Banking regulators have observed that "poorly designed compensation
policies can create perverse incentives that can ultimately jeopardize the
health of the banking organization," Bernanke told a meeting of smaller
The Fed chief's remarks come amid public and congressional outrage over millions of dollars in 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. He 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.
Obama said Wednesday his administration soon will propose new financial industry oversight that includes a resolution authority with powers similar to those of the FDIC, which can seize control of banks, take over their bad assets and sell the good ones to competitors.
The proposal would give the Treasury secretary the power, after consulting with officials at the Fed, to take control of a major financial institution and run it. The Treasury chief is an official of the administration, unlike the FDIC, which is an independent regulatory agency.
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.
But Fannie Mae Chief Executive Herbert Allison warned Friday that canceling bonuses for workers at institutions receiving federal bailout money could undermine his company's efforts to stabilize the U.S. housing market.