The Obama administration's assertion that the federal government had no power to stop A.I.G. from awarding $165 million in bonuses to the derivatives traders in its financial products unit, whose reckless decisions both destroyed the company and exacerbated the collapse of the international banking and insurance industries, rests on a faulty interpretation of the US Constitution. Speaking on ABC's "This Week," Lawrence H. Summers, director of the National Economic Council, explained that the United States could not block payment of the bonuses, despite A.I.G.'s receipt of more than $170 billion in federal TARP funds, because "We are a country of law. There are contracts. The government cannot just abrogate contracts."

President Barack Obama meets with Treasury Secretary Timothy Geithner. (Photo: AP)

    Although, it is true that the "government cannot just abrogate contracts" for no good reason, the law is clear that the United States has the authority to impose significant restrictions on the administration of both public and private contracts to ensure that the expenditure of federal funds is consistent with the public interest. Although, it is too late to void the A.I.G. bonuses, the administration's narrow reading of the law should not deter Congress from amending the Emergency Economic Stabilization Act of October 2008, the legislation that created TARP, to authorize the president or the secretary of the treasury to modify executive compensation agreements that are contrary to the purposes of the Act.

    Article I, Section 10 of the Constitution provides that "No State ... shall pass any ... Law impairing the Obligation of Contracts," but the Supreme Court has held that the contracts clause is limited to state actions and is inapplicable to the federal government. Actions by the United States that allegedly impair contracts are governed instead by the Fifth Amendment's directive that no person "shall be deprived of ... property without due process of law." The Supreme Court's cases interpreting the due process clause distinguish between federal laws that may impair private contracts and laws that allegedly abrogate contracts to which the United States itself is a party. Under both sets of cases, the United States could have prevented A.I.G.'s use of TARP funds to pay executive bonuses, despite A.I.G.'s compensation agreements with its derivatives traders.

    Federal actions that impair the performance of private contracts are valid as long as the regulations are rationally related to a legitimate public purpose. As the Supreme Court has explained: "Federal regulation of future action based upon rights previously acquired by the person regulated is not prohibited by the Constitution.... Immunity from federal regulation is not gained through forehanded contracts."

    There are, in fact, myriad reasons for the United States to prohibit A.I.G. from awarding bonuses to the members of its financial products unit, and the Supreme Court's precedents would require the courts to defer to these regulatory judgments. As President Obama explained on Monday, these policies include ensuring that the TARP funds are spent to increase financial liquidity throughout the lending and insurance system, deterring future malfeasance by not rewarding bad business judgments and disastrous financial performance and preventing the loss of political support for the financial bailout and regulatory reform program - a risk that the administration is now struggling to contain.

    There may be legal questions whether the Emergency Economic Stabilization Act grants the administration authority to take this type of action to protect the TARP, but these are questions of delegation and separation of powers, not questions of due process or authority to alter the terms of performance of private employment and compensation contracts.

    If the administration's concern is that blocking the executive bonuses would violate the contracts by which the United States has awarded A.I.G. its $170 billion in TARP funds, a different constitutional standard would apply. The Supreme Court has held that the sovereign power of the United States is an "enduring presence that governs all contracts subject to the sovereign's jurisdiction and will remain intact unless surrendered in unmistakable terms. Therefore, contractual arrangements, including those to which a sovereign itself is a party, 'remain subject to subsequent legislation' by the sovereign."

    This means that the United States retains the authority to alter the terms of government contracts, as Congress defines or redefines the public interest, unless one of three countervailing conditions is present: First, the government may not alter contracts to which the United States is a party "to repudiate its own debts .... simply to save money." Second, it may not change the governing law to take back "the fruits actually reduced to possession of contracts lawfully made." Third, the United States is liable for breach of contract for legal changes that impair the performance of government contracts where either the contract or the original legislation under which the contract was made expressly assigns financial liability for the risk of such regulatory changes to the government.

    None of these exceptions to the "sovereign acts" doctrine would apply to future statutory or regulatory changes to prevent companies that receive TARP funds from granting A.I.G.-type executive bonuses. As noted above, the purposes of such a law would be to ensure that the TARP participants use the funds to fulfill the purposes of the program. (Besides, could there be a less plausible claim that the federal government is trying to save money in its administration of the TARP?) Prospective limits on compensation and bonuses would not take back funds already vested in the miscreant executives, although A.I.G.'s fait accompli may make it legally impossible for the United States to force the company to rescind the bonuses.

    Nor is there anything in the TARP contracts that either waives Congress's sovereign power to change the governing law or assigns financial liability for the risk of such legal changes to the United States. To the contrary, these contracts stipulate that the United States "may unilaterally amend any provision of this Agreement to the extent required to comply with any changes after the Signing Date in applicable federal statutes."

    Under these circumstances, Congress is free to amend the Emergency Economic Stabilization Act to protect the regulatory scheme and to shore up the confidence of the millions of taxpayers whose hard-earned money is financing both A.I.G.'s past mismanagement and its ongoing cupidity. Contract rights - neither private nor public - stand in the way. As the Supreme Court recognized more than 50 years ago, "Those who do business in the regulated field cannot object if the legislative scheme is buttressed by subsequent amendments to achieve the legislative end."

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