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AIG Bailout: Breaking Up Is Hard to Do

The Fed can exchange preferred shares for common equity, thereby halting dividend payments and giving AIG more flexibility to handle its losses. Such a move would also grant the government board seats and more control over operations, but give taxpayers a heap of penny stock instead of the cold, hard cash they were promised.

Regulators may also be able to defer loan payments under revised terms, or take over some of AIG's cash-generating businesses in lieu of outright dollars.

While the U.S. government may not be interested in operating life-insurance business, such a move would not be unprecedented, notes Steuber, who says state agencies have taken over bankrupt insurers in the past. While AIG's businesses may be larger and far more complex, keeping them running under the auspices of Uncle Sam will be far less difficult - and preserve more value - than letting the firm go under or selling assets at rock-bottom prices.

After all, the government has the luxury of holding onto assets with greater economic value than the market is offering, until the market can repair its balance sheet and start making heady offers again. Such a deal might offer better return for taxpayers than all the money-losing businesses they have been forced to invest in so far.

"If I'm Tim Geithner and I want to get the best return-on-investment," says Sherman, referring to the Treasury Department chief, "I would let AIG sit tight, repair itself and then chop off the company and sell off the healthy parts. But do it in an adequate timeline, not at these fire-sale prices."

However, Paduda doesn't see this as a likely scenario. He notes that the government is handling multiple crises in the banking, auto and housing sectors, and isn't interested in running byzantine insurance operations for extended periods of time.

"There's no question the feds want to get outside of this business as fast as they can," he says. "I wouldn't be surprised to see the feds tell AIG that if they get a decent offer for whatever they've got, you have to bring it to us and you have to sell."

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