Short-circuiting capitalism's self-correcting mechanisms (updated)

By Thomas Lifson

John Hinderaker of Power Line makes the essential point about the AIG bonus imbroglio: allowing AIG to go bankrupt would abrogate the bonus obligations the firm contractually entered into. Keeping the company alive and 80% owned by taxpayers merely short-circuits the highly effective cleansing mechanisms capitalism provides for "creative destruction" (Joseph Schumpeter's term) of firms that waste resources.

Instead, the federal government is attempting to interfere with private contracts because it doesn't like them. Making private contracts subject to the whim of the ruler (the king, president, or führer - it doesn't matter) weakens the private economy. If contracts are not enforced, we do not have the possibility of a private economy any more. Nobody will trust in the ability to gain from the private arrangements they make.

Capitalism is undergoing the death of a thousand cuts.

Hat tip: Dennis Sevakis

Update:

Harvard economics Professor Tim Mankiw asks his former colleague Larry Summers whether he really meant it when he said:

"We're not a country where contracts just get abrogated willy nilly," [Larry] Summers, a former treasury secretary, said on CBS's "Face the Nation" program.

The financial services industry and House Republicans are fighting back against a bill pushed by House Democrats that would empower bankruptcy judges to write down mortgage interest rates and principal....Since Monday evening, the financial industry and House Republicans have sent a flurry of letters to the administration and House members in strident opposition. The "cramdown" provision is sponsored principally by House Judiciary Committee Chairman John Conyers Jr. (D-Mich.) and is part of a combined bill backed by Conyers and House Financial Services Committee Chairman Barney Frank (D-Mass.)

Hat tip: Ed Lasky