Maybe it'll also mean turning off user generated content too, and only have admin made posts, the same as Digg did. They could hire the power-users to keep making the relevant posts.
People you don't have on contract are a liability
how so? there are more than enough moderators left who have no issue with reddit's current behaviour and will continue modding for free.
I guess they could audit submission history, but there's a chance of that blowing up as users decide the mods are shills. I've rarely seen Reddit as mad as when they decide someone is a shill, and the vitriol is likely to make the new mods' lives hard. Especially so if they're new mods, and aren't as used to people hurling insults and maybe death threats at them (I don't know how likely death threats are, but it seems like everyone with any online visibility gets them these days).
I'm sure they could eventually find mods, but I think there will be chaos in that process. I guess the question is whether they're willing to extend the current chaos to keep free moderation, or if they'd rather pony up some money to end it now.
Edit: added "free" in the last paragraph, last sentence between "keep" and "moderation"