Nick Ashooh, AIG spokesman, said the group has made headway in its attempts to reduce its exposure to credit default swaps and other derivatives. The notional value of its derivatives exposure has dropped to about $1,600bn from about $2,700bn a year ago, and its CDS exposure has been cut from $433bn to $302bn.

And more from the NYT:

A.I.G.'s insurance commitment stood at "only" $302 billion in part because the government has already voided $62 billion of the protection A.I.G. had written on pools of especially toxic securities. The underlying collateral on those contracts, valued at about $32 billion or so, now sits in a facility that the Federal Reserve Bank of New York oversees and which we, the taxpayers, own.

In order to rip up those contracts, the taxpayers had to make A.I.G.'s counterparties whole by buying the debt that A.I.G. had insured and paying out -- in cash -- the remaining amount owed to the counterparties.

So at least $62 billion is officially off AIG's book because the government bought the underlying assets.  

The same NYT article also provides another bit of information in just how long the process of "winding down" can take:

Another troubling aspect of these deals is how long it takes to untangle them when they go awry. Back to Mr. Buffett's recent shareholder letter: when Berkshire acquired the insurance company General Re in 1998, he wrote, General Re had 23,218 derivatives contracts that it had struck with 884 counterparties.

Mr. Buffett wanted out from under the contracts and he began unwinding them. "Though we were under no pressure and were operating in benign markets as we exited," he said, "it took us five years and more than $400 million in losses to largely complete the task."

The discussion about "sanctity of contracts" is really about preserving the integrity of contracts from arbitrary and capricious government intervention.

AIG executives gave more than $630,000 during the 2008 political cycle even as the company was falling apart

According to the Center for Responsive Politics, which tracks campaign finance reports, more than $120,000 of that money was donated after AIG received its first $85 billion in federal bailout funds in September. The company has since received a total of $170 billion in taxpayer cash to prevent its collapse.

  Essentially all aspects of the crisis begin with some entity purchasing risk based on the assumption it can make money. But, that entity doesn't want to carry the risk so it sells the paper at a discount but for enough to take a profit. then the buyers of these risks engage in bundling the risks into collateralized securities, then they sell the bundled risks, also at a discount but for a profit to still another entity (which may well do the same thing). Then whether you  call them insurers, reinsurers or guarantors still other entities, for a fee, guarantee the holders of the paper against loss from the risks. these entities are supposed to know what they are doing and have sufficient capital reserves to meet any obligations.

   When the houses of cards collapse and the capital reserves are far short of the losses incurred from all the risks, we are where we are. AIG says it cannot meet its obligations. Many of the entities to which AIG has obligations have their own obligation to entities futher down the line. AIG also has other obligation to other entities not directly invested in the risks which have broght about this crisis.

  So, we are told if we don't give AIG money to satisfy its obligations in a somewhat reasonable time frame not only will that cause AIG to fail but other intermediate entities in these risk  chains will fail eventually all the way down to your local community bank, and entities not even in these will possibly fail if their unrelated claims against AIG cannot be met.

  So, we are told our only option is to give AIG billions and billions which does of course go to the entities to which AIG has obligations (except stuff like money used for huge bonuses and other operating expenses. We're not getting many of the details beyond these bonuses at this point.

  I'm not convinced that this explanation is true. I have not seen any actual evidence that placing AIG in chapter 11 or other form of receivership and reorganizing (or, who knows, even liquidating) it and structuring pro rata payments to AIG obligees is not a viable option. Certainly, we know that will cause a lot of pain, but do we really know it will causer more pain than the course we appear to be meandering toward?