The Perpetual Rescue of AIG, the Insurer That Was Too Big to Fail.

THE COST to taxpayers of rescuing American International Group (AIG) keeps going up. In September, the insurance giant faced a sudden demand for collateral to back guarantees it had given on troubled mortgage-backed securities. Alarmed that AIG's liquidity crunch could turn into bankruptcy -- which could, in turn, lead to the meltdown of banks around the world -- the Federal Reserve supplied it an $85 billion line of credit. The terms were tough: a two-year deal at a stiff interest rate, in return for which the U.S. government got 79.9 percent of the company and installed new management. The idea was that AIG would sell its assets to repay the government, at which point Uncle Sam would cheerfully retreat from the insurance business.

It hasn't worked out that way. Instead, the global economy plunged more dramatically than anticipated. Though AIG's core insurance business is strong and might have attracted interest under more normal circumstances, the company has been unable to find buyers at prices sufficient to repay the government. Its losses have mounted, and, with them, the need for more government aid; the bailout rose to approximately $150 billion by the end of 2008. And yesterday, as AIG announced a $61.7 billion loss in the fourth quarter of 2008 -- the largest in U.S. corporate history -- the government gave it access to an additional $30 billion. The terms of the deal are the most generous yet and convert the U.S. government from a short-term creditor of AIG's into a longer-term equity investor. Over time, as economic conditions improve, AIG may finally be able to sell itself off and repay the taxpayers. We shall see.

There are some lessons here. The first, of course, is that AIG never should have been allowed to endanger the global economy in the first place. Appended to the firm's insurance business was an unregulated "financial practices" shop that exploited AIG's triple-A bond rating to sell derivative contracts supposedly protecting counterparties against remote economic meltdown scenarios. AIG set aside no reserves against these risks, so that, when they materialized, those who had bought the company's baloney suddenly found themselves at risk of failure. And AIG's customers included pension funds and big banks across the United States and Europe: The U.S. bailout of AIG is a bailout of the global financial system more generally. This is why U.S. officials believe that it's a necessary evil, even as the costs rise.

The second lesson relates to the plight of U.S. banks, at least one of which, Citigroup, resembles AIG in its global reach. No one should be under any illusions that the process of bailing out these institutions will be quick or straightforward. More likely, we're looking at years of government involvement. It has become distressingly easy to design scenarios under which it becomes necessary for the government to get more deeply into the ownership and control of banks than it already has -- up to and including nationalization. The hard part will be getting out again.