Management at AIG (AIG) has calculated exactly how much money the Treasury and Fed will have access to after all of the TARP, financial stimulus, and mortgage bailout projects have been funded. The insurance company then plans to ask for whatever is left  to fund its deficits so that it can stay in business, effectively making the federal government insolvent.

According to CNBC, AIG is about to post another huge loss. “Sources close to the company said the loss will be near $60 billion due to writedowns on a variety of assets including commercial real estate.” The financial channel also reports that the need for capital may be so great that AIG might have to enter Chapter 11, something the government has spent over $130 billion trying to prevent.

Just like Detroit, Bank of America (BAC), and Citigroup (C), AIG is playing a game of chicken with Washington that the government does not feel it can afford to lose. Imagine what it would be like if all of these businesses failed at the same time.

It is actually worth imagining. The government has so many balls in the air between the financial systems and deteriorating parts of the industrial sector that it may not have either the capital or intellectual capacity to go around. The Treasury has just appointed a prominent investment banker to help oversee the mess in Detroit, but it would take an army of financiers to first comprehend and then advise on what should happen to GM (GM) and Chrysler. The period for comprehension is already in the past. The trouble in the auto industry has to be addressed in the next few weeks or its capacity to operate will go up in flames.

The government made noises about taking a larger position in Citigroup (C). Based on the market’s reaction, not may analysts and investors believe that the action will solve much. The poison of bad investments is in the blood of the financial system. Quarantining Citigroup will not solve that problem. The Treasury and Fed will have to take a holistic approach which involves healing the entire financial system. It is not clear that can even be done. How it would be done is an even more complicated matter.

The Little Dutch Boy is running out of fingers. The water that threatens to swamp the international financial system is getting closer to breaching the walls and pouring in. A month ago that seemed inconceivable. Now the odds that the government will have to allow large operations like AIG go into bankruptcy are fairly high. The trouble with that is not what will happen to AIG. As the market found out with the Lehman Brothers bankruptcy, many of the firms that are doing business with a very large financial institution when it becomes insolvent can have transactions worth billions of dollars wither voided or devalued.

In the intricate global financial system, there is no such things as one big player going down in a vacuum.

Douglas A. McIntyre

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