Along with defending his legal obligation to pay the bonuses, Liddy asked employees to "do the right thing" and return at least half of the "retention payments" that have outraged American taxpayers who spent billions bailing out the troubled insurance giant.
AIG has been kept afloat with more than $170bn of taxpayers' money since September.
The US federal government now owns over 80% of the insurance company.
The current row is over $165m worth of bonus payments made to 418 executives.
AIG says it is a legal obligation to honour contracts drawn up before the government bailout.
But the so-called "retention bonuses" include over $33m for 52 people who have left the company.
Testifying under oath at the congressional hearing, Liddy, who was appointed by the government to head AIG just six months ago, said he understood the rage over executive bonuses and said some AIG executives had already stepped forward to give money back.
Paul Hodes, a US congressman, said on Wednesday that AIG now stood for "Arrogance, Incompetence and Greed".
Gary Ackerman, a fellow Democrat, spoke of "a tidal wave of rage" sweeping the recession-hit United States.
But Alex Brill, a former economic adviser to George Bush, the former president, told Al Jazeera that "these contracts were put in place prior to the bailout".
"Now the taxpayer has gotten involved, and Washington is involved, they don't like the agreements on the ground between AIG and its employees, and they're discovering it right now."
Rush for regulation
Barack Obama, the US president, said he would ask congress to pass legislation giving the government greater regulatory authority over financial institutions such as AIG.
Obama criticised the $165m handed out by AIG as an "inappropriate use of taxpayer funds" and expressed confidence in Timothy Geithner, his treasury secretary, as well as his economic team to deal with the financial crisis.
"I think people are right to be angry, I'm angry," Obama told reporters about the bonuses."
AIG, whose murky and complex financial dealings have contributed to the global financial meltdown, is the largest recipient of the government bailout with more than $170bn so far.
"Just as outrageous is the culture that these bonuses are a symptom of, that have existed for far too long - a situation where excess greed, excess compensation, excess risk-taking have all made us vulnerable," Obama said.
A senior legislator said the House of Representatives planned to take up a bill on Thursday that would impose a 90 per cent tax on bonuses paid to the highest-earning employees at AIG and other companies receiving big government bailouts.
Geithner said on Tuesday that AIG would have to promise to reimburse taxpayers as a condition for receiving a further $30bn of bailout money from the government.
"We will impose on AIG a contractual commitment to pay the treasury from the operations of the company the amount of the retention awards just paid," Geithner said in a letter to congressional leaders.