This morning, American International Group (AIG) announced the largest quarterly loss in corporate history at $61.7 billion. Much of that loss was based on write-downs of credit default swaps after the government acquired an 80% stake in the insurance firm last September. As a result of this massive loss, the government is now pumping $30 billion more into AIG, with even fewer strings attached than before.

The big question is why does AIG keep sucking money? Why do governments blanch at the thought of letting it go under? It’s just an insurance company, right?

As Joe Nocera pointed out in an excellent article last week, AIG is the house of cards that the entire global financial system is based on. AIG sold credit default swaps to institutional investors and banks, helping them to fudge the ratings on their securitized investments to AAA; AIG was blessed with a rare AAA rating that it sprinkled on anybody who paid a sum. But, while AIG’s “ratings arbitrage” scam boosted the ratings of hundreds of billions of dollars in bonds to AAA, AIG itself went ahead and invested heavily in sub-prime-based mortgage backed securities. In September, just after Lehman Brothers collapsed, AIG was downgraded to junk bond status and the government was forced to either nationalize the firm (and save the credit rating of the counterparties to AIG’s credit default swaps), or let it fail. A failure then – and now – would mean that over a trillion dollars worth of assets in banks across the world – in Europe particularly – would be forced to take an immediate, massive loss. It could single-handedly destroy the Western banking system.

Yes, we really did create a financial system based on a house of cards. We can thank Phil Gramm for ensuring that credit default swaps were left unregulated by the SEC. Brilliant…the financial system will regulate itself, right? And we can thank the geniuses behind the modern AIG who applied all their mathematical genius to the science of modern legalized fraud.

So here we are, pumping another $30 billion into AIG after shoveling $150 billion already.

The only question now is: when will the banks of the world undo those shady credit default swaps and reckon with their real losses? A better question: How will we do that?

I actually think this is a case where the European governments should be doing much more to buttress AIG; they, more than American banks, were exposed to AIG CDS exposure. Yes, AIG is an American company, but its influence is global.

The Dow is taking another big hit today, thanks largely to AIG (as well as more bad manufacturing news).

We still have a long way to go before we hit the bottom.