Worrying About Bailout Banks' Brain Drain

For the past year, the bailout banks have been complaining that the compensation restraints that came along with their acceptance of government aid would cause their best employees to flee to greener pastures. Although we've begun to see some repots of that, Bloomberg has a more tangible one, explaining who some of the major beneficiaries have been: Barclays and Nomura. I don't think we can be particularly surprised, but should we care?

First, here's what Bloomberg is reporting:

Barclays Plc and Nomura Holdings Inc., which never ranked among the top 10 merger advisers worldwide in the past decade, are luring hundreds of bankers as competitors cut jobs and cap bonuses under government pressure.

The banks are expanding globally after they bought parts of Lehman Brothers Holdings Inc. out of bankruptcy last year. Barclays, which acquired Lehman's U.S. unit, plans to hire more than 30 bankers in Europe for its mergers advisory business and has hired about 750 people for European and Asian equities this year. Nomura, which bought Lehman's European arm, has increased its U.S. workforce by about 36 percent since March and this week hired former Goldman Sachs Group Inc. currency strategist Jens Nordvig, 35.

The article goes on to explain that some significant bankers from Bank of America and Citi have also been poached. It's interesting to note, however, that these two firms are even going after bankers from healthier banks like Goldman. Obviously, they will have a much easier time luring talent away from bailout banks that can't pay their employees what others can.

My first reaction to news like this is: so what? If banks like Citi and Bank of America deserved to fail, who cares if bankers and traders leave? After all, they would have anyway if the companies didn't survive.

The problem is that the government saved them. As a result, taxpayers are stuck with the bill that will result if they do, ultimately, fail. But Washington clearly has no intention of lifting its compensation restraints. Indeed, they're as strict as ever. That leaves taxpayers in a precarious situation, since the more talent that departs, the less likely they'll get their money back.

This raises an important problem with bailouts: if you're going to play the game, you have to play by the rules of the industry you bail out. Otherwise, the bailouts can't be fully successful. If you don't allow banks to pay their employees what the market demands, then those firms won't be able to compete.

Now I'm not saying that the government compensation requirements aren't sensible for a variety of reasons -- they are. But you can't realistically expect Citi or Bank of America to retain investment banking talent with the current restraints in place.

The solution? Well, there might not be one. The public will, rightly, get their pitchforks out if Uncle Sam starts letting these firms pay their bankers seven-figure bonuses again. Meanwhile, more talent leaves with each day the banks remain under the government's watchful eye.

My suggestion would be to wind down or sell the investment banking arms of these institutions and turn them into just retail banks. Even under current pay restraints, those firms would be able to retain most of the talent necessary to compete in that sphere, especially given their existing dominance of the retail market. That's the strategy the government should encourage to ensure that taxpayers get as much as they can from these institutions.