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Pittsburgh

To: Mr. Bank CEO

Message: Your compensation package has been rejected by the Financial Stability Board.

Yes, in the next few months, regulators of the financial industry in individual countries could have this international review board looking over their shoulders. This board would be measuring progress in ensuring that banks have higher levels of capital and that executives don’t take home huge incomes as a result of risky behavior.

Reform of the financial and banking sector, says Treasury Secretary Timothy Geithner, is the Obama administration’s second biggest priority at the Group of 20 summit in Pittsburgh. (The first priority at this gathering of major countries is to keep economic stimulus going.) Secretary Geithner said he hopes financial reforms, especially as they relate to executive compensation, could be in place by year-end.

“We are not going to walk away from the greatest economic crisis since the Great Depression and leave … in place the tragic vulnerabilities that caused this crisis,” he said at a press conference Thursday.

The Financial Stability Board, or FSB, was established in April, and the duties now envisioned for it represent a great expansion of its role. The board is composed of finance ministers, central bankers such as the Federal Reserve, supervisors of banks, market regulators like the Securities and Exchange Commission, and the setters of accounting standards.

Geithner compares the FSB to the International Monetary Fund, the World Bank, and the World Trade Organization. He calls it the “fourth pillar of that architecture.”

One of Geithner’s rationales for working toward banking reform within the framework of the G20 is that financial firms will simply migrate to wherever regulation is the most lax. “We need to see competition for stronger standards, not weaker standards,” he said.

For example, during the just-ended mortgage boom and bust, some investment banks decided that disclosure and regulation was more lax for some sophisticated financial products in London, says Mark Zandi, chief economist for Moody’s Economy.com.

“We have to have consistent regulation across the board,” Mr. Zandi says. “The investment banks can move quite easily. It’s just a matter of moving people.”

But others think that zeroing in on bankers is just a matter of political expediency.

“It’s an obvious whipping boy and girl but economically not an effective way to tackle the problem of how companies are governed,” says Mark Zupan, dean of the Simon Graduate School of Business at the University of Rochester in New York. “It’s not fair to turn around now and blame the private sector when the public sector played a role.”

One key reform effort: to ensure there is some regulation of top bankers’ pay. On Friday, the G20 apparently decided to link bonuses to the capitalization of a bank. And the FSB appeared to be entrusted with developing more extensive rules and regulations on other matters.

“It depoliticizes the issue,” says Andrew Cooper, a distinguished fellow at the Centre for International Governance Innovation in Waterloo, Ontario.

But reform of executive pay will be a controversial undertaking.

“As a rule, capping compensation is not a good idea,” says Jayant Kale, professor of finance at the J. Mack Robinson College of Business, part of Georgia State University in Atlanta. “Capping compensation would stifle innovation.”

The structure of compensation is more important, he argues. For example, many banks are now enacting “clawback” provisions, which force executives to return pay in the event of large losses.

Once the government gets in the business of regulating pay, Mr. Zupan says, it could become a “slippery slope.”

“Do you want salary caps for professional athletes or singers?” he asks.

( More politics stories )