Rescue AIG?

I have been looking a bit into the AIG situation. From their 2007 annual report, one can read about what their financial products group did:

AIG Financial Products Corp. (AIGFP) is at the forefront of
AIG’s global capital market activities. It acts as a principal in nearly
all of its transactions... AIGFP focuses on a variety of over-the-counter derivative and structured finance transactions...
A key attribute that differentiates AIGFP from its peers is its
ability to commit significant amounts of its own capital—depending
on the opportunity arising from a particular investment—at different
levels of a company’s debt and equity capital structure.
The firm is also a major investor in a wide array of debt and
equity securities.

As a result of the severe disruption in the U.S. residential mortgage
and credit markets that accelerated during the fourth quarter of 2007,
AIGFP recognized unrealized market valuation losses of more than
$11 billion on its credit default swap portfolio written principally on
the super senior tranches of multisector collateralized debt obligations."

I read this as follows. We have a profitable full line traditional insurance company that generates lots of cash, but returns have not been extraordinary. In search of extraordinary returns, we set up a financial services group to write insurance (credit swaps) on all kinds of debt securities. Counterparties bought our insurance, not understanding that in the event of a systemic crisis, we would either renege on our insurance or not be able to pay. In the meantime, we booked a lot of revenue and profit from selling this insurance.

Now that the systemic crisis has occurred, we are asking the Federal government to bail us out, and thereby, all of our customers as well.

I fail to see the compelling argument here. Let those who unwisely bought the insurance go without it; we do not want to save them from their mistake -- too little of caveat emptor remains in our economy as it is. Send the holding company into bankruptcy, with losses taken by equity and by all the claimants on the financial services insurance. Separate the traditional AIG insurance business from the rest and let it continue -- no problems there.

The long term interests of a free market economy would seem to prevail in this case, unless someone can convince me that the collapse of AIG would cause not just a further decline in equity markets but a true banking crisis. Otherwise, I have to think that we can get over this.