naked capitalism

The most interesting aspect of the latest stage of the tempest-in-a-teapot over now famous Phibro trader Andrew Hall’s contract. which could reap him as much as $100 million in 2009, is that Citi appears to be girding itself for a fight with the government over it. This stance suggests several possibilities, which by the way are not mutually exclusive:

Citi is going to fight every and all pay restrictions on general principle

Citi is really dependent on Hall’s earnings, which means the rest of the bank is much weaker and more badly managed than even cynics think

Citi is willing to negotiate a spin-out of Hall, but if the government intervenes, Citi’s negotiating posture will be weakened considerably.

Now of course, this list does serve to highlight the complete and utter lack of concern that the big bank has for propriety and social responsibility (although at this point, it verges on belaboring the obvious). The government should be backstopping ONLY critical banking functions, not proprietary trading, and particularly not in a the oil market. Oil has a proud history of price manipulation, as demonstrated by the fact that OPEC moved away from pricing its contracts based on spot prices, which were gamed, to a weighted average of future prices. Even the CFTC has come to the view that speculation can and has influenced oil prices.

The reason the government continues to behave in a schizophrenic fashion, getting tough on issues that are largely symbolic, is that the public has increasingly caught on that it is being had, that we all are paying tremendous subsidies to keep the financial system intact, with nary a demand made of bankers: no requirement that they renegotiate debt, no shared suffering by bank bondholders, who are supposed to be risk capital, no restrictions on risk taking. The rationale for saving the banks is that they are crucial to the economy.

With such extensive safety nets, there are ONLY two approaches that make sense. Either figure out a way to let banks fail, even very big ones, or treat them like utilities, with extensive controls over how they operate. But since a big bank failure could not be resolved overnight, and it also could not be permitted to collapse, that means the authorities would need to be willing to take it over and wind it down. But that looks like nationalization, and we don’t do that in America.

But it seems we aren’t wiling to get tough with bankers either. Geithner is able to work up a rage as far as Shiela Bair is concerned, but when he calls the banks in and chews them out over their failure to do loan moss, no one takes him all that seriously. Yes, the bankers will go back and cranks up the volumes to look like they are complying, but since they make far more off the current system, expect continued foot dragging and procedures designed to produce mods that will fail.

And from Citi’s standpoint, $100 million for Hall is a screaming bargain. After all, they paid $800 million to secure CEO Vikram Pandit’s services, and what do they have to show for that?

Oh, and to clarify my earlier remarks on Hall’s contract, I said that the normal procedure was to go over the employee’s conduct with a fine tooth comb. Why? Even f Hall’s contract does not have a clause discussing termination for cause, violating written company policy is considered a contract violation. For instance, Hall probably has signing authority for expenses of his unit up to a certain level, and probably approves routine staff expenses. He’d thus be responsible not just for his own activities but also those of his team. And far more often than not, the risk-seeking big producer types push the envelope on company guidelines. Trust me, if Citi wanted Hall out. they can probably find contract violations if they looked hard (or maybe even not hard at all). They are making it abundantly clear they are not playing ball on this one.

Also notice some reporting differences between the New York Times, Reuters, and the Wall Street Journal. First, the Times:

Citigroup is planning to claim that an energy trader who is due to receive compensation of $100 million this year should be exempt from review by a federal authority given responsibility for setting pay packages at financial companies that received taxpayer bailouts, executives at the bank said Wednesday.

Such a claim would come as the Obama administration is set to begin examining the pay packages and, if accepted, could set off a new wave of criticism from the administration and from lawmakers already incensed over recent Wall Street pay packages.

Citigroup executives say the trader’s compensation is exempt because it is part of a contract signed before the law establishing the review system was passed….

In recent discussions with senior executives at Citigroup, which has received $45 billion in taxpayer assistance, Treasury officials sent signals that they would almost certainly reject Mr. Hall’s proposed pay package as excessive….

The law establishing the review, passed on Feb. 11, provides that employment contracts signed before that date are exempt from review if the Treasury secretary concludes that they are valid contracts….

The companies that are required to seek approval of pay packages have until Friday to file proposed employment contracts for their 25 top executives and highest paid employees. Mr. Feinberg then has 60 days to determine whether to accept them. While he cannot reject Mr. Hall’s contract if it was signed before Feb. 11, he has the authority to issue advisory opinions, which while not carrying legal weight could have significant political clout with Congress.

So the Times spends the two third of the article discussing Citi’s posture, and in the last 1/3 mentions the legal stipulations and indicates strongly that Feinberg has no authority to break the contract.

By contrast, Reuters goes straight to whether Citi’s stance is correct, and suggests things are not that clear cut:
Citigroup Inc’s contract with an energy trader who may be owed up to $100 million in compensation this year is exempt from

rulings by the Obama administration’s pay czar, a source close to the bank said on Wednesday.

While pay czar Kenneth Feinberg has authority over Citi’s 100 top-paid employees’ — and Hall surely ranks among those — the source said Hall’s contract will be exempt from review because it was signed before a cut-off date of February 11, 2009.

But not everyone who has examined the issue agrees that trader Andrew Hall’s contract will escape scrutiny. A separate source familiar with the matter told Reuters Feinberg will have flexibility in applying his authority on a case-by-case basis, potentially impacting future outsized payments to employees.

As the debate raged over what power the pay czar will possess, two leading U.S. lawmakers warned on Wednesday of signs that companies bailed out by taxpayers were resuming risky pay practices and urged the Obama administration to act on limiting bonuses.

The Journal says Citi and Hall are trying to structure a deal to improve its optics this year and reduce his upside next year:

Energy trader Andrew J. Hall has proposed to Citigroup Inc. that it modify his contract in a way that would avert a potential confrontation with the Obama administration’s pay czar but likely cut his cash payout next year, according to people familiar with the situation.

The discussions include converting a substantial chunk of Mr. Hall’s compensation for 2010 to equity from cash, these people said. A deal wouldn’t affect the head of Citigroup energy-trading unit Phibro LLC’s ability to collect as much as $100 million for this year, but it would expose him to the risk that his compensation suffers next year….

Mr. Feinberg can’t reject existing contracts like Mr. Hall’s, but he can prod companies to renegotiate payments he deems excessive. If that doesn’t work, he is expected to reduce future compensation to adjust for the contractual amount.

The energy trader is considering an appeal to Mr. Feinberg with a letter that would include details about the huge profits Phibro has generated for Citigroup compared with the capital it uses and the unit’s independence from parts of the financial giant that have generated massive losses since the credit crisis erupted, these people said.

Note two elements of this angle. One, if Hall is willing to accept a meaningful reduction in his deal (as opposed to cosmetic, which this may well be) it says the idea he can get as good a deal elsewhere is exaggerated. Second, the letter makes clear his business is non-core. These banks simply refuse to accept the basic concept: if Hall is at Citi, he benefits from a government backstop, and the state cannot afford to throw safety nets under high risk ventures. The state should backstop only essential financial functions.

One could say we will see soon enough, but given Team Obama’s bank friendly stance, they are unlikely to be serious about fighting this fight. Look for them to find an excuse to declare victory and decamp. I’d bet the efforts to craft a deal that allow the Feds to act like they prevailed, even if the economic substance is largely intact, will be hailed as success.

And in an amusing related story, the Financial Times reports that the FDIC has sent Citi to the woodshed and is making the bank hire a HR consultant to assess whether management is up to snuff, a non-uncommon demand for troubled institutions.