A bill to block multi-million dollar executive pay packages at government-owned Fannie Mae and Freddie Mac moved forward on Tuesday even as their regulator defended them as needed to retain top talent and limit taxpayer losses.

The House of Representatives Financial Services Committee approved the legislation 52-4, clearing it for consideration by the full House for a vote. A similar measure has been introduced in the Senate.

Lawmakers from both parties have expressed shock at revelations the two mortgage finance firms, which have been propped up with about $169 billion in government aid, were paying out $12.79 million in bonuses for ten executives.

"The taxpayer-funded bailout of Fannie Mae and Freddie Mac is the biggest bailout in history," said Representative Spencer Bachus of Alabama, the chairman of the House panel. "Adding insult to injury, the top executives of these failed companies receive multi-million dollar pay packages."

Edward DeMarco, acting director of the Federal Housing Finance Agency, tried to parry the congressional critics, saying a better idea would be to push compensation lower over time.

"At the present, my plan for executive compensation is to continue to seek opportunities for gradual reductions, particularly when executives leave," he told a Senate Banking Committee hearing.

DeMarco said the firms, the top two providers of funding for U.S. mortgages, needed to be able to compete with other financial service companies for highly skilled employees.

"We have an entire competitive marketplace in the industry that suggests compensation is an important factor in attracting and retaining top talent," he said.

PUTTING A CAP ON IT

The House bill would suspend the 2011 pay packages for Fannie Mae and Freddie Mac executives. Instead, the FHFA would be required to come up with a compensation system for executives that is based on a government pay scale.

The committee adopted an amendment that would use the pay scale that applies to independent financial regulators, such as the Federal Deposit Insurance Corp, which allows for higher pay than at most federal agencies.

Rep. Al Green, who offered the amendment, said this would have the effect of limiting the highest salaries to about $260,000 per year.

Senate Banking Committee Chairman Tim Johnson, a South Dakota Democrat, expressed concern legislation to place employees at the two companies on the government pay scale might do more harm than good.

"I fear that the federal pay scale will chase away the knowledgeable people we have and rely on to do a great job in a highly complex situation," he told Reuters.

But the top Republican on the Senate committee, Richard Shelby of Alabama, made clear his discomfort with taxpayers footing the bill.

"The American taxpayer should not have to subsidize million-dollar compensation packages for Fannie and Freddie executives," Shelby said at the Banking Committee hearing. "This is just another example of the flawed structure" of the two government-sponsored enterprises.

Fannie Mae and Freddie Mac were taken over by the government in 2008 as soured home loans threatened insolvency. Given the central role they play in the U.S. mortgage system, the Treasury offered them an unlimited credit line through next year to protect the already battered housing sector.

DeMarco told the Senate committee any changes in pay should not be a "sudden shock" and said the best way to reduce compensation would be for lawmakers and the Obama administration to decide on the future structure of housing finance.

Both the administration and Republican lawmakers want to eventually wind down the two firms.

"Then we could have a final resolution of Fannie Mae and Freddie Mac in conservatorship, which would resolve the compensation issue once and for all," DeMarco said.

The pay packages approved by their regulator have followed the same pattern over the last few years. The bulk of the pay is set by the boards of Fannie Mae and Freddie Mac and approved by FHFA in consultation with the Treasury Department.