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AIG bailout profits came with a price

SAN FRANCISCO (MarketWatch) -- As the government readies what will be the biggest sale of American International Group Inc. stock since it bought the insurer in 2008, the profits may be realized, the financial system saved, but the price was steep.

The Treasury Department said Monday it plans to sell $18 billion in AIG (AIG) stock, an amount that would lower its stake to a minority position for the first time in five years. The sale also is expected to turn a profit on the government's initial stake that included more than $180 billion in committed aid (about $67 billion was actually spent).

Selling down the stake is a relief to many who thought the U.S. would never recover the taxpayer dollars invested.

Last month the Federal Reserve Bank of New York sold Maiden Lane III, a portfolio of AIG's assets for a profit of $17.7 billion, an almost shocking figure considering many thought the N.Y. Fed would take sweeping losses on the assets estimated at $62 billion at face value.

Though some analysts have suggested the government could have made better returns on its bailouts because it didn't charge appropriate rates, the windfall of tens of billions of dollars has its own strings attached.

Some believe the profits only ensure that the principle of moral hazard is in place. That is, the government knows it can profit from the rescue of too-big-to-fail financial institutions and those firms will take risks knowing that the government is willing to halt their fall when bets go awry.

It's an alarm that's being sounded by people such as Sheila Bair, former FDIC chairman, Simon Johnson, the former International Monetary Fund economist and Neil Barofsky, the former inspector general for the bank bailouts, known as the Troubled Asset Relief Program. Their solution: break up the big institutions.

Ultimately, the failure of smaller institutions may be hard to take, but they have the advantage of not taking taxpayers along for the ride.