Revamping traders’ pay

July 27, 2009

Roger Ehrenberg has a much-linked-to piece about how Wall Street banks might revamp the way they pay their traders: basically, he says, turn them into fund managers, with a large ownership stake in their virtual funds.

The main problem with this, that I see, is that a Wall Street investment bank has lots of very good traders, and they never all have big bets on at the same time. When one desk wants to put on a big trade, it generally needs to make a case for putting at risk a large amount of the bank’s capital. But the capital doesn’t then belong to that desk in perpetuity: it lasts only as long as the trade does. So capital is always flowing to where it can best be put to use. That’s how a bank’s prop traders, as a group, can often make much more money than any given trader or desk could on their own.

Under Ehrenberg’s scheme, I think, that flow of capital from desk to desk would be seriously diminished, since the whole point of his plan is that traders get to compound their profits after they’ve made them.

I’m also not a great fan of Ehrenberg’s “sanctity of contracts” argument in favor of Citigroup paying Andrew Hall $100 million this year. (For the reasons why it shouldn’t, see Yves Smith.) Hall’s contract would be worth bupkis if Citi had gone bankrupt; the only reason it didn’t was that the US government bailed it out. So if the US government wants to call some shots here, it can. Sure, Hall can sue if he wants, and he might even win. But depending on how the negotiations go between Hall and Citi, it’s probable that he won’t.


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