AIG: Geithner's next big headache

(breakingviews.com) -- It's not as if U.S. Treasury Secretary Tim Geithner doesn't have enough to worry about. Now, American International Group is back. The struggling insurer said on Monday that it continues to "work with the U.S. government to evaluate potential new alternatives". Unfortunately, Geithner is already familiar with the most likely not-so-new scenario.

The company is expected to report a huge $60 billion quarterly loss, according to CNBC, after writedowns on commercial real estate. That is a problem for the U.S. government, which has a 79.9% equity interest in AIG and has put $150 billion into the company in a two-stage rescue. AIG is said to be looking for a new deal, which would probably include tens of billions more of government cash.

It might sound like throwing good money after bad. Taxpayers aren't likely to be repaid in full for their past investments, never mind any new money. A government debt-for-equity swap, which is also said to be under consideration, could buy AIG some time, but wouldn't do much to improve taxpayers' returns.

The question of value for government money first arose last September. Geithner, then president of the New York Federal Reserve, played a central role in deciding to keep AIG (AIG, Fortune 500) afloat. He feared a bankruptcy of this key participant in the credit default markets would likely worsen the already traumatic post-Lehman Brothers market meltdown.

The goal then was to get AIG and its counterparties to unwind much of their CDS exposure. But massive market turbulence, not to mention post-election eddies in Washington, make it hard to believe that there has been enough progress to let AIG go without risking making an already terrible situation in the financial markets even worse.

If so, Geithner is left with only one unpalatable option: to throw more cash into the AIG money pit. That would be a bad idea in many ways -- a lousy investment, a bank-style rescue for an undeserving non-bank and a poor precedent for other desperate companies. But as long as AIG is judged too big to fail, the government will keep it going, whatever the cost.