Don't lose sight of the real scandal in the latest AIG bonus controversy--the fact that the US Treasury under former secretary Henry Paulson used your money to make whole Wall Street firms who had bet against AIG, 100% whole, 100 cents on the dollar.

The news breaking now is that AIG is forking over another round of bonuses and that the administration's newly appointed pay czar can't do a thing about the payouts, up to $450 mn in bonuses for employees in AIG's financial products unit. AIG is asking the White House's new pay czar whether it's okay to pay $235 mn out of that $450 mn in bonuses for workers at its financial products unit.

That is the impenetrably foolish AIG division run by former Drexel Burnham cronies of junk bond king Michael Milken which sold more than $500 bn worth of insurance on ticking time bonds built on the backs of Kryptonite subprime mortgages. AIG then paid itself lavish bonuses based on those bad insurance bets.

But by effectively rubberstamping these toxic bonds with its triple-A rated insurance, AIG became the subprime risk taker of first resort. And because AIG didn't have adequate capital cushions against its insane market bets--insane because no one at AIG or on Wall Street had in their risk models a large scale, catastrophic housing collapse--the insurer eventually left US taxpayers holding the bag.

AIG's derivatives insurance, called 'credit default swaps,' helped inflate the bubble to cataclysmic dimensions. And the AIG's unit's losses were enough to cause the insurer's sensational collapse, triggering a $173 bn taxpayer bailout.

The real controversy is this. AIG insured bonds built on subprime trash, loans taken out by borrowers with credit histories shot through with more holes than Swiss cheese. Meaning, AIG sold insurance to Goldman Sachs, Deutsche Bank and Credit Suisse for their own bonds, insurance that came without any adequate capital cushion against this nonsense whatsoever.

And get this--Wall Street firms got to price tag on their own, what's called 'fair value,' the cost of those bonds that AIG insured. That meant Wall Street firms could potentially lowball the value of their bonds in order to get AIG insurance payouts. Which, again, the US taxpayer eventually covered at 100 cents on the dollar.

The question is this: Did the Goldman Sachs of the world purposely lowball the value of their bonds that were underlying AIG's insurance and in turn did they eventually get even more money out of AIG--meaning, your money?

Remember, because AIG didn't have an adequate capital cushion to back up the insurance on those ticking time bonds, it was left high and dry.

AIG eventually forked over $59.5 bn in US taxpayer money to make good on its trades and these absurd insurance contracts, with $12.9 bn going to Goldman Sachs, even though Goldman Sachs told the world it had hedged its bets against AIG. Meaning, these Wall Street players were made entirely whole. While you were not.

So what is happening now with the AIG bonuses? AIG has already tried to pay out $165 mn in bonuses last March, bonuses aimed at retaining workers at the AIG financial products division (the unit that sold more than $500 bn in such insurance, or credit default swaps; the majority of the swaps were made on corporate bonds, the rest on toxic subprime loans).  

The bonus move has ignited a national outcry, but the government couldn't do anything about those bonuses because they were based on contracts (even though the government has broken contracts right and left in other bailouts, for example, with the GM bondholders).

Because of taxpayer outrage, the US Congress tried to pass a brand new tax on bonuses at bailed out Wall Street firms, to claw back some of those payouts, but to no avail, as that tax legislation was spiked.

And now AIG has asked pay czar Kenneth Feinberg to bless $235 mn out of $450 mn in bonuses, even though Feinberg's hands are tied because he has no authority over these bonuses as they are for 2008, and his purview is pay made prospectively in 2009 and going forward.

Feinberg was appointed by President Barack Obama to oversee the compensation of top executives at seven firms that have received large federal bailouts, including General Motors and Citigroup (C).

The thinking is, a Feinberg sign-off might stop another round of rakes and torches outside AIG employees' houses in Connecticut (the financial products division was based in Wilton). AIG has argued that it is contractually obligated to make these bonus payments, and that it has to keep these employees in their jobs in order to stop the bleeding on trades that the unit still has in place and is trying to unwind.

Now, some of AIG's derivatives insurance contracts, or 'credit default swaps,' actually demand that AIG officials remain on the job, and if these executives quit, then the company that bought the AIG insurance contract on their bonds can say, hey, the contract is now null and void, causing yet another quasi-run on the AIG bank--meaning, the US taxpayer.

The AIG bonus furor won't go away. Here's why. After pressure from Treasury Secretary Timothy F. Geithner and other government officials, AIG retooled its bonus plans for 50 top executives.

The senior executives were to get half their 2008 bonuses -- which summed up to about $9.6mn -- last spring, with another quarter disbursed on July 15 and the rest on Sept. 15 (in November, AIG's top seven executives, including chairman Edward M. Liddy, agreed to forgo their bonuses through 2009.)

That's why you're now hearing about $2.4 mn in bonuses for about 40 high-ranking corporate officers at AIG.