Andrew Ross Sorkin Vs. John Carney On AIG Bonuses

Should the government block $165 million in bonuses to AIG?

In his DealBook column, Andrew Ross Sorkin takes the unpopular position, arguing for the bonuses as a symbol of our belief in the sanctity of contracts as a "fundamental value." He writes:

That may strike many people as a bit of convenient legalese, but maybe there is something to it. If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

Valid point, but I'm not convinced. At Clusterstock, John Carney says the government can break contracts because, well, without the government there wouldn't be an AIG left to write bonus checks:

The key to understanding the AIG bonus issue is that AIG would be bankrupt and in the process of a court supervised liquidation but for the extraordinary government action that has kept the company afloat. If not for the government bailout, the contracts would be worthless because the employees would be unsecured creditors in a company worth less than zero.

To put it differently, the abrogation of the contracts is just a normal form of counter-party risk run by anyone entering into a contract. All contracts are at risk that the other party will go broke before they can perform. You take a job from your employer, perform work and expect to get paid. But if your employer goes broke before you are paid, you have to line up with the other creditors and hope there's enough left over to pay you.

I tend to side with Carney based solely on recent history. Market manipulation by the government (banning the shorting of financial shares, executive pay caps, bailouts generally) may skew confidence a bit, but the majority of frightened investors who are unwilling to borrow, spend or lend aren't concerned about whether or not a new loan would be invalidated. They're worried about getting one at all. Trust in the fundamental value of contracts isn't our biggest problem, and if it is, the shell game in the derivatives markets and credit ratings surely hurt confidence more than the threat of a few clawed-back bonus checks from AIG. Take 'em if you can get 'em.