyst with Concept Capital in Washington.

Democrats and Republicans alike expressed doubt Geithner, who led the New York Federal Reserve Bank at the time, could have been in the dark over a decision by American International Group Inc AIG.N not to disclose for months details of billions of dollars the insurer paid banks to settle swaps contracts.

The payments amounted to letting Wall Street “loot the corpse” after the government had propped up AIG, said Edolphus Towns, the New York Democrat who chairs the U.S. House of Representatives Oversight Committee.

PROTECTING TAXPAYERS

AIG’s trading partners received 100 cents on the dollar to settle the swaps deals and lawmakers questioned why taxpayers did not get a better deal.

Geithner held steadfast to his defense that he had withdrawn from decisions by the New York Fed, which led the AIG bailout, after he was nominated to the Treasury post in late 2008. He forcefully defended his role in helping rescue the insurer.

“For the first time since the Great Depression you were seeing a full-scale run on the financial system,” Geithner said, his temper occasionally flaring.

He said he had “no role in making decisions regarding what to disclose about specific financial terms” of the AIG rescue in November 2008, a bailout that eventually grew to cost more than $180 billion.

Neil Barofsky, special inspector general for the Treasury’s $700 billion financial rescue fund, questioned whether the New York Fed and Treasury could have taken a harder line with bank counterparties, rather than paying them at par.

“They could have just tried a little harder,” he said. “It may have resulted in saving U.S. taxpayers billions, if not tens of billions of dollars. We’ll just never know.”

GEITHNER SHOWS REMORSE BUT DEFENDS DECISIONS

Geithner ceded little ground during the 2-1/2-hour grilling but did express some remorse at AIG-related decisions taken after he had recused himself.

“In retrospect I wish I’d known” that AIG was keeping details quiet about the names and amounts of payments it was making to banks, he said.

Geithner insisted, however, that the decision to save AIG was “the best of a terrible set of choices” the government faced. “People were taking their savings out of the banks, they were wondering if a dollar was a dollar ... There was a basic calamitous breakdown in the fabric of our system.”

Henry Paulson, who was Treasury secretary when the initial decision to bail out AIG was taken, denied any knowledge of AIG’s payments to banks, saying the Fed had authority to deal with counterparties. He backed Geithner’s position that an AIG rescue was necessary.

“The decision to rescue AIG was correct and I strongly supported it,” he said.

Several lawmakers protested that not enough effort was made to negotiate “haircuts” or discounts with bankers. They said New York Fed officials had concurred with an AIG decision not to reveal the names of banks that got payments, or amounts.

Democratic staff members said they had found no evidence in hundreds of thousands of pages of documents subpoenaed by the committee to suggest Geithner was directly involved in decisions on the bank payments.

Rep. Dan Burton, an Indiana Republican, said, however, it "stretches credulity" to believe Geithner was not aware AIG was keeping quiet on details of its payments to banks. <For Insider programming, please click on link.reuters.com/dud26h> (Editing by Andrew Hay)