By Kathleen Silvassy, CQ Staff

The situation with insurance giant AIG, which received $170 billion in government bailout money and plans to pay out employee bonuses totaling $165 million is “outrageous,” President Obama’s top economic adviser said Sunday, but noted that “the government cannot just abrogate contracts” that were in place.

Word of the bonuses has generated such deep concern in the Obama administration that Treasury Secretary Timothy F. Geithner told the firm they were unacceptable and demanded they be renegotiated.

“There are a lot of terrible things that have happened in the last 18 months, but what’s happened at AIG is the most outrageous, what that company did, the way it was not regulated; the way no one was watching, what’s proved necessary is outrageous,” National Economic Council chief Lawrence H. Summers said on ABC’s “This Week.”

The payments to AIG’s financial products unit are in addition to $121 million in previously scheduled bonuses for the company’s senior executives and 6,400 employees across the corporation. Treasury Secretary Timothy F. Geithner last week pressured the company to cut the $9.6 million going to the top 50 executives in half and tie the rest to performance.

“He stepped in and berated them, got them to reduce the bonuses following every legal means he has to do this,” said Austan Goolsbee, director of the president’s Economic Recovery Advisory Board, said on “Fox News Sunday.” “I don’t know why they would follow a policy that’s really not sensible, is obviously going to ignite the ire of millions of people, and we’ve done exactly what we can do to prevent this kind of thing from happening again.”

Goolsbee added that “the root of the problem has been some of the people have things written in their contract that say, ‘Look, you sell this much life insurance, you get a bonus of X,’ and it’s in their contract and that part can’t be changed.”

“We are a country of law. There are contracts,” said Summers. “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.”

In another appearance on CBS’s “Face the Nation,” Summers acknowledged the likely degree of public anger about the situation but noted Obama’s speech to Congress in February in that “you can’t govern out of anger. And if we simply throw up our hands, refuse to deal — refuse to deal with any of this, well, we’ll have the kind of financial catastrophe that we saw after what happened at Lehman Brothers.”

He said Geithner has done everything “that is legally permissible” regarding payment of the bonuses but that “binding contracts were entered into long before the government put any money into AIG.”

“We’re not a country where contracts just get abrogated willy-nilly,” he added. “And if we were to start doing that, there would be potentially very, very destabilizing consequences.”

Senate Minority Leader Mitch McConnell , R-Ky., also appearing on “This Week,” reiterated Summers’ “outrageous” comment about the AIG situation and that he had written in October to former Treasury Secretary Henry M. Paulson Jr. “complaining about the way AIG had been doing its business.”

“The point here is, if you’re going to take the government as a partner, the message here, I’m afraid, to any business out there that’s thinking about taking government money, is ‘let’s enter into a bunch of contracts real quick, and we’ll have the taxpayers pay bonuses to our employees.’ ”

McConnell also questioned the timing involved. “Did they enter into these contracts knowing full well that, as a practical matter, the taxpayers of the United States were going to be reimbursing their employees?” he asked. “Particularly employees who got them into this mess in the first place. I think it’s an outrage.”