Traders and compensation -- set those traders free!

What's going to happen to Citi?  That seems to be a question that's coming up a lot lately.  A story in today's NY Times talks about how Citi will soon be the last of the government-rescued big banks to pay back the Fed, and quotes Chris Whalen as saying “Citi needs to focus on solvency and asset sales,"...:"They shouldn’t even worry about repaying TARP.”  (Tend to think he's pretty dead on here, but that's not the topic ;)  The article then goes on to haul out the "industry standard" that the world is going to melt down for the Citi trading desk unless they get the government out of there, and, most importantly, ensure that there are no limits on their traders' compensation --

Inside Citigroup’s Lower Manhattan offices, traders were resigned to the idea that Citigroup remained tied to the government, but they acknowledged the intense pressure on Mr. Pandit to pay back the bailout money quickly. Citigroup board members have moved TARP repayment to the top of the bank’s priority list. (emphasis added)

But time is running out. Several Citigroup traders, who were not authorized to speak publicly, said they expected most of their colleagues to remain at Citi until they received their bonuses early next year. If a TARP payback plan is not place by March, some predicted an exodus to rival banks where pay is not subject to government restrictions.

The above at least implied that Citi's board feels that it will not be competitive if there are limits on its traders compensation -- all of the traders will -- GASP! take their bonus and go home if they aren't permitted unlimited upsides.  Clearly, as a bank, when you're having trouble making money on your core business, you need to protect your legal betting business.  And the only way to do that is get the meanest, hungriest, slickest, most experienced, hard to find, super valuable star traders out there and give them minimal supervision, right?


At least, that's the gist of the argument. And it always seems to be worse for Citi -- they keep getting themselves into messes requiring government help -- this is by no means that first time the US taxpayer has donated to the cause of keeping Citi  or it's predecessors alive.  But there's something really wrong with the fundamental argument in the first place -- the world doesn't work that way anymore, if it ever did.
Let's make a list of some of the things that have changed over the past 10-20 years, specifically related to global securities trading and more specifically to who does the job(s) on the trading desk:

• Asset class specialization has set in -- there's more desks out there, for more types of products.
• Global trading has opened up opportunities for the best, brightest, most competitive, and, sometimes less scrupulous from all over the world -- NY and London can no longer claim to be the habitats of 90+% of those who know how to play the game.
• There's really, globally, at most 100 global banks competing for the supply of traders who can thrive in a bank.  Realistically, there's only about 50 of them.
  
• The hedge fund industry is the place where the hot traders go -- if they're really all that, they're not hanging around on a bank trading desk.  The corollary of this one is that the banks function as learning centers or training grounds for traders, and not the end game.
• Trading for house accounts is consistently screwing up the banks -- and occasionally bailing them out from poor quarters.

The last point strikes me as the one where the board's attention should be focused.  Is it really the business model here to lose money everywhere else and hope that the asset management part of the business can bail out the balance sheet, while taking on extremely hard to measure (or understand, at times) risks?  Sounds pretty strange for a business that is funded primarily by depositors.  Certainly haven't seen that business model being vetted about the same way "originate to distribute" was.

So it seems to me a pretty simple solution for the board -- fix the core businesses, make sure you know where your risks are and where your profits come from, and set your traders free ...