- The Washington Times - Friday, March 20, 2009

Federal Reserve Chairman Ben Bernanke on Friday called for banking supervisors to pay “close attention” to compensation practices as they examine the soundness of financial institutions.

Banking regulators have observed that “poorly designed compensation policies can create perverse incentives that can ultimately jeopardize the health of the banking organization,” Bernanke said in prepared remarks to a meeting of smaller “community” banks in Phoenix, Ariz.

The Fed chief’s remarks come amid public and congressional outrage over bonuses paid to employees of American International Group Inc., which has been bailed out by the government four times. The situation has created a public relations headache for President Barack Obama and unleashed fresh congressional furor over the handling of AIG’s bailout by the Treasury Department and the Fed.

Bernanke, who will appear before Congress on the AIG flap next week, didn’t mention any companies by name in his speech, which made a fresh pitch for an overhaul of banking regulations to prevent another financial crisis like the one gripping the U.S. and other countries worldwide.

Regulatory gaps need to be closed, he said. Regulators must make sure financial companies have a sufficient capital cushion against potential losses.

And Congress must enact legislation so that the failure of a huge financial institution can be handled in such a way to minimize fallout to the national economy _ similar to how the Federal Deposit Insurance Corp. deals with bank failures. Such “too big to fail” companies must be subject to more rigorous supervision to prevent them from taking excessive risk, Bernanke said.

On compensation, Bernanke said management policies should be aligned with the “long-term prudential interests of the institution … (and) provide appropriate incentives for safe and sound behavior.”

“Supervisors must pay close attention to compensation practices that can create mismatches between the rewards and risks borne by institutions or their managers,” he said.

Rep. Barney Frank, chairman of the House Financial Services Committee, on Thursday sent a letter asking the Federal Housing Finance Agency, which regulates mortgage finance companies Fannie Mae and Freddie Mac, to cancel retention bonuses for hundreds of executives approved for this year and next.

The public “rightfully insists that large bonuses such as these awarded by institutions receiving public funds … cannot continue,” the Massachusetts Democrat wrote.

Fannie Mae plans to pay retention bonuses totaling at least $1 million over two years to four key executives. Freddie Mac is planning similar awards, but hasn’t reported which executives will benefit.

For strengthening regulations, Bernanke said steps should be taken to make the U.S. financial system less susceptible to “exuberant booms and disastrous busts.”

The patchwork of U.S. financial rules dates to the Civil War. Congress, the administration and the Fed are working on ways to overhaul the regulatory system to better protect against any future financial crises.

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