The Obama administration wants government to have a say in how financial institutions pay their employees and is working to change Wall Street practices so that compensation is more closely tied to performance over time.
The attention to pay practices arises from the Obama administration's belief that lucrative compensation packages encouraged financial sector executives to engage in short-term risky ventures that had adverse consequences and contributed to the financial crisis.
Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke, as recently as last week, called for new compensation standards and principles that would guide banks and other institutions.
Options include giving the Fed, which regulates banks, and the Securities and Exchange Commission, which oversees the financial markets, greater powers to set those standards.
The financial industry is watching warily and is discouraging policymakers from setting rules that are too stringent.
Such standards would be included in a broader effort by the administration and Congress to adopt new regulations some time this year that would govern financial institutions for the long-term and reduce the kind of risk that can lead to a financial system meltdown.
A senior congressional official said compensation standards could also be adopted more quickly if tied to legislation that would set up an overarching regulator of systemic risk -- an entity that would guard against financial practices that could have negative, systemwide repercussions.
Lawmakers such as House Banking Committee Chairman Barney Frank, D-Mass., are still discussing whether to move the risk regulator bill separately or as part of a comprehensive regulatory package.
"We had a period where compensation practices just became completely unmoored from reality, defied gravity, and they created incentives for risk-taking that overwhelmed all the basic checks and balances in the system," Geithner told PBS' Charlie Rose last week. He stressed that the goal was not to set specific limits on compensation.
Industry and government officials believe public outrage over executive pay, which peaked in March following disclosures of bonuses to employees of American International Group, has subsided, creating a less volatile environment to discuss compensation standards.
Separately, the Treasury is close to releasing new pay restrictions for institutions receiving federal money. Those regulations are in response to legislation included in the $787 economic stimulus package that Congress passed in February.
Those limits would apply only to banks benefiting from the $700 billion Troubled Asset Relief Program. But officials want changes in compensation practices for the long-term, as well.
The pay standards also would apply to sectors of the industry that have been less regulated before, such as hedge funds and private equity firms.
"That is going to apply —has to apply across the financial system," Geithner said on PBS.
Bernanke has repeatedly stressed the need for banking supervisors to examine bonuses and other compensation practices to make sure they provide incentives that promote the "long-run health" of a financial institution.
The Fed has been working in international forums on these issues, Bernanke said in a speech last week.
Bernanke told Congress last week that compensation should be structured in a way that ties closely to "actual, measurable performance" and that it does not induce "unnecessary or excessive risk taking."
The Fed, he told lawmakers, is working on supervisory guidance or rules on this that "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."
Scott Talbott, the senior lobbyist for the Financial Services Roundtable, an industry group, said institutions are already making adjustments, delaying full compensation to take into account the long-term success or failure of a product or type of transaction.
As a result, an executive might get a portion of his compensation in the first year, another portion three years later and the remainder in five years.
"On the short term, there are rewards for selling the product," he said. "But we want to defer compensation until the risk horizon of that product is known."