Citigroup (C, news, msgs) is increasing base salaries by up to 50% this year, and the company's plans have reignited public furor over outsized compensation at financial-services companies.
The reaction is no surprise. For all the talk of needing to change employee compensation to better reflect performance, a main driver of government regulation was Main Street's sheer disgust at seeing millions in taxpayer dollars flow to so-called high performers at failing companies.
But, putting aside the anger over whether Citigroup should raise salaries, let us focus on another, more-pressing question: How can it afford to?
Citigroup says it can because it's not increasing the amount it pays its employees overall, just the way they are compensated. Folks who see their salaries increase will qualify for much smaller year-end bonuses.
"Any salary adjustments are not intended to increase total annual compensation, rather to adjust the balance between fixed and variable compensation," said Citigroup spokesman Alexander Samuelson.
- Talk back: Should Citi be raising salaries now?
Other than the obvious goal of quelling public criticism over bonuses, salary increases should also temper employee appetites for taking huge risks in hopes of earning large bonuses. Historically, investment bankers could earn bonuses that were even bigger than their salaries, a system that many claim encouraged excessive risk taking.
"I think compensation needs to reflect sound risk management, and this structure is a way to engender more long-term thinking rather than just annual thinking," said Samuelson.
That makes logical sense. But there is a flip side to raising salaries instead of awarding large bonuses. Bonuses can be sliced and even cut out entirely during bad times. Salaries can't. That raises the question of what happens to Citigroup if its loan losses are greater than expected and it needs to move money around at the end of the year. It won't have the same flexibility with employee pay. Will it fire employees? Or will it, perhaps, ask the government for another loan?
Some analysts have questioned whether Citigroup is keeping adequate reserves. The company absorbed $7.3 billion in bad loans during its quarter that ended in April and has set aside $2.7 billion to cover additional losses. In May, Citigroup saw defaults on credit card debt rise to a record 10.5%. That number could rise as unemployment continues to climb, costing the bank additional billions.
Samuelson insists that the bank is sufficiently capitalized for this not to be an issue. The company will convert $58 billion of preferred stock into common shares and exchange $25 billion of its government preferred shares into preferred securities. The stock conversion could increase common equity up to $61 billion, giving the bank a substantial financial cushion.
"Following completion of the exchange offers, Citi will be among the best capitalized banks in the world," said CEO Vikram Pandit in a June 10 statement. "Our employees have worked tirelessly to get Citi fit by taking control of our balance sheet and expenses."
It's difficult to believe that President Barack Obama's administration would allow Citi to make a move that could put its financial stability at risk. The government -- which now owns a 34% stake in Citigroup thanks to a $45 billion bailout -- likely knew of the plan.
Earlier this month, the Obama administration appointed Kenneth Feinberg as its special master to review compensation at companies that received government funds. Feinberg has the authority to set compensation for the 100 highest-paid employees at troubled companies like Citigroup. But he has no power to set compensation for Citigroup's 300,000 other employees.