in the middle of the night

The mess at AIG represents a colossal conflict between two almost sacred principles of a free market democracy – the sanctity of contracts and accountability for taxpayers’ money.

Contracts – The insurance industry, more than most businesses, rests squarely on the sanctity of its contracts. In return for their premiums, policyholders literally receive nothing but a contractual promise from an insurance company that lawful claims for damages will be honored (and paid) by the company. Indeed, the very foundation of our financial and commercial markets  rests on the reliability of contractual arrangements and customary business practices among companies and their suppliers and customers.

Taxpayer Accountability – On the other hand, the screaming about where the AIG bailout money went and the bonuses proposed to be paid hits raw nerves everywhere. People expect companies and individuals being helped by the government to comply with a higher standard including that they sacrifice themselves by not taking advantage of taxpayers.

How this conflict gets resolved will inevitably set a dangerous precedent. Contracts will either become increasingly vulnerable to involuntary politically motivated modification or abrogation, or growing taxpayer cynicism about bailouts will lead to taxpayer demands for a dramatic increase in government regulation of the markets and the economy.

Neither outcome will be good for the American economy in the long run. In hindsight, bankruptcy might have been a better choice.