AIG counterparty obligations may not be enforceable, but we're paying them anyway
Olga Pierce has a nice piece in ProPublica explaining why AIG is still paying its counterparties in full.
I submit that the short answer is money laundering. Paying the holders of credit default swaps in full is a convenient method of funnelling money to the banks without congressional oversight. The government has already paid out $52 billion this way. Much of that money is going to the same banks that are getting bailed out by TARP. Congress can impose conditions on TARP money, but payouts from credit default swaps count as ordinary revenue, even if that money ultimately came from TARP.
The government now owns 80% of AIG, but the feds are refusing to exert meaningful influence over the management of the company. As Pierce explains, Tim Geithner could informally pressure AIG to take a haircut on these. That is, to renegotiate the contracts and take a loss. Given that the payout is holding steady at 100%, it's fair to assume that Geithner's not trying too hard.
One excuse for not making AIG and its counterparties renegotiate is that the counterparties would sue the federal government. The really amazing part of Pierce's story is that most of the counterparties probably lack the grounds to sue:
"I don't see why it would have been necessary to pay out to the counterparties at all," said Timothy Canova, a professor of international economic law at Chapman University in California.
Such a suit may not fare well in court because some legal questions swirl  around whether the bulk of credit default swaps are legally enforceable.
Some of the swaps function like insurance policies on corporate bonds. Purchasers of such credit default swaps know that even if the bond issuer defaults, they will limit their losses. But many other swaps are more like bets (akin to buying "insurance" on another person's house), and it is unclear from a legal perspective if there is enough of an insurable interest to make the contracts enforceable.
"I say let them litigate it and let the courts decide whether they have any kind of insurable interest," Canova said.
If the UAW has to renegotiate its contracts with the Big Three in exchange for government help, AIG's counterparties should be asked to make the same sacrifice.
AIG is a black hole, but dammit, it's our black hole. Let's start acting like it.