Why Bail Out AIG's Bondholders?

Much as the prospect of an AIG bankrupcy terrifies me, I'm not a fan of an $85 billion government bailout either. Bond investors have already taken enormous mark-to-market losses on their AIG paper; if they realized just a fraction of those losses, that would provide AIG with a huge proportion of its needed capital right there. Instead, it seems that they're being bailed out.

AIG has about $190 billion in debt outstanding, which has a market value of about $65 billion. So conceptually it should be possible for someone to buy that debt for $100 billion, forgive the $75 billion of new capital that AIG needs, and still end up $15 billion ahead. AIG would be solvent again since its liabilities would have shrunk by $75 billion; its bond investors would make a mark-to-market profit of 50% on where their bonds are trading right now; and the white knight with the $100 billion would make a tidy profit to boot, so long as the remaining bonds were worth more than 87 cents on the dollar, which they would be.

Instead, the proposed bailout, far from reducing AIG's liabilities, seems to comprise increasing them by another $85 billion. It also seems to leave all existing bondholders with a haircut of precisely zero -- effectively trebling the value of their bonds overnight.

Why should holdco creditors get back 100 cents on the dollar after making such a dreadful investment? They shouldn't. There's a strong case for bailing out policyholders, or people who bought financial insurance (credit default swaps) from AIG. The case for bailing out those who lent to AIG directly, however, is much weaker.