Ruth Marcus: I understand the outrage, but it's wrong

WASHINGTON - Could we put down the pitchforks for just a moment and have a reasonable discussion about the bonuses at AIG?

No, I didn't think so. Here goes anyway.

I get the outrage. It's galling to pay $165 million to a bunch of wealthy traders to clean up a mess that they, or at least their company, made.

I get the political fix in which President Obama finds himself. The sums are staggering -- if not to Wall Street, then to everyone else who's ever worked for a living. The public is worked up, increasingly convinced that its money is being flung around recklessly, to a gang of extortionists at AIG and at European banks, without any hint that the fundamental problem is being fixed.

As a result, the administration's already dim prospects for obtaining another boatload of money for the bank bailout have gotten even dimmer. This presents a huge problem because of the likelihood that another enormous sum will be needed. The president's budget envisions $750 billion, and even that may not be enough.

So I understand Obama's railing against the bonuses -- but I think he may be making a mistake, both short-term and long-term.

"This is a corporation that finds itself in financial distress due to recklessness and greed," the president said on Monday. "Under these circumstances, it's hard to understand how derivative traders at AIG warranted any bonuses, much less $165 million in extra pay. I mean, how do they justify this outrage to the taxpayers who are keeping the company afloat?"

In the longer term, having the government void existing contracts, directly or indirectly, as with the suggestions of a punitive tax on such bonuses, will make enterprises less likely to enter into arrangements with the government -- even when that is in the national interest. This is similarly counterproductive.

Remember, the contracts were negotiated long before the government put a cent into AIG. "The plan was implemented because there was a significant risk of departures among employees at [the company]," AIG wrote in a paper explaining the plan, "and given the $2.7 trillion of derivative positions at [the company] at that time, retention incentives appeared to be in the best interest of all of AIG's stakeholders."

And federal legislation explicitly states that compensation limits for companies receiving bailout funds do not apply to preexisting contracts.

"That was then, this is now" is not a valid legal principle. "We are a country of law," economic adviser Lawrence Summers said Sunday. "There are contracts. The government cannot just abrogate contracts." He was right.

But, you ask, what about autoworkers who are being squeezed to renegotiate their contracts? Those renegotiations involve the terms of employment going forward. If an autoworker doesn't want to show up on the assembly line under the terms of that deal, he or she doesn't have to.

OK, so what about cramdown proposals to allow bankruptcy judges to change the terms of mortgages? This is more analogous, but bankruptcy is a legal mechanism designed precisely for the abrogation of contracts. It is intellectually consistent to support expanding the power of bankruptcy courts to rewrite mortgages on primary homes -- as they can with vacation property -- but balk at reneging on the AIG contracts.

The administration argues that anger over the bonuses, among the public and members of Congress, was at such a level that the president needed to say something to show that he understood the fury. Perhaps, but there is a countervailing risk in stoking this populist rage -- especially if the administration needs to come back for more money for the banks.

Once the pitchforks are out it's awfully hard to convince the mob to put them down.