The U.S. isn’t the only country rolling back on free-market principles. Communist China is also busy bailing out its economy. Over the weekend, the People’s Republic announced a $586 billion ’stimulus’ plan of it own. U.S stock futures are up on the news.

- Italy may be the next country to ‘rescue’ its economy with taxpayers’ money. According the The Times the Italian government was working on plans over the weekend to pump as much as $26 billion into its biggest banks.

- Uncle Sam is about to bailout AIG from its bailout. Apparently, the original handout was too tough on poor old AIG. So now its going to get a sweeter deal. This from the WSJ:

The U.S. government reached a deal Sunday night to scrap its original $123 billion bailout of American International Group Inc. and replace it with a new $150 billion package, according to people familiar with the matter.

While the arrangement stands to considerably ease terms on the faltering insurer, it gives the government an unprecedented role as an actor in financial markets. It could also spark a political backlash, especially from congressional Democrats, because the Treasury, while adding to its AIG obligations, has thus far refused to extend a hand to the struggling Big Three auto makers.

- According to Infectious Greed blogger Paul Kedrosky, AIG “is serving as a kind of orifice via which the global credit default swap system pushes out its collateral calls, and it is forcing the U.S. government (read: you and me) into levering up on the other side. As long as asset prices keep falling, increasing the amount of collateral required in AIG’s ‘policies,’ these calls will keep coming, making AIG’s liabilities – and therefore ours – frighteningly open-ended.”

As Milton Friedman once put it, ” Nothing is so permanent as a temporary government program.”

- Of course, the story of AIG’s demise and its now near “zombie” status – it now relies on taxpayers’ money to stay afloat – is replete with ironies. AIG’s immediate problem is that it is neck deep in credit default swaps (CDSs), which it now must cover. As George Soros points out in the December issue of the New York Review of Books, the same administration that let the $50 trillion market for CDSs go “entirely unregulated” is now essentially left on the hook for these instruments.

Take for example credit default swaps … instruments intended to insure against the possibility of bonds and other forms of debt going into default, and whose price captures the perceived risk of such a possibility occurring. These instruments grew like Topsy because they required much less capital than owning or shorting the underlying bonds. Eventually they grew to more than $50 trillion in nominal size, which is a many-fold multiple of the underlying bonds and five times the entire US national debt. Yet the market in credit default swaps has remained entirely unregulated. AIG, the insurance company, lost a fortune selling credit default swaps as a form of insurance and had to be bailed out, costing the Treasury $126 billion so far. Although the CDS market may be eventually saved from the meltdown that has occurred in many other markets, the sheer existence of an unregulated market of this size has been a major factor in increasing risk throughout the entire financial system.

- Turns out Hank Paulson gave his bank pals and even sweeter deal than was oringinally reported under the terms of the $700 billion bailout bill. This from The Washington Post:

The sweeping change to two decades of tax policy escaped the notice of lawmakers for several days, as they remained consumed with the controversial bailout bill. When they found out, some legislators were furious. Some congressional staff members have privately concluded that the notice was illegal. But they have worried that saying so publicly could unravel several recent bank mergers made possible by the change and send the economy into an even deeper tailspin.

“Did the Treasury Department have the authority to do this? I think almost every tax expert would agree that the answer is no,” said George K. Yin, the former chief of staff of the Joint Committee on Taxation, the nonpartisan congressional authority on taxes. “They basically repealed a 22-year-old law that Congress passed as a backdoor way of providing aid to banks.”

The story of the obscure provision underscores what critics in Congress, academia and the legal profession warn are the dangers of the broad authority being exercised by Treasury Secretary Henry M. Paulson Jr. in addressing the financial crisis. Lawmakers are now looking at whether the new notice was introduced to benefit specific banks, as well as whether it inappropriately accelerated bank takeovers.

It sure does pay to have friends in high places…

- All of this is small potatoes next to the Fed’s spiraling loan portfolio. Accoridng to Addison Wiggan and Ian Mathias at The 5 Min Forecast:

Ben Bernanke’s balance sheet expanded to a record $2 trillion this week — $2.058 trillion, if those billions even matter any more. That’s more than twice its size at this time last year.

The Fed’s loan portfolio is so bloated, we hardly know where to begin: Average DAILY bank borrowing from the Fed exceeded $359 billion last week… the Fed’s Commercial Paper Funding Facility has nearly doubled, and now holds $243 billion in “no one else will buy it” cooperate debt… primary dealers and brokers are running a $71 billion tab… AIG still owes $81 billion… it just keeps going and going. Over a third of the balance sheet is made up of some sort of bank loan or toxic asset.

Who’s paying for it? The U.S. Treasury has set up a supplementary funding account with the Fed, which is fueled by T-bill sales. That fund now exceeds $558 billion.