Fed Plan Would Police Banks' Pay for 1st Time
September 18, 2009The Federal Reserve for the first time would police banks' pay policies to make sure they don't encourage excessive risk taking under a plan the Fed is drafting.
The proposal is the Fed's latest response to criticism that it failed to crack down on lax lending, reckless gambles and other practices that led to the financial crisis.
The central bank's more activist stance carries a risk, though: It could intensify accusations from lawmakers and other critics that the Fed is overstepping its bounds and should be reined in.
The compensation issue is likely to surface when President Barack Obama meets with his counterparts from other major industrialized countries in Pittsburgh next week. French President Nicolas Sarkozy is leading a European attempt to rein in banker bonuses at the Group of 20 summit.
G-20 leaders promised at their London meeting in April to pass "tough new principles on pay and compensation." But little progress has yet been made.
Under its proposal, the Fed would review - and could reject - pay policies that could cause too much risk taking by executives or other employers, according to two people familiar with the plan. The Fed would not actually set compensation, however, those people said.
They spoke on condition of anonymity because the proposal has not been finalized.
Yet the proposal is far reaching. The Fed would review salaries, bonuses and other compensation for CEOs and other senior management, the people with knowledge of the proposal said.
It also would cover certain employees, such as traders, who can take big risks on behalf of a firm, they said. And it would cover some workers whose compensation could affect their risk-taking, such as loan officers making mortgages, they added.
The Fed could examine not only the compensation level but also how it's structured, such as when it is awarded, the sources said.
The goal is to make sure banks' pay policies don't encourage top managers or other employees to take gambles that could endanger a company, the broader financial system or the economy. The failure of many banks to closely monitor risk and limit compensation that might encourage too much risk contributed to the financial crisis.
The proposal, in the works since early this year, could be unveiled within weeks, people familiar with the initiative said. The public, the industry and others would be able to comment on the proposal, which could be revised. A final plan, subject to approval by the Fed's Board of Governors, could be adopted by year's end.
Some details of the Fed plan were reported earlier Friday by The Wall Street Journal.
The proposal would cover all banks - nearly 6,000 of them - regulated by the Fed. It wouldn't cover savings and loans or other institutions overseen by the Federal Deposit Insurance Corp. or other regulators.
Because compensation plans can be structured in numerous ways, the Fed is avoiding a one-size-fits-all approach. The biggest banks - around 25 of them - would develop their own plans to make sure compensation doesn't spur undue risk taking. If the Fed approves, the plan would be adopted and bank supervisors would monitor compliance, people familiar with the proposal said.
At smaller banks, where compensation is typically less, the Fed would provide guidance about what steps it thinks could rein in excessive risk taking.
The Fed's proposal is running on a track separate from the Obama administration's efforts to curb executive pay. The administration's pay czar, Kenneth Feinberg, has been consulting with seven companies that received "exceptional" assistance from the taxpayer-funded $700 billion bailout pot.
Those companies - American International Group Inc., Bank of America Corp., Citigroup Inc., General Motors, GMAC, Chrysler and Chrysler Financial - last month had to propose compensation packages for their highest-paid employees. Feinberg has veto power over them.
Once those companies exit the government's bailout program, they would avoid Treasury oversight of their compensation. By contrast, oversight under the Fed's proposal would be lasting.
Fed Chairman Ben Bernanke started making a public push for the Fed to police compensation practices in March, after insurance giant AIG paid millions in bonuses to employees in the division whose excessive risk-taking pushed the company to near-ruin. That episode unleashed public and congressional outrage, in part because AIG has received more than $180 billion in bailout money.
Bernanke has stressed the need for banking supervisors to examine bonuses and other compensation to make sure they serve a bank's "long-run health." The Fed also has been working in international forums on these issues.
European countries have stressed their view that excessive compensation fueled risk-taking that contributed to the crisis. They have called for bonuses to be curbed.
Treasury Secretary Timothy Geithner has not raised the bonus issue, preferring instead to focus on U.S. attempts to start talks on an international accord to raise banks' capital reserves.
Bernanke told Congress in May that the Fed will "ask or tell banks to structure their compensation, not just at the very top level but down much further, in a way that is consistent with safety and soundness which means that payments, bonuses, and so on should be tied to performance and should not induce excessive risk."
Industry representatives say banks are already making adjustments, delaying full compensation to consider the long-term success of a product or type of transaction. As a result, an executive might receive some compensation in the first year, another portion three years later and the rest in five years.
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