Joe Nocera had an excellent column this weekend explaining the AIG meltdown in plain language.
As you may or may not know, the once AAA rated AIG (an insurance company, by the way) went all in on credit default swaps to insure mortgage-backed securities to the tune of $450 billion none of which was capitalized. And to add insult to injury, everyone knew AIG was taking on these obligations with no capital to back them up, including the regulators.
So why not let AIG fail? Because the banking system of the entire Western World (a real WTF moment) is infected with these mortgage-backed securities insured by AIG.
If AIG failed, $450 billion mortgage-backed securities would suddenly be uninsured. These securities being insured for full value is the only thing giving them any value at all right now. Major banks across Europe and the US would be insolvent if their mortgage-backed securities had to be valued as uninsured.
So, the US Treasury (which is of course the US taxpayer) is literally the dutch boy with his finger stuck in the dike.