Yesterday on ABC’s This Week, Larry Summers, head of President Obama’s National Economic Council, called insurance giant AIG’s plan to pay out $165 million in bonuses “outrageous” but insisted there was little the government could do about it. This despite the $170 billion in taxpayer funds that have been given to AIG. Summers cited the sanctity of contracts:

SUMMERS: We are a country of law. There are contracts. The government cannot just abrogate contracts. Every legal step possible to limit those bonuses is being taken by Secretary Geithner and by the Federal Reserve system.

Summers said that efforts by Treasury Secretary Tim Geithner had successfully “scaled back” the bonuses, but AIG chief Edward Liddy, defending the bonuses, told Geithner, “quite frankly, AIG’s hands are tied.”

Of course, not all contracts are sacrosanct. When Detroit’s Big Three arrived in Washington last year to plead for federal bailout funds, the right wing demanded that the United Auto Workers ignore their contracts and accept “steep cuts in pay and benefits” — on top of the cuts they already shouldered in 2007. The UAW agreed to “make major concessions in its contracts,” acceding to most of the right’s demands:

UAW President Ron Gettelfinger emerged from the meeting to say the union would rework a retiree health care trust fund, eliminate the union’s maligned jobs bank program…and cut additional measures that would loosen the union’s trademark job-security protections.

Along with other commenters, the American Prospect’s Robert Kuttner pointed out the government’s double standard on contracts, telling George Stephanopoulos yesterday, “You don’t think when the auto workers come in as part of the auto rescue deal, they’re not being asked to abrogate contracts? Of course they are.”

The Obama administration also supports rewriting mortgage contracts. It “has moved aggressively to pressure lenders to renegotiate the terms of mortgages,” and Obama supports an idea to allow bankruptcy judges to change the terms of a mortgage to help homeowners stay afloat.

To his credit, Obama today ordered Treasury Secretary Tim Geithner “to use that leverage and pursue every single legal avenue to block these bonuses.” But it’s still clear that while workers’ contractual benefits can be eviscerated in the name of bailout eligibility, millionaire bankers’ bonuses are a more sacrosanct part of “a country of law” where “there are contracts.”

The mortgage package that passed the House on March 5 is currently gummed up in the Senate, as various Senators — reportedly led by Sens. Evan Bayh (D-IN) and Arlen Specter (R-PA) — try to limit the borrowers eligible for cram-downs. Cram-downs enable a bankruptcy judge to lower mortgage payments for those who owe more than their home is worth and have exhausted all other options.

While the Senate dithers, new information has come out showing just how vital the mortgage package is. According to a new study conducted by the University of North Carolina at Chapel Hill’s Center for Community Capital, the Obama administration’s housing plan, along with cram-downs, can significantly lower the rate of mortgage defaults:

Letting homeowners reduce their monthly mortgage payments can significantly lower the rate of defaults compared with loan modifications that do not reduce payments…Further, combining lower payments with a write-down of the loan balances for loans that exceed the value of the home can prevent even more defaults.

According to the study, “homeowners who obtained a rate reduction were about 13 percent less likely to redefault than similar borrowers in similar situations who received a traditional modification. Those whose rate reduction was accompanied by a principal reduction were 19 percent less likely to redefault.”

As author Roberto Quercia said, “our results support the Obama administration’s efforts to seek more broad-based, systematic loan restructuring.” Quercia and co-authors Lei Ding, and Janneke Ratcliffe also noted that their study is “consistent with current bankruptcy reform efforts to pass legislation that would give bankruptcy judges new power to restructure mortgages and reduce mortgage payments.”

Bayh and Specter, meanwhile, want to limit cram-downs to subprime loans. However, the housing crisis has already spread well beyond subprime loans, so addressing them alone would be inadequate and behind the curve.

Skyrocketing unemployment is only going to exacerbate the housing crisis, which in turn blunts the banking rescue, as more foreclosures leads to more toxic assets on bank balance sheets. So a sensible solution to housing is desperately needed, and it needs to reach as many troubled homeowners as possible.

Despite receiving $170 billion in taxpayer funds — and being confronted by Treasury Secretary Timothy Geithner — insurance giant American International Group (AIG) still plans to pay out $165 million in employee bonuses and retention pay. AIG’s chief executive Edward Liddy expressed “grave concerns” about the company’s ability to retain staff if the bonuses — allegedly promised before AIG accepted taxpayer money — were renegotiated.

The bonuses have sparked considerable outrage in the administration and on Capitol Hill, and the White House is seeking “mechanisms” to recover the money. But this episode represents more than just AIG’s apparent blindness to public and lawmaker opinion. As Robert Reich pointed out, this “sordid story…illustrates better than anything to date why the government should take over any institution that’s ‘too big to fail’ and which has cost taxpayers dearly”:

As long as taxpayers effectively own a large portion of them, they should be accountable to the government. But if our very own Secretary of the Treasury doesn’t even learn of the bonuses until months after AIG has decided to pay them, and cannot make stick his decision that they should not be paid, AIG is not even accountable to the government. That means AIG’s executives — using $170 billion of our money, so far — are accountable to no one.

Indeed, we’ve noted before that Treasury’s strategy of pumping money into financial institutions without taking outright control would result in “sinking a lot of money…without gaining authority and accountability over the use of taxpayer funds.” And even with 80 percent of the company owned by the government, Geithner is powerless to do anything other than pressure AIG to rescind the bonuses.

Nationalization, meanwhile, would mean outright control over the hiring and firing of executives and the payment of bonuses and dividends. Treasury wouldn’t have to try to coax or embarrass institutions into voluntarily cutting back.

Of course, the ultimate decision regarding whether or not to nationalize financial institutions should be made on the basis of the stress test that Treasury is making them undergo. If the banks are rendered insolvent by the test (as many likely will be), the government will have every rationale for swooping in and taking over.

But in the meantime, AIG’s decision is symbolic of the current financial rescue: toxic assets are still clogging the system, while the financial institutions are unaccountable to anyone but themselves.