By Paolo M. Pellegrini

(Caijing.com.cn)The controversy over retention bonuses for AIG executives illustrates how difficult it is for the government to run a private business.

Taxpayers are understandably angry that the employees of a company that lost so much should get bonuses at all, let alone such large ones.

However, the bonuses had to be paid pursuant to AIG’s contractual obligations to employees of the company’s financial products division, AIGFP. We have to respect contracts, even when they are outrageously unfair to one party, provided they do not result from some kind of fraud (e.g. bribery of a government representative). There is legal precedent in the United States for invalidating contracts that are “unconscionable,” but the standard for that is very high.

So I don’t think much can be done about the AIG bonuses other than review whether Treasury Secretary Timothy Geithner -- and whoever assisted him with regard to the AIG matter -- acted competently and appropriately.

Questions include the following: Did Secretary Geithner (then chairman of the New York Fed) evaluate the appropriateness of the bonus plan (or even know about it) before lending money to AIG? Was it reasonable to believe that the bonus plan would motivate employees in a way that would result in smaller losses for AIG the first time, the second time, or later? Were there performance targets associated with the bonus payments? For example, were bonuses to be paid only if AIG lost less than a certain amount of money? If not, was it really advisable or even necessary to commit to pay the bonuses, regardless of circumstances?

Obviously, since AIG lost more than anybody could have imagined, it’s unlikely that there were any performance targets. This, in my mind, is the real shame and does not reflect well on Secretary Geithner’s diligence or judgment.

Beyond AIG, the most troubling aspect of government intervention (Bear Stearns, Fannie/Freddie, agency bond purchases, Lehman, Citi, BOA/Merrill, TALF, long-dated Treasury bond purchases, automaker bridge loans) is its ad hoc nature. Government decisions were so lacking in identifiable, unifying characteristics that they appeared arbitrary and, therefore, unfair to one constituency or another, depending on each situation.

Frankly, I do not think any bailouts were justified. In each case, the executive branch should have used its powers to facilitate orderly, market-based resolutions and instead pursued alternatives that appeased the most vociferous, or most recklessly determined, constituencies, without regarding ultimate consequences for the nation.

The only thing investors can take away from these episodes is a growing confidence that, whatever the government tries, it’s not going to work. This is not all bad given that some of what government is trying to do (for example, debasing the currency) is really wrong-headed.

At this juncture, it’s hard to reject the possibility that our democratic governance process may degenerate into a stalemate among competing special interest groups (financial services industry, labor unions, trial lawyers, etc.). For example, recently introduced mortgage modification legislation reflects heavy lobbying by commercial banks and incorporates provisions that benefit commercial banks at the expense of securitization investors.

President Barack Obama is trying to unify the middle class to transcend special interest groups. However, there is a gap in vision, leadership and competence between the president and his economic team. If that gap is not filled soon, it may damage even the president’s credibility and his ability to shape and control the political agenda.

Therefore, the outcome will depend on whether capable and intellectually honest economic policymakers emerge in time to revive our economy before the crisis becomes political and, possibly, constitutional in nature.

Protectionism in trade and finance is an obvious risk under these circumstances. China is showing vision and courage by stimulating its economy to support global growth. Ideally, China would negotiate repayment of its holdings of U.S. debt in exchange for a commitment to use related proceeds to buy U.S.-manufactured capital goods and invest directly in U.S. businesses and properties.

In a sense, China did well in the Fannie/Freddie situation, but only by happenstance. Had China’s interests not coincided with those of ex-Treasury Secretary Hank Paulson’s former industry colleagues, the outcome could have been drastically different.

Therefore, China should take the initiative from its position of relative strength to negotiate a mutually advantageous solution with the United States. In fact, the United States would benefit from thoughtful engagement by China, especially since the Obama administration seems to be running out of ideas even as the crisis continues to gather momentum.

Paolo M. Pellegrini is a managing member of PSQR Management LLC in New York.