The whole “Too big to fail” excuse is a red herring.
The problem wasn’t that AIG or other banks and financial institutions were too big, it’s that the problems they were having are so widespread. No bank in the world has been left untouched by the credit crunch that they’ve created for themselves. They all massively invested in these real estate instruments, basing value on anticipated sale value. So, when the housing bubble collapsed (duh!), their real estate investments all collapsed in value along with it. Suddenly, the amount of money backing up outstanding loans plummeted, and so they can’t issue new loans…
The main issue with the bailouts is the way that they’ve been structured. All the governments have done so far is to simply give these companies a ton of money. What should have been done is to attack the underlying problem directly. Governments could have, and should have, set up a system where they would purchase securities at an old (higher) price, and simply held on to them until the market straightens out some. Then, the banks would have been much healthier, and the government would have stayed out of private company ownership.
In my opinion, the way that the bailouts have been and are continuing to be structured is symptomatic of a larger issue. Politicians seem to have this need for control, so instead of dealing with the direct issue they go in and basically take over private companies. It’s silly I think.