Stephen Foley: Time to put the brakes on Citigroup

US Outlook: Vikram Pandit, Citigroup's chief executive, has spent the past week lashing a horse to the back of a cart and trying to persuade everyone that he's created a roadworthy vehicle.

In trying to pay back the government's bailout money before Citigroup has cut itself down to manageable size, before the US economy is unequivocally out of the woods, and before its shares have recovered substantially, the bank is doing things in the wrong order. To over-extend the cart-before-the-horse metaphor, if Mr Pandit is allowed to gallop off, he will endanger himself and other road users.

This is the big one, the one that the US Treasury really has to get right. It simply cannot bail out Citigroup again. There would be uproar in Congress, if not riots in the streets. The government should stop him, and his shareholders should stop him.

Mr Pandit's eagerness to get himself out from under the thumb of government is understandable enough on a human level. Mr Pandit has been working for a dollar a year while the company works through the consequences of its enormous follies in sub-prime mortgages, and the Obama administration's pay tsar, Ken Feinberg, is making demands that will restrict the riches he and his top lieutenants can make for as long as taxpayer money is on the line.

It must be particularly galling when his former colleagues at Old Lane, the hedge fund he sold to Citigroup in 2007, are once again setting up on their own in the hopes of earning a second fortune.

The chief executive also has a particularly frosty relationship with Sheila Bair of the Federal Deposit Insurance Corporation, one of Citigroup's most powerful regulators. She spent the summer trying to force him out of his job, claiming he was not moving fast enough to slim the bank, sell off assets, reduce leverage and put its finances on sounder footings.

None of these reasons add up to a good business argument. That case, such as it is, is based on two things. First, there is the issue of compensation, which dominates employees' minds at this time of year, as bonuses are decided. Mr Feinberg has jurisdiction over the top 100 best-paid employees, and Mr Pandit is worried they will be lured away by rivals.

Second, Citigroup's closest rival, Bank of America, made its exit from the bailout scheme this week. Two was company. Jamie Dimon of JPMorgan Chase called the bailout a "scarlet letter", and Citigroup worries that its status as the lone double-bailout bank could scare off potential clients.

It's difficult to see why this is more pressing now than it was a fortnight ago, before BofA's move stung Mr Pandit into action. Citigroup will earn its clients' business, if it deserves it, in the myriad ways that bankers always do, through price competitiveness and ability to execute. Mr Feinberg's strictures don't go down into the heart of the employee base. The relevance of the government's stake is more marginal than usually claimed.

In any case, the situation is much more complicated than at BofA, and it is not realistic to expect that the government can take one single step that ends its relationship with Citigroup and frees Mr Pandit. As Citigroup's finances were so shot, the government converted $25bn of its $45bn injection into shares, which will almost certainly have to be sold into the market over time. There is also an outstanding government guarantee on a little over $300bn of the bank's most toxic assets, the sliced and diced sub-prime mortgages and leveraged buyout loans of infamy.

As the economy recovers it seems unlikely that taxpayers will now be on the hook for these, but we can't be sure. The stress tests of earlier this year assumed what now seems an optimistic level of unemployment, so defaults could still cause problems for Citi both inside that portfolio and in its wider lending activities for years to come. Although Citigroup's capital levels are higher than other banks, its assets are riskier. Until a double-dip recession is off the table, the government should not gamble by removing its safety net, at least not until Congress sets up the new "resolution authority" to allow for orderly wind-down of banks deemed too big to fail.

One hopes that the sheer complexities of Citigroup's relationship with the government mean Mr Pandit will have to wait, but shareholders ought to be putting similar pressure on him to wait. BofA paid a hefty price to exit the bailout scheme, with shareholders diluted by 10 per cent in the fundraising needed to pay for the return of taxpayer funds. The dilution at Citigroup from issuing new shares comes on top of the overhang of the government's 34 per cent stake, which will keep a lid on the share price until it is divested. Better to wait until the economy is healthier, defaults have come down and Citigroup's anaemic earnings have picked up, so that the dilution might be much less.

Look at it this way. Mr Pandit is basically asking for permission to dilute shareholders and risk the financial system so he can pay a cadre of top executives more in the short term. He is flogging a dead horse.