Barack Obama's crusade against excessive Wall Street pay has hit an obstacle, with his administration admitting that it could not stop the nationalised insurance giant AIG from paying $165m (£118m) in bonuses.

AIG has received $170bn in government money since being saved from bankruptcy in September. The bulk of the bonuses will go to employees in the very business division that wrecked the company's finances.

Politicians have reacted with fury. Members of the administration took to television studios yesterday to insist that contracts written during the boom times had left their hands tied.

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Larry Summers, the president's chief economic adviser, said: "The whole situation at AIG is outrageous. What taxpayers are being forced to do is outrageous." But he added: "We are a country of law. There are contracts. The government cannot just abrogate contracts. Every legal step possible to limit those bonuses is being taken."

Mr Obama, who said paying bonuses was "shameful" while companies were on government life support, has found changing Wall Street culture to be more difficult than anticipated.

The administration engaged in a behind-the-scenes battle last week to cut remuneration at AIG. Senior executives agreed to forego some bonuses but Edward Liddy, the AIG chairman, said he was otherwise bound to pay employee's contractual entitlements.

He lobbied for the government to ease attempts to limit future bonuses, saying AIG could collapse entirely if its staff fled to rivals – it could not "attract and retain the best and brightest talent if employees believe that their compensation is subject to continued and arbitrary adjustment by the US Treasury".

The government has pumped hundreds of millions of dollars into financial institutions since Bear Stearns collapsed a year ago today. It is now a significant shareholder in dozens of banks and is struggling to contain public fury that companies are paying bonuses with the money. The Treasury Secretary, Tim Geithner, said the government would not be able to act to repair the financial system if taxpayers believed their money was being wasted.