A new report by GAO on Uncle-Sam-dependent AIG finds that the insurance giant is "stabilizing" due to the $182 billion in financial assistance from the Treasury Department and the Fed. However, the report's summary also notes that:

Indicators of AIG’s repayment of federal assistance show some progress in AIG’s ability to repay the federal assistance; however, improvement in the stability of AIG’s business depends on the long-term health of the company, market conditions, and continued government support. Therefore, the ultimate success of AIG’s restructuring and repayment efforts remains uncertain.[empahsis mine]

"Uncertain." That's an understatement.

The report suggested that A.I.G. would struggle just to stay current on its government debt, much less repay it. Under the initial bailout agreement, A.I.G. was to pay a 10 percent dividend on preferred stock, in exchange for $40 billion in capital from the Treasury. A quarterly dividend payment of about $1 billion is coming due in November. The company does not appear to have the means to pay it, and was granted the option of not paying as part of a debt relief package in March. If the company misses four payments, though, the Treasury can elect two directors to its board.

The report also cast questions about a debt restructuring with the Federal Reserve Bank of New York. The plan, outlined in March in broad strokes, would allow A.I.G. to extinguish about $8.5 billion of debt by giving the Fed an ownership stake in the future cash flows of its domestic life insurance businesses. The transaction has not been scheduled nor have details been disclosed, and it is not clear that the insurance units really have $8.5 billion to spare.

AIG's business model depended on revenues generated from insuring risky financial assets, the values of which were based on the bet that the $8 trillion housing bubble would continue to inflate, and indeed, never pop. When the inevitable happened, AIG was left holding the bag -- a bag full of billions in bad debt. If AIG made good on its bets insurance policies, the balance sheets of the firms holding the worthless-but-insured assets would remain just peachy.

Instead, however, AIG didn't actually have the cash on hand to cover its bets insurance policies, which meant that the worthless assets of the financial institutions turned out to be, well, worthless. Consequently, those firms' creditors balked as they wondered if those firms were viable businesses. And this turned out to be a massive credit crunch, and according to Fed and Treasury officials, would spell doom - DOOM! - for the entire economy.

The Fed and Treasury might very well have been correct that backstopping the assets insured by AIG was necessary to prevent an economic collapse. But, since AIG has spent the funds to prop up the values (100 percent, mind you) of tens of billions of dollars in bad assets, the government will have to wait for repayment until AIG's profitable units can afford to make good on its loans. And that could take a very long time.

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