* "Pay czar" approved all 18 pay raises sought by companies
* Watchdog: No resistance from pay czar on company requests
* Special Master says pay is down from pre-TARP levels
WASHINGTON, Jan 28 (Reuters) - The U.S. Treasury Department in 2012 failed to curb executive pay at companies rescued with taxpayer funds, the second straight year that it did not live up to its own rules, an internal watchdog said on Monday.
The inspector general for the government's bailout program had harsh words for Treasury's Office of the Special Master, the "pay czar" charged with setting compensation for companies that received rescue funds during the financial crisis.
"While taxpayers struggle to overcome the recent financial crisis and look to the U.S. government to put a lid on compensation for executives of firms whose missteps nearly crippled the U.S. financial system, the U.S. Department of the Treasury continues to allow excessive executive pay," the report said.
In 2012, the pay czar acceded to company requests in approving multi-million-dollar pay packages and pay hikes for top executives at General Motors, AIG and Ally Financial.
The Special Master approved all 18 pay raises requested by the companies, for a total of $6.2 million, and approved pay packages of at least $1 million for 68 of the 69 employees at the companies it was overseeing, the report found.
The government's Troubled Asset Relief Program, known as TARP, had pumped $68 billion into AIG, $50 billion in GM and $17 billion in Ally Financial, among others, to save them from collapse during the 2007-2009 crisis.
The special inspector general, Christy Romero, said it was not surprising companies asked for large pay packages and higher pay.
"But what we saw in 2012 that is somewhat different than prior years is that this time the companies pushed back on pay, but they seemed to have met no resistance," she said in an interview.
Romero is tasked with overseeing TARP.
In December, the Treasury sold the last of its common stock in insurer AIG and said it plans to sell its remaining shares in automaker GM in the next year or so, leaving Ally as the last major company that still owes money to the government under TARP.
The acting pay czar, Patricia Geoghegan, said her office achieved its mission, cutting average cash compensation for the top 25 executives at bailed-out companies by more than 90 percent from what they were getting prior to the TARP bailout, and cut average total pay by more than 50 percent.
In 2011 and 2012, the office also froze pay for the chief executives of General Motors, AIG and Ally Financial.
In a Jan. 25 letter accompanying the report, Geoghegan said she disagreed with the findings. She said her office "has sought the appropriate balance" between its competing priorities, which include curbing compensation that would encourage risk-taking, but also ensuring that companies remain competitive with their peers and able to repay TARP funds.
Last year, Romero's office found pressure from financial institutions undermined efforts to limit executive pay at bailed-out companies, especially as some Treasury officials were more concerned with getting TARP funds back than in limiting pay.
Romero said the situation has worsened since then. Contrary to recommendations the inspector general made last year, the pay czar's office has not developed procedures for how to decide compensation or when to determine high salaries are warranted.
"Without developing some criteria ... Treasury put itself in a position of essentially letting the companies drive what pay Treasury was approving," she said.
Under the rules governing pay for TARP recipients, cash salaries are supposed to rarely exceed $500,000. But in 2012, 23 of the 69 top executives at TARP recipients had cash salaries exceeding that level, a number that has quadrupled since 2009, the report said. And 94 percent received cash compensation of $450,000 or more.
'A LITTLE EXTRA'
Romero said in one situation, the Treasury approved a pay raise of $50,000 for one GM employee because the company wanted to "do a little extra for him."
"This shows the complete lack of appreciation that GM has for the fact that they're owned by taxpayers, and that Americans are in tight budgets and don't have any extra" funds, she said.
In another case, the pay czar approved a $200,000 pay raise for an employee of Residential Capital LLC, the bankrupt mortgage lending unit of Ally, despite knowing the unit was about to go bankrupt.
In response to the report, GM and Ally Financial both said they have complied with all TARP restrictions. Ally said it was focused on repaying all remaining Treasury funds.
Romero said the government's pay curbs were unlikely to have a lasting impact.
The report found it likely AIG will return to its "past practices" in setting high executive compensation now that it has repaid the government's TARP funds.
"The responsibility shifts to the Federal Reserve Board to ensure that AIG does not encourage excessive risk-taking through compensation," the report said.
AIG spokesman Jon Diat said the company is currently examining what portion of total employee pay should be tied to incentives, reflecting "our absolute commitment to pay for performance in a post-TARP environment."