AIG - A question for our readers

Last night’s shocking bail out of AIG hasn’t done much to calm the fears roiling through the markets this morning. It has, however, got me to thinking.

Clearly Paulson felt he was in a no-win situation, and made a decision based on the cold calculus of pragmatism. He ahd to decide which was the lesss terrible of two terrible options:

1) Let AIG fail, watch the shockwaves ricochet around the globe, and try to play defense – using small and quick interventions in the market to manage what would likely have been a huge crash in world markets. Essentialy this is the “let it blow up, then pick up the pieces” strategy


2) Bail out AIG, using the treasury to backstop souring credit and derivatives markets. this has the virtue of avoiding a crash, and possibly even turning a profit on AIG’s assets if the situation stabilizes over the next few months. The downside, as we’ve discussed, is the aspect of moral hazard. You are rewarding fools and crooks, forcing taxpayers to pay for their mistakes, and opening the government to a never-ending expectation of further bailouts every tie a major industry runs into trouble. It also, implicitly, encourages reckless bets in the financial markets, making future panics more likely and perhaps even more devastating. Essentially this is the  “save today and tomorrow is somebody else’s problem” strategy.

So, here’s my question:

Under what conditions would multi-billion-dollar bailouts of private businesses be acceptable?  What are the criteria you’d use, if you were Paulson for deciding when it is prudent to use public money to save private business?

I have my own thoughts on this, but I’d like to know what our readers and/or other contributors think.